Identifier
Created
Classification
Origin
04BRASILIA2939
2004-12-01 18:38:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Brasilia
Cable title:  

UPCOMING SHAKEOUT IN BRAZILIAN CIVIL AVIATION

Tags:  EAIR EINV BEXP PGOV ETRD BR 
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This record is a partial extract of the original cable. The full text of the original cable is not available.
UNCLAS SECTION 01 OF 04 BRASILIA 002939 

SIPDIS

SENSITIVE

STATE PLEASE PASS TO USTR
NSC FOR MIKE DEMPSEY
DEPT OF TREASURY FOR FPARODI
USDOC FOR 3134/USFCS/OIO/WH/EOLSON
USDOC FOR 4332/ITA/MAC/WH/OLAC/MWARD
DOT FOR SUSAN MCDERMOTT, CAROLYN COLDREN
FAA MIAMI FOR MARK RIOS

E.O. 12958: N/A
TAGS: EAIR EINV BEXP PGOV ETRD BR
SUBJECT: UPCOMING SHAKEOUT IN BRAZILIAN CIVIL AVIATION


UNCLAS SECTION 01 OF 04 BRASILIA 002939

SIPDIS

SENSITIVE

STATE PLEASE PASS TO USTR
NSC FOR MIKE DEMPSEY
DEPT OF TREASURY FOR FPARODI
USDOC FOR 3134/USFCS/OIO/WH/EOLSON
USDOC FOR 4332/ITA/MAC/WH/OLAC/MWARD
DOT FOR SUSAN MCDERMOTT, CAROLYN COLDREN
FAA MIAMI FOR MARK RIOS

E.O. 12958: N/A
TAGS: EAIR EINV BEXP PGOV ETRD BR
SUBJECT: UPCOMING SHAKEOUT IN BRAZILIAN CIVIL AVIATION



1. (U) THIS CABLE IS BASED UPON INPUT PROVIDED BY ECON AND
FCS SECTIONS AT AMEMBASSY BRASILIA, AMCONSULATE SAO PAULO,
AND AMCONSULATE RIO DE JANEIRO.


2. (SBU) SUMMARY. DESPITE RISING PASSENGER LOADS IN THE
BRAZILIAN CIVIL AVIATION MARKET, TWO CARRIERS - VARIG AND
VASP, WHICH TOGETHER ACCOUNT FOR 40% OF THE BRAZILIAN
MARKET - ARE STRUGGLING TO SURVIVE. VASP WILL HAVE GREAT
DIFFICULTY MAKING IT PAST THE END OF THE YEAR. VARIG,
CURRENTLY THE LARGEST CARRIER IN THE MARKET, IS COUNTING ON
A GOVERNMENT BAILOUT, ALTHOUGH WHATEVER GOB ASSISTANCE IS
FORTHCOMING WILL LIKELY BE INSUFFICIENT TO ENSURE ITS
VIABILITY IN THE MEDIUM-TERM. WITH THE LULA ADMINISTRATION
DETERMINED TO CURB SPENDING, AND WHATEVER LOOSE CHANGE IT
CAN COME UP WITH LIKELY DESTINED FOR SOCIAL WELFARE
PROGRAMS AND PUBLIC INFRASTRUCTURE DEVELOPMENT, THE GOB HAS
NEITHER THE MEANS NOR THE DESIRE TO MOUNT A FULL-FLEDGED
RESCUE PACKAGE. IF VARIG IS TO SURVIVE, ULTIMATELY A CASH-
RICH OUTSIDE INVESTOR WILL HAVE TO PURCHASE A STAKE IN THE
COMPANY AND NEGOTIATE A SETTLEMENT WITH THE CARRIER'S
CREDITORS. END SUMMARY.

CLEAR SKIES BUT WITH PATCHES OF TURBULENCE
--------------


3. (U) BASED ON RECENT STATISTICS, THE BRAZILIAN CIVIL
AVIATION INDUSTRY IS ENJOYING A GOOD YEAR. JANUARY TO
AUGUST 2004 FIGURES SHOW THAT THE NUMBER OF PASSENGERS
TRANSPORTED INCREASED 11.4 PERCENT COMPARED TO THE
CORRESPONDING PERIOD LAST YEAR, AND DOMESTIC SALES FOR 2003
STOOD AT 8.78 BILLION REAIS - UP FROM 7.98 BILLION IN 2002.
AS A WHOLE, THE SECTOR WENT FROM A DEFICIT OF 698 MILLION
REAIS IN 2002 TO A PROFIT OF 368 MILLION IN 2003.
NOTWITHSTANDING THESE POSITIVE OVERALL RESULTS, TWO PRIVATE
SECTOR BRAZILIAN CARRIERS - VARIG AND VASP - ARE IN DEEP
TROUBLE.

