Tam bonds falter as bet on Lan support becomes 'overplayed'

Bonds issued by Tam SA, Brazil's second-biggest airline, are lagging behind a debt rally as traders pare bets that Chile's Lan Airlines SA will guarantee the company's liabilities.

Tam's 9.5 percent dollar bonds due in 2020 have returned 1.5 percent in the past month, less than the 3 percent advance in Brazilian corporate notes, according to data compiled by Bloomberg and JPMorgan Chase & Co. Ten-year debt issued by Gol Linhas Aereas Inteligentes SA, the country's largest airline, gained 3.1 percent over that time.

The underperformance by Tam marks a reversal of the month- long rally sparked Aug. 13 after Santiago-based Lan unveiled plans to buy the Brazilian airline for $3.8 billion in an all- stock deal. Tam's bonds due in 2020 posted an 8.3 percent return, compared with a 0.4 percent gain on Brazilian corporate debt in the month through Sept. 13, on speculation that higher- rated Lan would back the Sao Paulo-based company's $4.1 billion of debt.

"The initial excitement that the debt was going to be guaranteed has backed off on the Tam deal," said Eric Ollom, chief emerging-markets strategist with Jefferies & Co. in New York.

Tam is rated B+, or four levels below investment grade, by Standard & Poor's and Fitch Ratings. Lan, Latin America's biggest airline by market value, is rated BBB by Fitch, or five levels higher than Tam.

'Overplayed' bet

While Tam Chief Financial Officer Libano Barroso said Aug. 17 that the combined company, which will be called Latam Airlines Group, wouldn't back Tam's debt, bond traders were counting on an implicit guarantee, said Juan Cruz, a credit analyst with Barclays Plc in New York.

"People are betting that if Tam needs financial backing, Lan will put its hands in its pockets -- I'm skeptical," Cruz said in a telephone interview. "Tam's debt levels are very high. The implicit support is overplayed."

Fernando de Andrade, the treasury manager for Tam, said yesterday that there's "no need" for Tam's debt to be guaranteed.

"We are in a deleveraging process and we believe this will show in our third quarter numbers," Andrade said in an e-mailed response to questions. The company's bonds have been rallying since the end of June and outperformed most non-investment grade Brazilian corporate securities in September, he said.

Tam-Gol spread

Tam's $300 million of 2020 notes yielded 7.85 percent, or 55 basis points below the yield on Gol's bonds due that year. On Aug. 12, the Tam securities yielded 26 basis points more than Gol bonds, which are rated BB-, or one level above Tam, by Fitch.

"Tam should trade, at most, at the same level as Gol," Cruz said.

Brazilian government dollar bond yields have declined 37 basis points, or 0.37 percentage points, over the past two months to 4.63 percent, according to JPMorgan's EMBI+ index. The extra yield investors demand to own Brazilian dollar bonds instead of Treasuries was 178 basis points, down from 195 on Aug. 12.

The cost of protecting Brazilian bonds against default for five years dropped five basis points to 89, according to CMA DataVision. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements. A basis point is 0.01 percentage point.

'Deteriorating' model

The real fell 0.3 percent to 1.6578 per dollar at 9:23 a.m. in New York. The yield on the overnight interest-rate futures contract due in January 2012 fell one basis point to 11.33 percent.

Tam shares have surged 44 percent since Aug. 13, compared with a 15 percent gain for Lan. Investors will get 0.9 Lan share for each Tam share held under the terms of the agreement. Tam is trading with a 12 percent discount to Lan's offer price, the smallest since the deal was announced, compared with an average of 16 percent over the past two months.

Tam reported its second consecutive quarterly loss in the April-to-June period as its market share fell and costs increased. The net loss was 154.1 million reais ($87 million), the company said in an Aug. 13 regulatory filing.

"The operational model at Tam is deteriorating," Cruz said. "There's no risk-reward in Tam's debt."

Andrade said Tam will likely post its "strongest" operating margins in a year in the third quarter.

'Stellar performance'

"The Brazilian market will continue its stellar performance and Tam is the company most suited to profit from this scenario," he said.

Brazil's antitrust regulator, known as Cade, could decide whether to approve the proposed takeover by early next year, according to an official who declined to be identified in accordance with government policy.

Lan doesn't have an estimate for when the transaction will be completed, said an official who asked not to be identified in accordance with company policy.

Tam's bonds "rallied on an implicit guarantee by Lan," said Natalia Corfield, a corporate debt analyst with ING Groep NV in New York. "But from these levels onward we'll need more news on the alliance."

(Published by Bloomberg – October 14, 2010)