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 
 
 
¶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