Avianca Aims for Latin Leadership

Six months ago, Avianca successfully reorganized under Chapter 11 of the US bankruptcy code, thereby becoming the first non-US airline to use the process to restructure its financial obligations. But the Colombian flag carriers journey through Uncle Sams legal system, which ended on Dec. 10, 2004, has done far more than add a footnote to American business law. It also has helped to write a fresh chapter in the continuing saga of the transformation of the Latin American industry from a collection of independent, nationally identified airlines into larger aggregations under regional and multinational ownership structures.

Avianca entered bankruptcy in early 2003 firmly under the control of Colombian interests: Valores Bavaria, the investment arm of the Colombian Santo Domingo conglomerate, and Federacion Nacional de Cafeterosthe National Federation of Coffee Growers in Colombiaeach held 50%. Today, the largest shareholder is OceanAir, a Brazilian Regional airline owned by Bolivian-born Brazilian entrepreneur German Efromovich, who also controls the Synergy Group conglomerate with interests in the oil and gas industry in Brazil, Colombia and Ecuador.

Before he surfaced as an interested bidder in the Avianca restructuring, Efromovich was little known in international aviation circles. But his $63 million bid in partnership with FNC ultimately prevailed over a $60 million offer by Copa of Panama supported by its part-owner Continental Airlines.
OceanAir/Synergy is providing $44.5 million in equity capital over a period of 8-22 months depending on Aviancas specific cash balance performance and holds 75% of the reorganized company. FNC holds the remaining 25%, having bought out Valores Bavaria with an $18.5 million investment in the reorganized carrier.

Aviancas odyssey was the outcome of a series of events that began several years earlier. Its losses had been increasing dramatically since the late 1990s, when fuel prices began to soar and the Colombian peso was devalued by 22% then and another 14% in 2000. Only 40% of Aviancas revenues were in dollars against 60% of its costs. At the end of 2001, Avianca and Colombias second-largest airline, Aces, were integrated to form Alianza Summa in an attempt to stop the bleeding, a solution that worked for a time. However, 9/11 sent insurance costs up 450% and adding to the companys headaches were economic instability in neighboring Venezuela, another peso devaluation in April 2002, new visa requirements for Colombian citizens and higher aircraft leasing rates.

Aces itself was unable to overcome the new challenges and was liquidated in 2003. Aviancas revenues decreased from $623.3 million in 1999 to $618.8 million in 2002 as accumulated losses grew from $104.4 million to $478.1 million. Despite a capital infusion of $259.2 million by Valores Bavaria between 2000 and 2002, the red ink continued flowing, totaling $601 million through 2003. By the time it entered bankruptcy in March 2003, it was in default on aircraft payments and lessors were beginning to repossess aircraft. Worse, it had less than $500,000 in cash on hand, according to the US-based Seabury Group, which served as the airlines financial adviser during the reorganization, helping it to slash more than
$100 million in debt, restructure its cost base and eliminate more than 60 money-losing routes.

German Who?

The boards designation of Efromovich as Aviancas new equity sponsor raised eyebrows in both Colombia and Brazil. German who? But by the time the Chapter 11 proceeding ended, he had gained acceptance in business circles as the boss of the fourth-strongest brand in the country, an icon of Colombian national pride, the second-oldest operating airline (incorporated in 1919) in the world after KLM. Avianca, meanwhile, turned a new page. In 2004, it earned $115 million, a better than $200 million profit swing from a 2003 loss of $107 million. Operating revenues rose 20.3% to $652 million on a 3.5% increase in passengers to 7.7 million.

Shortly after taking control, Efromovich unveiled another surprise, announcing his intention to turn the airline into the leading Latin American carrier by 2010 instead of just the national airline of Colombia as the Spanish acronym Avianca translates. A similar but rival vision is shared by others in Latin America including LAN, Taca, Copa and Aeropostal, each of which is moving to establish its own transnational aviation empire through equity sponsorship of subsidiaries in other than their own home countries.
Efromovichs vehicle for his plans is Synergy Aerospace, already the holding company for four airlines in four countries. OceanAir started as an air taxi operator in Brazil in 1998. Four years later it began scheduled services and now is Brazils largest Regional airline, operating seven Brasilias and three F50s to 34 destinations. Seeing an opportunity to grow further following the collapse of Vasp, OceanAir is applying for some of the route rights left vacant.

In conjunction with local investors, Synergy has created Wayra Peru to serve domestic trunk routes following the demise last year of Perus largest passenger airline, AeroContinente. In Ecuador, where transnational alliances are in place between Lloyd Aereo Boliviano and Ecuatoriana de Aviacion and where LAN is operating a subsidiary, LAN Ecuador, Synergy has acquired tiny VIP, which is to be upgraded and possibly renamed.