VASP'S TROUBLES
--------------


4. (U) ONCE RESPONSIBLE FOR 36 PERCENT OF THE BRAZILIAN
MARKET AND IN COMMAND OF A FLEET OF 62 AIRCRAFT, NOW VASP
IS HOUNDED BY CREDITORS AND BARELY FUNCTIONING. CURRENTLY,

THE CARRIER HAS ONLY 17 PLANES IN-SERVICE, NO INTERNATIONAL
ROUTES, AND A MERE 8.6 PERCENT OF THE MARKET. THE COMPANY
HAS DEBTS OF NEARLY 3 BILLION REAIS (OVER USD 1 BILLION),
AND RECENT HIKES IN FUEL PRICES HAVE ONLY MADE THE
CARRIER'S SITUATION EVEN MORE PRECARIOUS. ITS PILOTS
PERIODICALLY GO ON STRIKE BECAUSE OF UNPAID BACK WAGES,
CAUSING THE MASS CANCELLATION OF THE AIRLINE'S FLIGHTS. AS
A RESULT, TRAVEL AGENCIES HAVE SHIED AWAY FROM BOOKING
CLIENTS ON VASP, AND THE AIRLINE'S LOAD FACTOR HAS FALLEN
TO 49 PERCENT (THE NATIONAL AVERAGE IS 68 PERCENT). THE
NATIONAL AIRPORT AUTHORITY (INFRAERO) IS DEMANDING CASH UP
FRONT TO PAY LANDING FEES PRIOR TO ANY FLIGHT DEPARTING,
AND HAS THREATENED TO BAR VASP PLANES FROM FLYING IF THE
AIRLINE DOES NOT MAKE ITS ACCOUNT CURRENT. VASP OWES
INFRAERO ALONE 774 MILLION REAIS. UNABLE TO FIND ANY BANK
WILLING TO LEND THE COMPANY MONEY, VASP OWNER WAGNER
CANHEDO HAS SOLD HOTEL PROPERTIES HE OWNS AND EVEN CATTLE
FROM HIS RANCH TO PAY DEBT.


5. (SBU) EARLIER IN THE YEAR, THE GOB CIVIL AVIATION
AUTHORITY (DAC) RECENTLY GROUNDED 6 OF VASP'S 737-200S FOR
HAVING SURPASSED STRUCTURAL SAFETY LIMITS, AND LACKING IN
MONEY TO PAY MAINTENANCE THE CARRIER HAS HAD TO WITHDRAW
OTHER AIRCRAFT FROM ITS ACTIVE FLEET. CURRENTLY, VASP IS
STUCK FLYING ELDERLY AIRCRAFT (ITS FLEET HAS AN AVERAGE AGE
OF 25 YEARS),WHICH, ACCORDING TO ITS COMPETITORS, ONCE NEW
GOB ALTITUDE SEPARATION RULES (RVSM) GO INTO EFFECT JANUARY
1, WILL NOT HAVE THE NECESSARY EQUIPMENT TO FLY SAFELY OVER
30,000 FEET. THIS LAST PROBLEM COULD WELL BE THE DEATH
KNELL FOR VASP AS THE COST OF EQUIPPING THE CARRIER'S AGING
AIRCRAFT WITH RVSM WOULD BE PROHIBITIVE, WHILE THE EXTRA
FUEL COSTS ASSOCIATED WITH FLYING UNDER 30,000 FEET WOULD
MAKE THAT ALTERNATIVE EQUALLY UNATTRACTIVE.

