Why Delta Air Lines Covets This Not-So-Profitable Latin American Airline

Delta Air Lines shocked travelers and investors late last month by making a major investment in Latam Airlines, a large but marginally profitable South American carrier.

By traditional economic metrics, Delta severely overpaid with its $1.9 billion investment. Its tender offer is priced at $16 per share, or almost 80 percent over Latam's stock price before the announcement.

But some experts agree that even at that price Latam is a significant prize for Delta, and why this is bad news for Latam's previous longtime partner American Airlines. Here's why this may be true.

What is Latam?

Latam is the largest carrier in Latin America, born out of the 2012 merger between Chile’s LAN and Brazil’s TAM. The airline group now operates under a unified brand, but contains a complex network of subsidiaries and separate airlines, including Lan Cargo S.A., Latam Airlines Colombia, Latam Airlines Ecuador, Latam Airlines Argentina, Latam Airlines Peru, Latam Airlines Chile, and Latam Airlines Brazil.

The airline group's CEO, Enrique Cueto, previously made plans to step down on March 31 after spending 25 years at the company. He will be replaced by Chief Commercial Officer Roberto Alvo. The airline has faced financial difficulties in the years since the merger, although it reported a nearly $182 million profit in 2018—the highest yearly result since the merger.

Why is Delta Paying So Much?

Courting Latam is not a cheap date, and Delta knows it.

The airline will pay $16 per share via a public tender offer, which Delta CEO Ed Bastian called a “significant premium” in a Sept. 27 call with analysts.

The next logical question is: Why would Delta want to pay so much? Well, Delta sees an opportunity to expand its network significantly in the fast-growing Latin America market. “Delta’s network is highly complementary to our own,” said Latam Chief Financial Officer Ramiro Alfonsin during a Sept. 27 investor call.

The only overlapping route between the carriers will be Sao Paulo-New York, he said. Delta said that this agreement will put it in the top spot for U.S. market share in five of the six top Latin American markets: Brazil, Argentina, Chile, Peru and Ecuador (the other is Colombia).The two airlines plan to serve 435 destinations globally under the partnership.

“Strategically, it makes sense for Delta, as the partnership will strengthen its network in South America where it had been underrepresented,” Stifel analyst Joseph DeNardi wrote in a Sept. 26 research note, pointing out that Delta lags American, United, and Latam in U.S.-South America capacity.

“Latam's U.S. to South America business is approximately $1.6 billion a year, a revenue pool we've not had meaningful access to historically, and is a big driver of the opportunity for Delta,” Bastian said. Moreover, Delta has an opportunity to grow its frequent-flyer members and its credit “card portfolio,” executives said.

What's the Plan?

As serious couples do, Delta and Latam are planning a future together marked by some short- and long-term objectives. To set up the partnership, Delta is investing $350 million in Latam in addition to what it will pay for a 20 percent stake. The plan is to form a joint venture, in which they likely would share revenues, but the airlines would codeshare first, a development that travelers could see as soon as this year, Bastian told analysts.

The deal will include a few more key elements. Delta will take 14 Airbus A350s from Latam, including four already operating and 10 orders that would be added to its fleet between 2020-25. Delta will also get representation on Latam’s board of directors.

What About Gol?

We can’t have a special connection with everybody—and the same goes for airline partners. So, Delta will be saying so-long to Brazil’s Gol as it plans its future with Latam.

“We will support Gol through an orderly transition,” Bastian said during the conference call. Gol has been a key partner for Delta since the U.S.-based airline invested $100 million in the airline in Dec. 2011, and then boosted its investment again in 2015.

When comparing Gol and Latam’s reach in South America, there is a clear difference—LATAM has a strong footprint throughout the region, whereas Gol’s reach outside Brazil is limited. However, Delta isn’t abandoning the country. “We get some codeshare feed that will certainly be replicated quickly from Latam within Brazil, and with Latam's improved distribution capabilities, we expect to grow that Brazil feed meaningfully going forward,” Bastian said.

What About American?

The Delta-Latam tie-up also will have implications for American, which has a codeshare partnership with Latam. It was even planning to form its own joint venture with the Chilean carrier and its IAG sister airline British Airways. However, Chile’s Supreme Court blocked the partnership due to competitive concerns, even after it had cleared Chile’s competition authority. The airlines had been considering reworking the deal to exclude Chile, but ultimately Latam went another direction.

Delta, on the other hand, said it is not expecting regulatory roadblocks for its own deal, because it is so small in Latin America.

American responded to the news with a message of “business as usual” for customers, announcing that it will continue to accept Latam customers and baggage for now. But it is preparing for changes, and said it has already suspended new codeshare bookings.

“Over the next few months, as we wind down our agreements with Latam that are still intact today, American will work with Latam to ensure all of our customers are taken care of,” the airline said in a media release. When asked if American and Latam would continue to have any agreements at all, codeshare or otherwise, spokesperson Nichelle Barrett said: “It’s too soon to tell, as details are currently being decided.”