Merger of Avianca and Taca reshapes Latin American aviation

In October 2009, Grupo Taca Holdings and the Synergy Group announced their plans to merge and create a new company, “Avianca-Taca Ltd.” In February 2010, the two companies received the regulatory and antitrust approvals to merge. Grupo Synergy owns 67% and Group Taca Holdings 33% of the new holding company.

With revenues of US$3 billion, the combined airline serves 100 destinations—75 of which are in Latin America. The airline carries around 15.4 million passengers with hubs in El Salvador, Costa Rica, Colombia and Peru.

The new company benefits from geographic diversity and a larger network that provides new revenue opportunities. Its leaders have identified growth in north-south traffic and flights to Europe as opportunities. It is also leveraging its scale to cut costs with suppliers. There are also fleet synergies to be had since both use A319s and A320s as their main aircraft. In 2007, Grupo Synergy placed orders for 100 planes, which now can be distributed across the wider network as they are delivered.

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Increased competition

Although the leaders of Avianca-Taca Ltd stated that they were not looking for a fight with the major Latin American carriers, their merger does create a stronger competitor that may result in market share battles if capacity outpaces demand growth dramatically. Euromonitor investigates the merger’s implications in the various markets.

Panama: Copa to remain dominant on international routes

In Panama, Taca’s regional brand has split the domestic market with Air Panama. The merger is not likely to impact this market as both have a comfortable duopoly. However, the merger could pose a risk to Panama’s Copa Airlines, which uses the Tocumen Airport as its international “Hub of Americas.” Copa Airlines accounts for 56% of arriving and departing passengers from Tocumen, but more importantly, it flew 1.7 million transit passengers in 2009—96% of the transit total. In Avianca-Taca’s bid for more north-south traffic, the airline could reduce fares into its competing hubs in San Salvador and Bogota to steal share from Copa at Tocumen.

This is an unlikely scenario. These hubs are at high altitudes and are subject to more volatile weather whereas Tocumen is at sea level and has a better geographic position, not to mention recent renovations. Fare discounts are not likely to sway passengers to switch their routes and instead, Avianca-Taca will have to rely on new routes to stimulate growth.

Copa, in fact, will remain a strong competitor for north-south traffic as the expansion of Tocumen finishes in the early summer of 2011. There will be an additional 12 international gates for a total of 34, so Copa will be able to add even more destinations.

Colombia: Hyper-competitive market

In Colombia, Avianca-Taca will continue to compete directly against Copa Airlines through their subsidiaries. Avianca-Taca owns Avianca and SAM while Aero República is a wholly owned subsidiary of Copa.

The merger is not expected to significantly change the dynamics of the Colombian air market. However, the cost savings may allow Avianca to pad its margins a bit and the airline can now align its international routes from Bogota with the airlines’ subsidiaries in other countries. This fits into its overall strategy to make Bogota an international hub. However, both carriers have to contend with the entrance of low cost carriers into the market.

The Colombian airline, Aires, had operated as a regional carrier serving small routes with turboprops, but launched the low cost model on the most popular routes in early 2009. The airline caused air fares to drop by 20% in some cases, which was the main driver for the 13% total market growth for domestic passengers in 2009.

Aero República pursued a strategy to match the lower fares while Avianca retained its pricing. As a result, Aero República saw 14% growth in domestic passengers while Avianca experienced a meager 0.8% growth. Aero República has reported that although the decline in fares has stimulated traffic, it has not been enough to offset the lower fares.

Aires is also flying internationally and aims to continue that expansion. It already flies to the US, Panama, and the Caribbean although its share of international passengers was 1.4% in 2009. It joined US-based low cost carriers, JetBlue and Spirit Airlines, on the international routes to the US. Combined, these three low cost carriers accounted for 13% of international passengers on routes to the US—not an insignificant share.

Their presence pressure fares on their routes and solely impacts Avianca as Aero República does not fly to the US.

To make the Colombia even more competitive, LAN Airlines announced in May 2010 that it had an agreement with the Colombian airline, Aeroasis, to help Aeroasis obtain an operating permit from the Colombian Civil Aviation Authority.

Once Aeroasis has its permit, it will likely become part of LAN Airlines. It is uncertain if the Colombian market is large enough to sustain the current three (Avianca/SAM, Aero República, Aires). The addition of LAN will add greater competition and likely keep fares low.

Without deep pockets, Aires is likely to exit the competitive market and may even be forced to exit before LAN enters. Either way, the Colombian air market, especially the domestic market, is expected to be extremely competitive for the next three to five years, resulting in high capacity growth, low fares and strong passenger growth.

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Peru: LAN Airlines’ stronghold

With the merger, Avianca now has a domestic presence in the Peruvian domestic air market through the Taca-Peru subsidiary.

However, LAN Airlines, which began operating in that market in 1999, has built a commanding lead, carrying over 90% of domestic passengers in 2009. While it is likely that Taca will continue to expand within the domestic market, especially given Avianca’s large plane order, it will have a minimal impact on LAN. Undercutting LAN on price would not be a wise strategy as the company would surely match the prices to defend its turf, igniting a fare war.