VARIG'S WOES
--------------


6. (SBU) VARIG'S SITUATION, WHILE NOT AS DIRE, IS SERIOUS
AS WELL. THE PRESS REPORTS THAT THE COMPANY IS MIRED IN 7
BILLION REAIS WORTH OF DEBT, A GOOD CHUNK OF WHICH IT IS
UNABLE TO SERVICE GIVEN THAT THE COMPANY CONTINUES TO RUN
LOSSES. ACCORDING TO ONE INDUSTRY SOURCE, MUCH OF VARIG'S
DEBT MOUNTAIN IS DUE TO MISMANAGEMENT AS COMPANY OFFICIALS
NEGLECTED TO HEDGE THEIR DOLLAR-BASED LOANS PRIOR TO THE
SHARP DECLINE OF THE REAL IN THE LATE 1990S. AN OFFICIAL
FROM ONE COMPETITOR AIRLINE NOTED THAT, NOTWITHSTANDING
RECENT BELT-TIGHTENING, VARIG WOULD NEED 20 YEARS OF
EXCELLENT PROFITS (WITH NONE OF ITS RETAINED EARNINGS
CHANNELED TOWARDS INVESTMENT) TO PAY OFF WHAT IT NOW OWES.
VARIG IS IN HOCK NOT ONLY TO BOEING, GE (LEASEHOLDERS OF
ITS AIRCRAFT),AND JAPANESE AND EUROPEAN BANKS, BUT TO ITS
EMPLOYEE PENSION FUND AS WELL. ALTHOUGH THE PENSION FUND
BOOKS SHOW A NOMINAL VALUE OF 2.3 BILLION REAIS, ABOUT HALF
OF THIS AMOUNT STILL HAS TO BE PAID IN BY THE COMPANY.
VARIG FURTHER SUFFERS FROM HIGH FIXED COSTS AS A RESULT OF
ITS BLOATED EMPLOYEE ROLLS. ACCORDING TO ONE INDUSTRY
CONTACT, THE COMPANY HAS 200 EMPLOYEES PER AIRCRAFT - WHILE
ONE OF ITS CUT-RATE COMPETITORS FIELDS A RATIO OF 98
EMPLOYEES PER AIRCRAFT.

TOO BIG TO FAIL?
--------------


7. (SBU) ONE ADVANTAGE THAT VARIG HAS (WHICH VASP DOES NOT)
IS SIZE. WHILE VASP HAS A WORK-FORCE OF 4,400 EMPLOYEES,
VARIG EMPLOYS ALMOST 20,000 WORKERS, PROVIDES MORE THAN
HALF OF THE JOBS IN THE DOMESTIC CIVAIR INDUSTRY, AND
BRINGS MORE THAN USD 1 BILLION IN FOREIGN EXCHANGE INTO THE
COUNTRY. WITH THE COMPANY'S EXTENDED REACH, IT HAS A
READY-MADE CONGRESSIONAL BLOC INTERESTED IN ENSURING THE
CARRIER'S SURVIVAL. INDEED, THE LOCAL PRESS REPORTS THAT
ONE PROPOSAL CURRENTLY CIRCULATING IN CONGRESS (AND WHICH
PURPORTEDLY HAS THE SUPPORT OF 272 SENATORS/DEPUTIES) WOULD
SEEK TO RESTRUCTURE THE AIRLINE, WITH OUTSTANDING
SUPPLIER/PENSION FUND DEBT BEING CONVERTED TO SHARES AND
MONIES OWED TO THE GOB BEING RENEGOTIATED. WHETHER THE GOB
SHARES CONGRESS' ENTHUSIASM FOR SEEKING TO BAIL OUT VARIG,
HOWEVER, IS ANOTHER MATTER.


8. (SBU) WHILE THERE HAVE BEEN A PLETHORA OF RUMORS OVER
THE PAST FEW MONTHS THAT THE GOB IS CONSIDERING A RESCUE
PACKAGE FOR VARIG, SO FAR THE LULA ADMINISTRATION HAS NOT
PUT FORWARD ANY PROPOSAL. THE DEPARTURE OF DEFENSE
MINISTER VIEGAS IN EARLY NOVEMBER LIKELY SLOWED GOB
DECISIONMAKING AS REGULATION OF CIVIL AVIATION FALLS UNDER
THE MINISTRY OF DEFENSE. STILL, ANOTHER LINE OF THINKING
IS THAT THE GOB WILL WAIT UNTIL VASP GOES BUST PRIOR TO
UNVEILING ANY PACKAGE SO IT THAT IT WON'T BE CALLED ON TO
BAIL OUT THAT CARRIER AS WELL. BASED ON MISSION
CONVERSATIONS WITH GOB OFFICIALS, IT IS CLEAR THAT,
IDEALLY, THE GOVERNMENT WOULD LIKE VARIG TO SURVIVE (VASP
ALREADY BEING SEEN AS A LOST CAUSE) BUT IS NOT QUITE SURE
WHAT STEPS TO TAKE TO MAKE THIS SO.

