World's new air giant taking off at turbulent time.

Agenda-Setting Financial Insight.
June 18 2012 4:17 PM

World's New Air Giant Taking Off at Turbulent Time

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Chile’s LAN Airlines is on track to finally consummate its marriage to Brazilian rival TAM this Friday, almost two years after announcing the tie-up.

Photo by KAREN BLEIER/AFP/Getty Images

Get ready for the world’s largest airline to take off this week. But don’t look north or east - the globe’s most valuable carrier is set to be South American. Chile’s LAN Airlines is on track to finally consummate its marriage to Brazilian rival TAM this Friday, almost two years after announcing the tie-up. But the promise of greater regional integration has fueled big expectations that economic headwinds will make difficult to meet. 

Investors eager to buy into a promising Latin America growth story have pushed TAM shares up by more than a third since the deal hit in August 2010. That values the firm at $3.6 billion - a pricey bump for LAN, whose shares have risen by just 10 percent. But at $12.5 billion the combined airline will be worth almost double Ryanair, 50 percent more than Delta and around 15 percent more than Air China. 

The new airline, to be called LATAM, is enticing for several reasons. There’s not much overlap. LAN gets access to Brazil, the region’s largest airline market, while TAM gains from its partner’s far larger cargo business. And LAN is growing fast: executives expect passenger traffic to grow by 14 percent this year. That should boost its already solid performance: LAN cranked out a 16.8 percent EBITDA margin last year, handily surpassing Delta’s 9 percent. 

But economic growth is slowing across Latin America. Brazil’s crowded airline industry is struggling to cut capacity. In fact, TAM’s bosses have already signaled a problem with seat capacity, estimating a 2 percent decline this year in available seat kilometers, a key metric. Meanwhile, LAN’s cargo business is facing increased competition as European rivals redeploy planes from their home markets to a healthier Latin America - the company expects growth in available tonne kilometers to be 5 percent this year, a fifth of its 2010 level. 

Combined, that makes it harder to achieve the sales growth that was supposed to account for most of the $700 million in synergies promised from the deal. LATAM may well start life as the world’s most valuable carrier. But it might not retain the title for long. 

Read more at Reuters Breakingviews.

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Raul Gallegos is the Latin America financial columnist for Reuters Breakingviews. Raul has more than a decade of experience covering the region’s business, finance and economics.

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