This could create a situation similar to that of Colombia, where the volume increases do not offset the price decreases and revenues suffer. Consumers would be the main beneficiary of this strategy.

On the international front, LAN continues to build Lima as an international hub and controls over 40% of passenger traffic. Again, it will be difficult for Avianca-Taca to break this control significantly but the company will benefit from the ability to coordinate international flights among its subsidiaries.

Although LAN’s dominance in Peru is assured, it is still a key market for Avianca-Taca because it offers geographic diversification. Additionally, Peru is a fast-growing air market thanks to the country’s strong economic growth and international promotion. There is still room to grow organically in Peru for Avianca-Taca without stepping on LAN’s toes. However, if the company decides to pursue an aggressive strategy, competition in the market could heat up.

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In Ecuador, Avianca-Taca acquired Aerogal officially in February 2010 and began codesharing between Avianca and Aerogal in March 2010. Aerogal is the second largest player in the Ecuadorian domestic market of 3.3 million passengers—TAME is the leader.

However, the arrival of LAN Airlines’ domestic operation in April 2009 made the market extremely competitive. By November 2009, LAN Airlines had a share of 16% of domestic passengers. As a result, it may be a more difficult to grow within this market, but the value lies in the geographic diversity and the organic growth of the market in the long term.

The combination of Aerogal and Avianca-Taca leads to a strong second-place contender against LAN’s leadership in the international market for Ecuador. At 2.6 million passengers, though, it is smaller than both Colombia and Peru, so aside from rationalizing the network, opportunities may be limited.

Brazil: An uphill battle or land of opportunity?

In April 2010, Avianca-Taca changed the Brazilian subsidiary’s name from Oceanair to Avianca in a move to strengthen ties between the Colombian brand and the Brazilian operation, especially for international flights. Although the company is in the process of modernizing of the Brazilian fleet, the company faces an uphill battle in Brazil.

TAM and GOL overwhelmingly dominate the market. The main airports in Brazil are operating at capacity and newcomer, low-cost carrier Azul, ignited a fare war, especially in the fall of 2009. However, a presence in the largest market in South America is key—even a small market share translates to large volumes for Avianca-Taca especially compared to its operations in other Latin American countries.

The company plans to end 2010 with 18 planes and 37% more seats than in 2009. The company doesn’t think it will ignite another fare war, hoping that the strong growth in the domestic market will not lead to market share grabs. However, TAM and GOL could respond aggressively to make it difficult for Avianca to gain a significant share of passengers.

The company would prefer to differentiate itself with a better product (hot meals, single television screens, more room). It also has asked for approval to fly internationally with Lima, Colombia and Ecuador cited as potential destinations, where the company has domestic operations to offer a range of destinations.

If the government keeps its promise to expand the airports ahead of hosting the World Cup in 2014 and Olympics in 2016, this could be a huge opportunity to expand the airline. Another option would be to acquire a regional player to bulk up and acquire valuable slots—a strategy used by TAM with Pantanal.

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Chile: The next frontier for Avianca-Taca?

At the ILA Berlin Air Show in June 2010, Germán Efromovich, one of the leaders of Avianca-Taca, revealed that Avianca-Taca is evaluating how to enter the Chilean market, including domestic operations. Chile allows 100% foreign ownership as long as the airline passes certain tests, so Avianca-Taca would be able to create a subsidiary with relative ease.

Currently, Avianca-Taca has a minimal presence in the overall Chilean market, carrying a small fraction of international passengers. As LAN moves to enter Colombia, Avianca-Taca moving into Chile is only fair. Although it is a significantly smaller market, there may be a few more opportunities since the Chilean market isn’t beset by overcapacity and price cutting like the Colombian market. Aerolineas del Sur, which carried 374,000 passengers in 2008, failed. This helped boost passenger traffic for LAN and Sky, which Avianca-Taca may be able to steal. Furthermore, the airline may be able to steal share from Sky, which is a weaker competitor and is not likely to have a comparable amount of resources as Avianca-Taca. However, Sky is strongest on routes from Santiago and the extreme regions of the country, especially the southern cities. These routes are very thin and Avianca-Taca may avoid taking on these risky routes. In all likelihood, Avianca-Taca will compete directly against LAN and this could lead to a decline in fares. LAN has been extremely successful in operating efficiently and stimulating traffic with lower fares (a strategy implemented in 2007). In addition to its 80% share of domestic passenger, it carried 63% of international passengers in 2009. As a result, it has an unrivalled network in Chile, including its oneworld membership. It will be a challenge to unseat LAN from its strong position, but Avianca-Taca is a well managed airline and could heat up the competition in the market. Despite promises not to pick a fight with other carriers, it seems as though Avianca-Taca is aiming for LAN with potentially aggressive moves in Peru and Chile.

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