THE OPTIONS
--------------


9. (SBU) IN POST'S VIEW, IN THE ABSENCE OF ANY UNFORESEEN
NEGOTIATED OFFERS COMING FROM THE PRIVATE SECTOR, THERE ARE
THREE BROAD COURSES OF ACTION THAT THE GOB CAN TAKE WITH
RESPECT TO VARIG. FIRST, IT COULD MOUNT A FULL-FLEDGED
EFFORT TO SAVE THE AIRLINE AT ALL COSTS. SUCH A PACKAGE
COULD INCLUDE: A) CUT-RATE FINANCING FROM THE GOB'S
NATIONAL DEVELOPMENT BANK (BNDES),B) PRESSURING LOCAL
PENSION FUNDS TO INVEST IN THE AIRLINE, C) SEARCHING OUT
POTENTIAL FOREIGN PARTNERS, D) SETTLING AN OUTSTANDING
LAWSUIT BY VARIG SO AS TO INJECT FURTHER CASH INTO THE
COMPANY, AND E) MANIPULATING THE CIVAIR REGULATORY REGIME
TO BENEFIT VARIG.


10. (SBU) COMPETITORS COMPLAIN THAT THE LOCAL CIVIL
AVIATION AUTHORITY (DAC) HAS TO SOME EXTENT ALREADY ENGAGED
IN THE LAST STEP AS IT HAS DELAYED APPLICATIONS BY
COMPETITORS TO OBTAIN NEW LEASED AIRCRAFT WHILE EXPEDITING
SIMILAR APPLICATIONS BY VARIG. HOWEVER, TAKING MORE
AMBITIOUS STEPS IN THIS REGARD (SUCH AS EXPLICITLY DIVIDING
UP THE MARKET AND CHANNELING PROFITABLE ROUTES TO VARIG)
WOULD RAISE BOTH LEGAL AND ANTI-TRUST CONCERNS. IN 2003,
CADE - ONE OF THE GOB'S ANTI-TRUST ENFORCERS - INDICATED
THAT IT WOULD TAKE A CLOSE LOOK AT A PROPOSED TAM-VARIG
MERGER. AS TAM, WHICH HAS SEEN ITS REVENUES INCREASE AS
THE MARKET EXPANDS, NOW APPEARS TO NO LONGER BE INTERESTED
IN THE DEAL, THAT PROPOSED FUSION NOW LOOKS TO BE DEAD
(ALTHOUGH ON CERTAIN ROUTES TAM-VARIG CODESHARES LIVE ON).


11. (SBU) PERHAPS THE BEST ARGUMENTS AGAINST AN AGGRESSIVE
BAIL-OUT WERE ENUNCIATED BY ONE PLANALTO INSIDER THE
AMBASSADOR SPOKE TO. WHY SHOULD A GOVERNMENT HEADED BY A
WORKER'S PARTY PRESIDENT SUBSIDIZE A POORLY-MANAGED FIRM
WHICH SERVES THE ELITE (THE POOR DON'T HAVE ENOUGH MONEY TO
FLY) WHEN IT DOES NOT SUBSIDIZE THE MODES OF TRANSPORT
(BUS/METRO) MOST USED BY THE WORKING CLASS, HE ASKED
RHETORICALLY? ALL THIS AT A TIME WHEN THE GOB IS SQUEEZING
EXPENDITURES TO THE MAXIMUM EXTENT POSSIBLE TO PUT ITS
FISCAL HOUSE IN ORDER. BESIDES, OUR CONTACT ADDED, VARIG'S
SITUATION WAS SO GRAVE THAT IT WAS LONG PAST THE TIME WHEN
ANY FINANCIAL PACKAGE COULD BE REASONABLY EXPECTED TO KEEP
THE COMPANY ALOFT FOR ANY LENGTH OF TIME.


12. (SBU) ANOTHER OPTION AVAILABLE TO THE GOB IS TO SIMPLY
SIT ON ITS HANDS, I.E., DECLINE TO ASSEMBLE A RESCUE EFFORT
AND LET THE MARKET DETERMINE THE COMPANY'S FATE. UNDER
THIS SCENARIO, TAM, GOL, AND BRA - ALL WELL-RUN AIRLINES -
WOULD TAKE OVER VARIG'S MARKET SHARE AND POSSIBLY EVEN HIRE
A PORTION OF VARIG'S WORKFORCE. NEVERTHELESS, THIS COURSE
WOULD EXPOSE THE GOB TO POLITICAL HEAT FROM BOTH THE
CONGRESS AND THOSE WHO LOST THEIR JOBS, AND LIKELY IS NOT
THE SOUND-BITE PRESIDENT LULA WOULD DESIRE FOR HIS
REELECTION CAMPAIGN IN 2006.