Meanwhile, Juan Emilio Posada was moved in February from the post of CEO of Avianca, the position he held through the stormy years of restructuring, to CEO of Synergy Aerospace. His most important priority: To integrate the four airlines in a format that respects local management styles but maximizes synergies in economies of scale, simplifying procedures and coordinating the fleet and route network.
Fleet Expansion There also are the goals of getting Wayra Peru into operation and growing OceanAir and VIP in their respective markets.

Additionally, there is the acquisition of 29 F100s previously flown by American Airlines to be managed. They are mostly of 1992 and later vintage and have an estimated future useful life of six years. They were well maintained, says Posada, but became too expensive in the US because of high labor costs. They are being overhauled and fit well into the groups plans in terms of operating cost and performance. This common fleet choice does not mean Avianca and its sister carriers will shift to an LCC style because the combination of international and domestic services makes this impossible, Posada says.

Ten of the F100s are to enter Aviancas fleet while five or more are to operate with Wayra Peru and the remainder with either OceanAir or VIP depending on how things develop in Brazil and Ecuador. Each of the airlines faces its own challenges, Posada explains. Depending on the number of routes assigned to OceanAir, we are to support its expansion with a fleet of F100s.
The number to be deployed is pending.
At the time of ATWs visit, the business plan and operational scheme for Wayra Peru were being worked out for a possible start of services in July or August. In Ecuador, VIP may operate a mixed fleet of F100s and turboprops. At Avianca, a decision was being taken on whether F100s would replace entirely or just partially the fleet of 10 F50 turboprops. The carrier will add two more MD-83s and a 757-200 this year as well.

On the competitive scene, after
losing out at Avianca, Copa acquired
an unspecified major stake in AeroRepublica, the second-largest Colombian airline with a 35% domestic market share. As the government opens up foreign ownership, fearing local carriers will not survive without strategic partners, rumors have spread that other Latin American players may move in to purchase stakes in Aires and West Caribbean Airways. Meanwhile, LCC Air Madrid has been granted three weekly Bogota-Madrid frequencies and is competing directly on Aviancas prime European route. Other international carriers have added services into Bogota, creating more competition.
We have to make sure we achieve a good route network integration, mainly in the Andean services comprising Colombia, Peru and Ecuador, says Posada. Bogota is to become a hub for European traffic bound to the Galapagos Islands and connecting to Ecuador, for example.
Wayra Peru and OceanAir may combine connecting flight schedules at Sao Paulo.

The current activities represent the first phase of an integrated development plan. After July 2006, the next phase is to consolidate the groups carriers into a multinational brand name equally appealing to markets in its own countries and as the group of choice to link all of Latin America to markets in Europe, the US and elsewhere. Direct services to Asia are a possibility as well.

Which takes us back to Avianca. The restructuring is over but the battles continue. What we are doing now is to approach our suppliers and financial agents and help them change their mindsets that we are a company in trouble, comments CFO Gerardo Grajales. We are showing them what financial impact the restructuring had on the company, why it is now viable. This is needed for us to recover credibility and to access credit lines.

Improved Efficiency

Revenue per employee has grown from $489,000 in 2002 to a projected $581,000 in 2005. On the cost side, the exchange rate has reached a comfortable level and some 60% of revenues and 51% of costs are in US dollars. CASK is 10 cents, down from 16 cents in the two previous years. Grajales considers this a good number but admits something in the 8-9 cent range would be ideal and reckons that Copa and AeroRepublica have lower costs. Thorny labor issues remain to be settled. A dispute with the carriers pilots resulted in a month-long work slowdown last summer that was resolved through a modification and temporary extension of the pilot contract. The issue returned after ATW visited.
And Avianca has to be ready to cope with two planned low-cost new entrants, Universal and Estele. Service is being improved in both international and domestic markets as a competitive tool, while the lowered cost structure will allow more appealing fares.
Meanwhile, financing has to be generated for a long-haul fleet renewal in 3-4 years. Current leases on five 767s and five 757s will expire in 2008, so negotiations need to begin now for 10-15 long-haul aircraft. One of the options being studied is an IPO in 3-5 years. Additionally, $50-$60 million will be needed in the next two years for service and technology upgrades.

Can Avianca achieve its goal of becoming a major player in Latin America? Seabury Group MD Scott Gibson believes so. Probably the most challenging thing for airlines going forward is how to deal with an environment with high fuel costs. Avianca is well positioned from an overall cost structure standpoint to deal with this, he says.
The other issues that airlines must deal with are scale and scope, Gibson says. Avianca is just barely of scale. A rule of thumb is 15-20 aircraft for each fleet type. Scale drives cost efficiency and as Avianca grows it should cautiously be able to drive lower unit costs as it achieves scale with each fleet type. Scope is what Latin American airlines are trying to achieve. Scope is what drives alliances. Avianca and Grupo Synergy/OceanAir clearly aim to have the scope to survive the coming shakeout in Latin American aviation.