Aeromexico, Avianca and LATAM: at what chapter it all went wrong?

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Despite the unparalleled crisis, airline bankruptcies so far have been few and far between. Some bankrupt airlines even received a helping hand – case in point, Virgin Australia that was bought out by Bain Capital. However, in South America, bankruptcy proceedings have become an unfortunate trend even amongst the biggest players. Aeromexico, Avianca (AVHOQ) and LATAM are operating under Chapter 11 bankruptcy proceedings, despite being among the largest airlines in Latin America. What went wrong?

“This is our last chance to survive this crisis. Time is against us and every day that goes by places more agony on an industry that is seeking clarity on timelines to restart operations,” commented International Air Transport Association (IATA)’s regional vice president for the Americas Peter Cerda. On average, tourism accounts for 8.1% of the total Gross Domestic Product in Latin America, accounting for about $298 billion, according to IATA data.

Question of state aid?

It goes without saying that tourism and air travel go together much like peanut butter and jelly does. Take out one and the other is not as tasty anymore. If no tourists can feed air travel money due to international travel restrictions, the latter encounters severe issues. During the current crisis, many airlines were kept alive and well-fed by government aid.

Seemingly, Latin America’s trio of Aeromexico, Avianca (AVHOQ) and LATAM stayed hungry and were forced into Chapter 11 bankruptcy protection. June 30, May 10, and May 26, 2020, respectively, were the dates then three based in Latin America had to write their eleventh chapters, seeking protection from their creditors as they restructured.

At first glance, it could look like it was down to the fact that neither of the three has received state-aid at the time of their bankruptcy. Airlines in other regions have, including CARES Act in the United States or numerous government-backed measures across Europe.

But was this inevitable?

Low-cost domination in Mexico

Aeromexico is the de facto national flag carrier of Mexico. The Mexican government disinvested from the airline in 2007, leaving the airline at the mercy of the public market. Since, the path ahead has been turbulent, to say the least. Aeromexico had to weather the financial crisis of 2008, including the fact that its main competitor, Mexicana, closed operations in August 2010. Nevertheless, the airline kept on operating.

Its competition, namely from low-cost carriers, was growing. The mid-2000s saw several LCCs in Mexico opening up, namely Interjet, VivaAerobus and Volaris. The trio of carriers joined a market that was slowly but steadily growing. If in 2003 there were 18.4 million domestic passengers, the domestic market in Mexico finished 2008 with 27.6 million passengers, according to the Federal Civil Aviation Agency (AFAC) data. 10 years down the line, and the market has gone on to grow massively. In 2018, it was a 49.7 million-strong domestic traveler market.

However, market growth was primarily driven by low-cost carriers. In 2008, Interjet, VivaAerobus and Volaris had a market share of 10.8%, 4.8% and 12.2%, respectively, which grew to 20.5%, 18.4% and 28.4% in 2018. Meanwhile, Aeromexico lost 0.3% of its total market share and was dethroned as the largest airline in Mexico by Volaris in 2018.

Aeromexico stopping momentum

Overall, while domestic passenger numbers grew by 33.5% from 2015 till 2018, throughout the period, Available Seat Kilometers (ASK), measuring capacity, grew by 36.9%. Aeromexico struggled to capture the momentum, as it is now entering a four-year streak of net losses. On the bright side, it always managed to post an operating profit, albeit the operating profit margin has only gone down since 2015. If in 2015 it was 8%, in 2019 the number dropped to 4%. In 2018, Aeromexico barely scraped by with an operating profit margin of 0% and an operating profit of MXP9 million ($443,346).

Outside factors were unfavorable as well for the Mexican airline. The country’s economy slowed down, as Mexico’s Gross Domestic Product (GDP) contracted by 0.3% in Q4 2019, including the fact that the passenger numbers grew only moderately. Aeromexico’s own passenger numbers decreased by 5.4% in 2019 compared to 2018. The pain was further exacerbated by the Boeing 737 MAX grounding in March 2019. At that time, the airline had six 737 MAX aircraft in its fleet and planned to receive an additional eight units, which substantially hindered its future plans.

In January 2020, Aeromexico completed a confidential agreement with Boeing over the compensation of the financial losses related to the grounding.

The airline’s cash reserves were draining. If it started 2018 with MXP11.4 billion (565.4 million), it finished 2019 with MXP9 billion ($446.3 million). As of June 30, 2020, the airline had MXP5.7 billion ($282 million) of cash. Worrisome was the fact that shareholders’ equity, which indicates the residual value of assets after repayment of debts, was at a whopping deficit of MXP21.7 billion ($1 billion). The same day that Q2 2020 ended, on June 30, 2020, Aeromexico filed for Chapter 11 Bankruptcy protection in the United States.

“We expect to utilize the Chapter 11 process to strengthen our financial position, obtain new financing and increase our liquidity, and create a sustainable platform to succeed in an uncertain global economy,” stated the chief executive officer (CEO) of the airline Andres Conesa. The carrier has continued operations while it looks over its finances and operations in order to come out of the bankruptcy intact.