13. (SBU) ONE OFFICIAL FROM A COMPETITOR AIRLINE TOLD US
THAT IF VARIG WERE TO GO BANKRUPT, THEN HE EXPECTED THAT
THE DOMESTIC MARKET WOULD IMMEDIATELY SHAKE OUT WITH GOL
AND TAM EACH ASSUMING A 40 PERCENT SHARE, AND BRA SERVING
THE REMAINING 20 PERCENT. OVERSEAS, HOWEVER, VARIG'S QUICK
DEATH WOULD MEAN THAT BRAZIL WOULD LOSE ITS MOST WELL-KNOWN
INTERNATIONAL CARRIER. WHILE TAM, GOL, AND BRA HAVE TAKEN
INITIAL STEPS TO ESTABLISH THEMSELVES ABROAD, NONE OF THEM
CURRENTLY HAS THE INSTANT NAME RECOGNITION NEEDED TO
ATTRACT LARGE NUMBERS OF FOREIGN PASSENGERS. NOR, SHOULD
VARIG ABRUPTLY CEASE OPERATIONS, WOULD THEY BE ABLE TO
QUICKLY RAMP UP TO GET THE NECESSARY SLOTS INTO CROWDED
AIRPORTS IN THE U.S. AND EUROPE. FOREIGN CARRIERS,
THEREFORE, WOULD LIKELY FILL THE VOID LEFT BY A QUICK VARIG
EXIT - A RESULT WHICH THE GOB WOULD CERTAINLY SEEK TO
AVOID.


14. (SBU) THE THIRD PATH THE GOB MIGHT PURSUE IS TO OFFER
UP A PARSIMONIOUS, HALF-HEARTED RESCUE PLAN - INCORPORATING
ONE OR MORE OF THE ELEMENTS OUTLINED IN PARAGRAPH 9 ABOVE -
-DESIGNED TO PROLONG THE PERIOD BEFORE WHICH VARIG DECLARES
BANKRUPTCY. THIS, ONE WELL-CONNECTED VARIG SUPPLIER TOLD
US, WOULD MIMIC THE GOB'S EARLIER RESPONSE TO THE EMERGENCE
OF FINANCIAL PROBLEMS IN THE NOW-DEFUNCT TRANSBRASIL
AIRLINES AND IS THE TRADITIONAL BRAZILIAN WAY OF HANDLING
SUCH MATTERS. UNDER THIS SCENARIO, VARIG WOULD NOT CEASE
OPERATIONS UNTIL AFTER THE FALL 2006 PRESIDENTIAL ELECTIONS
AND TAM, GOL, AND BRA WOULD, IN THE INTERIM, HAVE TIME TO
READY THEMSELVES FOR THE INTERNATIONAL MARKET. WHILE THE
FINANCIAL COST OF KEEPING VARIG ALIVE UNTIL FALL 2006 IS
UNCLEAR, A LIMITED TWO-YEAR REPRIEVE WOULD CERTAINLY BE
CHEAPER THAN A RESCUE EFFORT DESIGNED TO RETURN THE AIRLINE
TO GOOD HEALTH. GIVEN THE DRAWBACKS OF ALL THE OTHER
COURSES OF ACTION AND THE LIMITED FINANCIAL IMPLICATIONS
THIS OPTION WOULD POSE FOR THE TREASURY, POST BELIEVES
THAT, ABSENT THE SUDDEN EMERGENCE OF A PRIVATE SECTOR
SUITOR, THIS IS THE PATH THAT THE GOB WILL EVENTUALLY
ADOPT.


15. (SBU) COMMENT. THE DILEMMA THE GOB FACES IS A FAMILIAR
ONE: WHETHER TO RESCUE A KEY INFRASTRUCTURE PROVIDER FROM
THE CONSEQUENCES OF ITS OWN BAD DECISIONS OR WHETHER TO
INSTEAD LET THE MARKET DETERMINE THE COMPANY'S FATE. UP TO
NOW, THE GOB HAS KEPT IS POWDER DRY, ALTHOUGH SOONER OR
LATER IT WILL HAVE TO COME TO A DECISION. AS THERE IS NO
GOOD OPTION HERE FOR THE LULA ADMINISTRATION, IN THE END IT
WILL SIMPLY HAVE TO DECIDE WHICH IS THE "LEAST BAD"
ALTERNATIVE.

CHICOLA