This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 BRASILIA 001566 
 
SIPDIS 
 
SENSITIVE 
 
STATE PLEASE PASS TO USTR 
NSC FOR BREIER 
DEPT OF TREASURY FOR FPARODI 
USDOC FOR 3000/JOHN TOCCO 
USDOC FOR 3134/USFCS/OIO/WH/EOLSON 
USDOC FOR 4332/ITA/MAC/WH/OLAC/MWARD 
USDOC FOR 6950/DEAN WODDARD - AEROSPACE 
DOT FOR SUSAN MCDERMOTT, CAROLYN COLDREN 
FAA MIAMI FOR MARK RIOS 
 
E.O. 12958: N/A 
TAGS: EAIR EINV PGOV ETRD BR
SUBJECT: VARIG FINANCIAL CRISIS DEEPENS 
 
REF: A) 2004 BRASILIA 2939, B) RIO DE JANEIRO 198 
 
¶1. (U) This cable is based upon information gathered by the 
Econ and FCS Sections at AmEmbassy Brasilia. 
 
¶2. (SBU) Summary. The financial situation of VARIG, 
Brazil's troubled flagship carrier, is worsening.  Airline 
officials have told Deputy Senior Commercial Officer that 
in the absence of some sort of rescue package the company 
would only survive 30 days.  So far, however, key GOB 
officials have not signed on to the restructuring deal 
being negotiated by VARIG's new board.  Meanwhile, one of 
companies which leases aircraft to VARIG has demanded the 
return of its planes because of the failure of the airline 
to pay the lease expenses.  We foresee the current crisis 
shortly becoming very public and very messy. End Summary. 
 
¶3. (SBU) On June 7, USCS Deputy Senior Commercial Officer 
(DSCO) telephoned Vice-President (and Defense Minister) 
Alencar's Chief of Staff to inquire about the status of 
VARIG.  Our interlocutor pledged to pass this query to 
VARIG; ten minutes later VARIG President Henrique Neves 
called back to relay the following information: 
 
--  On May 9, VARIG's management was taken over by a new 
board of directors comprised of executives from major 
multinational corporations doing business in Brazil.  The 
Rubem Berta Foundation (i.e., the VARIG employee 
association), which proved incapable of making difficult 
decisions, now no longer has any direct involvement in 
company management. 
 
--  VARIG and the Portuguese airline TAP are working on a 
4-stage plan to return the company to financial health. 
Stage 1 of the plan contemplates conversion of much of 
VARIG's outstanding debt into equity shares of a 
reorganized corporation. 
 
--  Stage 2 of the plane envisions TAP purchasing 20 
percent (US$300 to $400 million) of the reorganized 
corporation.  This, along with the debt restructuring, 
would generate approximately US$500 million. 
 
--  Stage 3 involves VARIG and the GOB coming to an accord, 
whereby the latter agrees to drop its appeals to a US$1.1 
billion judgment in the airline's favor and VARIG, after a 
six-month grace period, agrees to start paying its debt to 
the GOB. 
 
--  Finally, in Stage 4 the shares from the newly-formed 
VARIG would be sold on the market and the creditors who 
became asset holders would then receive their cash. 
 
¶4. (SBU) Significant obstacles stand in the way of the 
realization of this plan.  First, VARIG reports that while 
creditors such as Boeing and GE Engines have agreed to the 
plan, leasing companies with newer planes - such as the 
International Lease Financing Corporation (ILFC), a 
subsidiary of AIG -- are balking as they believe that their 
aircraft could be profitably diverted to another paying 
lessee.  VARIG worries that if ILFC, which supplies 11 of 
the company's 82 aircraft, remains recalcitrant, other 
lessors (like GECAS, GE's leasing arm) may adopt a similar 
stance.  (Indeed, even the extent to which Boeing is on 
board is still up in the air as in our contacts with Boeing 
representatives they declined to confirm any accord with 
VARIG.)  And without the debt-for-equity swap, TAP would 
not proceed with the purchase of 20 percent of the 
restructured company. 
 
¶5. (SBU) Second, key questions such as who would control 
the restructured company and the status of TAP's debt to 
the GOB remain unresolved.  Given its substantial 
investment, presumably TAP would want a majority of the 
voting (as opposed to the common) shares of the company. 
However, Brazilian law explicitly provides that foreign 
investors in the aviation sector may hold no more than 20 
percent of the voting shares of a carrier.  In addition, 
TAP itself owes approximately US$23 million in taxes to the 
GOB, although it maintains that a 2002 presidential decree 
partially extinguished at least part of this debt. 
 
¶6. (SBU) Third, the GOB has not yet agreed to drop its 
appeal in the US$1.1 billion court case, nor has it agreed 
to the six-month moratorium on payment of outstanding debt 
owed to government agencies.  Presidential Chief of Staff 
Jose Dirceu publicly characterized a recent meeting between 
VARIG, TAP, and high-level Lula administration officials on 
this issue as a "waste of time," federal attorneys who have 
reviewed the matter have weighed in against such a 
transaction.  Among other things, Dirceu and Finance 
Minister Palocci likely worry that if the government cuts a 
special deal for VARIG, it may face similar demands from 
both plaintiffs with similar lawsuits and recalcitrant 
debtors with just as compelling excuses.  For its part, 
VARIG reports that Dirceu has pledged that the GOB will 
analyze the carrier's proposal and respond within ten days 
after the June 2 meeting.  Meanwhile, VARIG says the GOB 
has released US$40 million in cash to allow the company to 
make its payroll. 
 
¶7. (SBU) Finally, even after the restructuring was 
completed, Neves told DSCO that the company would need to 
lay off 5,000 employees and gain access for four to six 
months to a US$100-150,000 line of cash per month.  And 
while the new airline would possess key national and 
international routes, it would also inherit a fleet of 
aging, high-maintenance aircraft, declining market share, 
and stiff competition from an increasing array of low-cost 
domestic carriers. 
 
¶8. (SBU) Comment.  There is ample reason to believe that 
the hour of reckoning for VARIG has arrived.  Unidentified 
VARIG officials have been quoted in the local press as 
stating that without a rescue package the airline won't be 
able to survive past year's end.  Neves was even more 
pessimistic, declaring that if the restructuring did not 
work the airline would only survive 30 days.  While VARIG 
certainly has an ulterior motive for emphasizing its dire 
straits, the tone of its contacts with the Embassy over the 
past few days has become increasingly desperate.  Whether 
the proposed restructuring will inject enough capital into 
the carrier to actually satisfy all the creditors will soon 
become apparent.  Now could truly be make or break time for 
the airline. 
 
¶9. (SBU) While Vice President Alencar -- the GOB's 
principal point man on VARIG issues -- has vacillated 
between a bail-out and the "let the market  resolve the 
situation" option, VARIG's selection of a new management 
team may well have precipitated its end rather than its 
rescue.  The new president of the company's Administrative 
Council is David Zylbersztajn, the son-in-law of former 
President (and now opposition leader) Fernando Henrique 
Cardoso.  Analysts here had worried that Zylbersztajn and 
his hand-picked team, members of which are closely 
associated with the PSDB - i.e., the rival party to the 
Lula administration, would set VARIG on a "collision" 
course with the GOB. 
 
¶10. (SBU) Who blinks first and the ultimate consequences 
for VARIG are still open questions.  While the demise of 
VARIG, for years the country's flagship carrier, would 
definitely be a bitter pill for the Brazilian public to 
swallow, the prospect of a cash-strapped government using 
public funds to heal a private company is medicine just as 
unpalatable. 
 
Danilovich