Analysis: GOL airlines assumes its own route after buying Smiles and paying off old debt

RIO DE JANEIRO, BRAZIL – Buying and incorporating the loyalty company Smiles was a vital issue for GOL. Last week, the businesses’ merger was approved after the acquisition price was raised from R$2.76 billion to R$3.35 billion. After pandemic management, the question that remains for the airline is how to return to growth.

After 14 years since the purchase of Varig, the origin of Smiles, the group has only 20 more planes, although its current airline network can accommodate another 50. The existing barriers within the group will finally be eliminated by the end of this year.

Although the crisis with the new coronavirus has made the transaction more urgent, the companies’ separation was understood as a wall to growth since 2017, when a comprehensive diagnosis of the group’s challenges was conducted. It was a minor problem while other companies in the sector adopted the same model, but it became essential after direct competitor Latam incorporated Multiplus in 2018.

Reintegrating Smiles, therefore, came to be seen as essential to put the company back on the growth path.

A look back at GOL points out that the company had not made great leaps since 2007, after the acquisition of Varig, when it ended the year with 106 aircraft, compared to 65 the previous year. From then until 2015, the business grew and reached a total of 144 aircraft.

But, it was then realized that the expansion was being done without the associated return and the business had to shrink, reducing to 119 aircraft in 2017. Back and forth, a decade and the company stopped. The recession of Dilma Rousseff’s government and extratropical interest rates at the time weighed on the bill.

At the end of 2019, after an ambitious fleet renewal and expansion plan announced the previous year, GOL had 137 units in operation and major orders for Boeing’s MAX-737. The crisis (now overcome) led to the delay in the approval of the model – which implies an increase in the number of seats and reduces fuel use – and the pandemic put the company’s fleet today at 127 units.

Together with Smiles, the 2017 plan was to solve the company’s financial crisis with a reorganization of its debts, which reached unsustainable levels and conditions by the end of 2016. Although already equated structurally, this step also has its final moves linked to the loyalty company, which was segregated and listed on B3 in 2013.

GOL will finally be able to kiss its debt to Delta goodbye. Now, the companies will become one again. The combination should be completed in the second half of this year.

Sources close to the company ponder that, even with all these challenges, GOL has conquered and not lost the domestic market’s leadership, not even with the emergence and growth of Azul in the middle of the way.

It currently has a 38% market share. But it is admitted that the company has lost its function of democratizing access to airplanes, which was its original proposal.

Therefore, it has failed to produce an inclusive expansion, making the total number of users finally increase from the 50 million level. The issue will be central in the industry’s post-pandemic life.

The expectation is that corporate demand, which accounts for about 50% of the industry’s worldwide turnover, may never return to pre-pandemic levels as companies discover digital life efficiencies. Increasingly, it will be necessary to encourage people to move on trips and visits to friends and family.

Farewell to Delta

Smiles announced on Thursday night an unexpected dividend of R$500 million. The funds will be deducted from the cash portion paid to minority shareholders in the merger. Part of the payment comes earlier to investors, which nobody expected would happen.

For GOL, the payment is also very welcome: R$ 265 million in cash on the jet. With the sum of the last contract of anticipated tickets and this benefit, the airline will settle its pending issues with Delta, referring to commitments of US$ 300 million that fell due in August last year. At the time, GOL paid off, but the largest part was refinanced directly with the American company, which was a guarantor in operation.

Currently, American Airlines is GOL’s partner, with a minority stake in the capital and a commercial fleet sharing agreement. But at the time the operation was contracted, Delta was the one who was in this position. The resources were used in the post-Dilma debt restructuring. It was money to shrink the business, not to grow it.

Therefore, closing this invoice is emblematic and important. It frees up resources for expansion.

The original structure of the debt was like this: GOL sought funds in the market, with Delta’s guarantee. But, in exchange, it used the shares of Smiles as collateral for the American company.

Before the transactions with Smiles this year, there was US$ 78 million left to pay Delta. GOL signed, in August, the commitment to repay US$ 16 million per month and, if it received any flow from the loyalty company, 67% should be used to reduce the commitment in advance.

With the R$300 million in tickets from the beginning of this month plus the R$265 million in dividends, about R$380 million will go to the former partner, which practically eliminates the outstanding balance. There will remain for GOL’s cash needs, from these receipts, just under R$200 million.

The expectation is that between April and May, GOL will go back to the market to raise between US$ 100 and US$ 300 million with an operation similar to the one carried out at the end of last year, with a guarantee on assets related to parts and engines. And when it takes over Smiles, the cash balance that is still there will come along with it.

Profitability and Growth

After buying slots from Avianca, within the process of judicial recovery of the company and the expansion of the network, GOL should have 180 aircraft flying, according to industry analysts’ calculations. In practice, it is an increase around 40% in relation to the company’s current total after the delay in Boeing’s schedule with the MAX-737 and the pandemic.

The company’s project is to reach this point. The time projection is difficult, as it is still tied to the strength of the recovery – economic and mobility – post-pandemic.

Smiles inside GOL will give the group the ability to expand the net premium per seat (per kilometer traveled) – in practice, the company’s return. In a billion-dollar industry, profitability comes from penny movements in this account. In 2020, this return, called net yield per ASK, was consolidated at R$28.73, of which R$1.39 was from Smiles.

GOL had to sell to Smiles at pre-contracted prices with the companies separated, an average of 7% of the seats per flight – the exact percentage varied per category (route extension). The airline had no way to increase or reduce this amount, nor the total number of points required per ticket, to take advantage of competitive flights or stimulate new routes and market openings. This management was in Smiles.

It was like selling a ticket that in the market was worth R$ 500 for R$ 200. Then, not being able to sell for lower prices, with fewer miles required, less explored flights and routes. Thus, in the management of the consolidated yield, there was no way to manage in the most efficient way possible the most important return, that of GOL.

Ticket price management, or yield management, those cents mentioned above, is the heart of the business. It is a department with more than a hundred people involved and a lot of applied mathematics, taken care of minute by minute, following demand and competitors.

When Latam incorporated Multiplus, the rival, which had an overlap of about 70% of the routes, became more efficient in this fight. Azul also has loyalty incorporated into the business. GOL’s hands were tied. Without being able to make itself profitable in an efficient way, thinking about growth was an unprecedented challenge.

Now, after paying the debt that financed its shrinking and more flexibility to produce better returns, the company is the master of its own destiny.

Source: Exame