Latin America’s Biggest Windfall Seen With Lan-Tam Airlines Deal: Real M&A

Lan Airlines SA (LAN)’s takeover of Tam SA (TAMM4) is offering the biggest potential windfall in Latin America even as traders grow more confident the deal will gain regulatory approval.

Tam, Brazil’s largest airline by market value, rose to within 3.50 reais yesterday of the all-stock deal with Santiago- based Lan, the narrowest gap since it was announced 15 months ago, according to data compiled by Bloomberg. While investors are more certain than ever that the 5.8 billion-real ($3.3 billion) agreement won’t be blocked, the 10 percent profit that traders buying Tam’s shares now would reap if the takeover closes is the largest for any pending acquisition in the region.

Lan, Latin America’s biggest airline by value, is trying to persuade regulators to approve a deal that would give it almost half of routes in Brazil, the region’s largest economy, and a network of more than 115 destinations in 23 countries. After more than a year of delays, Lan overcame objections from rival Pal Airlines and won over Chile’s antitrust tribunal in September. Lan’s president said he now hopes to gain approval from Brazilian regulators and his own shareholders by year-end.

“We are closer to the finish line and this is an opportunity for people to play the spread,” Sachin Shah, a Jersey City, New Jersey-based merger arbitrage strategist at Tullett Prebon Plc, said in a telephone interview. “There is a high probability that the deal should close. It’s an extremely attractive opportunity.”
Merger Arbitrage

The press offices of Lan and Tam said in e-mailed responses that they expect that the transaction will probably be completed toward the end of the first quarter of 2012.

They declined to comment on the regulatory approval process or the spread between the offer and Tam’s stock.

Shares of Tam, which also has American depositary receipts in the U.S., ended at 35.10 reais in Sao Paulo yesterday, while Lan’s agreement is valued at 38.59 reais a share.

Today, Tam’s ADRs advanced 1.7 percent to $20.36 in New York. One ADR represents one ordinary share of Tam.

Tam’s 9.5 percent dollar bonds due in 2020 have returned 2.5 percent in the past two months, more than the 0.1 percent decline in Brazilian corporate notes, according to data compiled by Bloomberg and JPMorgan Chase & Co.

While the difference between Tam’s shares and the offer has narrowed by more than 60 percent since it gapped out in August to the widest since the deal was announced last year, arbitragers still have the chance for about 27 percent annualized profit from buying Tam if the takeover closes by the end of March, data compiled by Bloomberg show.

Brazil Footprint

Without accounting for how long the Tam acquisition will take to complete, the gap represents an almost 10 percent gain, according to data compiled by Bloomberg. That’s more than any other pending takeovers over $100 million.

“It’s an attractive spread,” Peter Lobravico, New York- based vice president of merger arbitrage trading and sales at Wall Street Access, said in a telephone interview.

Under the August 2010 agreement, investors would receive 0.9 Lan share for each Tam share held. Lan would have about 70 percent of the combined carrier, Latam Airlines Group.

Lan’s Enrique Cueto will become chief executive officer of the new company, while Tam’s Mauricio Rolim Amaro will be chairman. Both airlines would continue operating separately with their own brands.

With Tam, Lan is gaining an airline that is 40 percent larger by sales and will give it one of the leading positions in Brazil, the world’s seventh-largest economy according to data compiled by Bloomberg. Tam posted revenue of $7.5 billion compared with Lan’s $5.3 billion in the last 12 months.
Relative Value

A Lan-Tam combination would have a market value of $11.3 billion, overtaking Singapore Airlines Ltd. (SIA) and China Southern Airlines Co. of Guangzhou as the world’s second-largest airline after Beijing-based Air China Ltd. (753), the data show.

“We are very positive on the deal,” said Christopher Palmer, who helps oversee $2.5 billion in Latin American assets as director of global emerging markets, including Lan stock, for Henderson Global Investors Ltd. in London. “Tam will bring extremely valuable slots in key Brazil airports. And there is excellent growth profile for air travel in South America in general.”

Tribunal de Defensa de la Libre Competencia, Chile’s antitrust court known as TDLC, accepted a request from consumer rights group Conadecus on Jan. 28 to review the transaction on grounds that it would hinder competition.

Tam tumbled 19 percent in the next three months on concern the process would delay Lan’s goal of closing the deal.
Regulatory Hurdles

After slumping to its low of the year in August, Tam rallied as the TDLC approved the tie-up with conditions on Sept. 21 and Lan said that it would push ahead with the takeover as it appeals to Chile’s Supreme Court to overturn some of the restrictions imposed by the TDLC.

Pal Airlines, Lan’s Chilean competitor, also agreed last month to end its opposition to the acquisition after Lan said it would pay its legal fees.

Lan’s shareholders are now set to vote on the agreement Dec. 21. Brazil’s antitrust regulator, known as Cade, was close to concluding its analysis and should vote on the deal by early November, Olavo Chinaglia, the commissioner responsible for the case, told reporters last month.

Brazil’s civil aviation regulator, known as Anac, already approved the takeover in March.

“There were a number of hurdles that they’ve now gotten past,” Richard Hurowitz, who helps oversee about $1 billion as chief executive officer of Octavian Advisors LP, a New York- based firm focusing on special situations and distressed investments, said in a telephone interview. “It’s a much less risky transaction at this point.”
Risk Versus Reward

The potential gains aren’t worth the price after Tam’s stock rallied about 50 percent in the past three months, especially if there are more regulatory delays, according to Leme Investimentos’ Joao Pedro Brugger. Henderson Global’s Palmer also said the cost to borrow Lan shares to take advantage of the arbitrage opportunity would erode trading profits.

“If there’s any turnaround in the case, the shares are going to suffer a lot,” said Brugger, who helps manage 80 million reais at Leme Investimentos in Florianopolis, Brazil. “I don’t know if it’s worth the risk to get in at these levels. There have been better entry points.”

Eric Conrads, who manages $1.2 billion in Latin American stocks at ING Groep NV in New York, says that concern the deal will unravel is overblown, which means the Lan-Tam acquisition is still a profitable wager.

“It remains an attractive play,” he said. “There’s no reason that this spread shouldn’t disappear as I don’t think the probability it will be rejected is higher than 10 percent. You have to play it through Tam.”