Analysis-Azul-Gol airline merger could be a ‘necessary evil’ in Brazil’s uneven market Reuters

By Patricia Vilas Boas and Kylie Madry

SAO PAULO (Reuters) – A plan to merge Brazil’s top two airlines to create a dominant carrier is likely to win regulatory approval as the government’s push for a financially healthy sector outweighs concerns about limited competition, experts and lawyers told Reuters.

The proposed combination of Gol and Azul, formalized in a memorandum of understanding last week, would give the new company enormous control over the country’s domestic market.

But both have faced financial turbulence since the pandemic, along with currently Brazil’s No. 1 carrier, local unit LATAM Airlines (NYSE: ). Costs remain high and air travel remains limited in Latin America’s largest country and economy.

A cocktail of factors – and the support of President Luis Inacio Lula da Silva’s administration – means that the merger process, while likely to face some pushback, is likely to continue.

“You have to think about the impact (of the merger) in the context of what the alternative is,” said Andre Castellini, senior partner at Bain & Company. – It is a necessary evil.

THUMBS UP FROM THE PIPE OFFICIALS

Airlines in Brazil have been hit by high taxes, tough consumer protections and are facing problems due to the recent weakening of the Brazilian real against the US dollar – which is used for costs such as jet fuel and aircraft leases – Nicole Villa said. , a lawyer specializing in aviation law.

Lula’s administration promised support for the airlines, as Azul had to restructure its debt with bondholders and contract with suppliers, and with Gol currently in Chapter 11 bankruptcy proceedings in the United States.

Gol and Azul probably “got that thumbs up from the government and they see a real possibility (of approving the merger),” said lawyer Xavier Rosales.

Ports and Airports Minister Silvio Costa Filho told reporters last week that the merger could be positive.

“The worse case scenario would be for companies to go bankrupt,” he said.

Given the current demand for travel in Brazil, only two airlines are needed to operate in the country, Seaport Research Partners analysts said in a note.

If the merger is blocked, the domestic market could shrink even more, Castellini and Villa said.

“Azul was already reducing his net,” Castellini said.

Azul CEO John Rodgerson told Reuters the airline had cut some routes due to the weakening real, a measure he described as “normal”.

“Without (CADE) approval, the market may not be as big as with the (merger) approval,” he said, although he dismissed concerns that Azul would have to downsize if the Gol deal doesn’t go through.

OPPOSITION, PROBABLE CONCESSIONS

Still, the merger “will not be an easy process,” Rosales said, with LATAM likely to oppose the deal and competition regulator CADE ruling that the carriers will give up flight frequencies and time slots at busy airports.

LATAM declined to comment on the matter.

Golo and Azul flights at Brazil’s biggest airports are likely to be on the board, Castellini said, adding that LATAM could take over some of those operations. Internationally, routes to and from Miami will likely be scrutinized, Rosales said.

But LATAM would also have to prove it has the capacity to provide the additional service, according to Villa.

GOOD FOR COMPETITION?

Despite the weight the merger will give Gol and Azul, the deal could ultimately present opportunities for competitors, analysts say.

Much of the market remains untapped in a country as large as Brazil, Villa said.

LATAM has the “critical mass” to remain competitive and could even benefit in the short term from the disruption the merger would present to Gol and Azul, Castellini said.

In the years after the merger, the new airline may also lack the agility to make aggressive expansion plans, analysts at Santander (BME: ) wrote in a note to clients.

Excluding Gol’s Chapter 11 filing, which is expected to be completed by May, the merger could close “in a little more than a year,” Rosales said. “There is a real chance of success here.”