Willing investors

There is no doubt that in addition to restructuring its cost base and operating structure, Aeromexico needed cash to continue flying onwards. It made significant moves regarding its fleet in the meantime.

On July 23, 2020, the company confirmed that the United States Bankruptcy Court for the Southern District of New York allowed the airline to terminate leases for 19 aircraft. Prior to the Chapter 11 bankruptcy, it had 122 aircraft, excluding six grounded 737 MAX jets.

Things were looking up for the airline, as Aeromexico found a potential investor to take up its debtor-in-possession (DIP) financing offers. Essentially, debtor-in-possession financing allows an investor to provide a loan to companies only operating under Chapter 11 protection. In return for their investment, the lenders of the financing take up the first position on the bankrupt company’s assets in a worst-case scenario, where a company does not come out alive and well during the bankruptcy period. The court has to approve the financing.

Aeromexico obtained a potential investor and filed a DIP financing motion with the court on August 13, 2020. Apollo Global Management, a United States-based investment firm, was the financier and was willing to provide the airline with a loan, totaling $1 billion. On October 9, 2020, the court granted final approval for the financing, and Aeromexico had two initial tranches available at its fingertips: Tranche 1, consisting of $100 million and Tranche 2, consisting of $175 million. Subsequent loan draws of $100 million would be made available to Aeromexico once it had met “conditions and milestones,” according to the airline’s documents.

On another note, the airline re-shuffled its agreements with a multitude of lessors. After the court approved to cancel leases for 19 aircraft, the carrier should downsize to about 103 aircraft. On September 21, 2020, Aeromexico confirmed that it had agreed with 27 leasing companies to shift its leasing agreements to power by the hour (PBH) leases. The airline managed to nail down PBH leases for 82 aircraft and 14 spare engines, meaning that it would only pay for them as they fly them. During such times of uncertainty, this massively helps to reduce costs as little-to-no flying could happen with some of the aircraft.

“This is a significant milestone in Aeromexico’s restructuring process, which paves the way to negotiate long-term agreements with our leasing company and financing partners on the aircraft equipment that makes sense to retain in our strategic fleet,” commented Conesa, possibly hinting that the airline is willing to reduce its fleet size by about 40 aircraft of its initial size of 122 prior to the breakout of COVID-19.

Safety net or safety trap?

On November 6, 2020, after the United States Bankruptcy Court for the Southern District of New York had approved the financing, the airline withdrew its first two tranches. In total, it bolstered its liquidity by about $275 million from a loan by Apollo Global Management.

Considering this is more than half the cash that Aeromexico had as of June 30, 2020, the two tranches were of very significant importance. However, Apollo is a very profit-driven investment firm that “invests in opportunities, communities, and our people to achieve exceptional outcomes for our investors and a positive social impact,” according to its own website. For example, during the financial crisis of 2008, the firm invested in LyondellBasell Industries under almost identical circumstances, as the plastics, chemical and refining company entered into Chapter 11 bankruptcy protection. The fund invested $2.1 billion in 2010, and Lyondell emerged from bankruptcy the same year.

“Following Lyondell’s emergence from bankruptcy, Apollo leveraged its experience in the chemicals industry to work with the company in driving value creation through a disciplined focus on cash flow and capital structure optimization, liquidity, cost reduction, margin improvement and sourcing strategic relationships.”

All in all, Apollo left from its investment in Lyondell throughout 2012 and 2013 and managed to snag a $10 billion profit from the investment. For Aeromexico, that could mean a very aggressive investment firm driving cost-savings on an unprecedented level to extract a maximum amount of profit from the investment. Potentially, a similar development has occurred in Australia, after Virgin Australia was saved by Bain Capital, another private investment firm from the US.

“This is a serious and worrying development. The ink is not yet dry on the sale of Virgin (VAH) and it appears that private equity firm Bain Equity are behaving as we feared: ripping out the heart of Virgin (VAH) and reneging on promises to the Australian people,” commented Michael Kaine, National Secretary of Australian Transport Workers Union (TWU), when rumors began to spread that Bain was looking to replace the then-CEO of the airline Paul Scurrah. Rumors turned out to be true, as Jayne Hrdlicka was eventually announced as the new CEO of the Australian airline on October 15, 2020.

The fate of Aeromexico now could be placed in the hands of Delta Air Lines, which holds a 49% stake in the Mexican airline. The Atlanta, United States-based airline is dealing with a crisis of its own, much like the whole aviation industry. For Delta, though, Aeromexico seems like a crucial investment after it initially acquired shares in the carrier in 2011. Their relationship goes back as far as 1994 and was further strengthened after the two were one of the founding members of SkyTeam in 2000. Whether Delta Air Lines would let Apollo choke-out Aeromexico to the bare-bones is a good question to ask. An even better one is a question of whether Delta even has a choice since it is fighting its own battle to sustain liquidity. After all, if there was no outside investor willing to help out Aeromexico, would have it been able to emerge from the bankruptcy?

Part II, where AeroTime News will look through the situation at Avianca (AVHOQ), is coming soon.

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