The eastern front: Chile's LAN is a top airline in the region, but what it really wants is to fly from neighboring Argentina

Stand in Concourse A of Miami International Airport any given weeknight, and Chilean airline LAN's supremacy is clear: The counters for a half-dozen airlines around the region are quiet while a huge line waits alongside the oversized LAN counter. That's because flights for company subsidiaries LanPeru, LanEcuador and LanDominica as well as LAN in Chile all leave from the same spot.

But LAN doesn't live on passengers alone, like many of its competitors. Cargo revenues regularly challenge passenger revenues for the airline. In fact, cargo revenues have grown at a quicker clip and the carrier wants to expand that business across the region. In 2003, cargo revenues hit US$602 million, a 16% rise from 2002. Passenger revenue rose 14% to $918 million during that period, but the carrier expects cargo revenues to carry even more weight in the future.

"LAN Chile isn't a traditional airline," says Alejandro de la Fuente, LAN's chief operating officer. "LAN combines two businesses: passenger and cargo, which are equally important. They complement one another, and the combination allows us to increase earnings while lowering operating costs."

LAN, however, faces a challenge in its neighboring skies. Earlier in 2004, Peruvian authorities clipped the carrier's wings there amid a battle for market share with Nuevo Continente. Both carriers are flying high in Peru today, yet LAN still can not fly within the one country with which Chile shares a significant border and which offers a big, fast growing air market--Argentina.

LAN has faced particularly rough times in Argentina. In June, LAN said it was considering buying American Falcon, an Argentine carrier; in the end, it chose not to. LAN has been stymied by strict regulations in Argentina--including a maximum foreign ownership cap of 49%--which the airline has said insulates Aerolineas Argentinas from competition. Aerolineas Argentinas, a unit of the Spanish holding company Marsans, already flies from Buenos Aires to Santiago.

Nevertheless, Chile's Aerolineas del Sur, also a Marsans investment, expects to battle LAN by flying domestic routes within Chile. Gustavo Manns, CEO of Aerolineas del Sur, doesn't see his airline as a bad thing for LAN or Sky, Chile's other domestic carrier. "The idea isn't that another airline dies," he says. "We believe that our arrival will help the airline market grow." Aerolineas del Sur seeks a 20% share in Chile by the beginning of 2006.

Sky Airlines wants to boost its domestic market share to 30% from 17% in a year and opposes Aerolineas del Sur the most. "We don't believe that in principle this entrance should be authorized in Chile, unless Argentina gives reciprocity to the Chilean airlines," says Jose Rebolledo, CEO of Sky.

Sky also would like to enter Argentina since the country offers more than three times the annual number of domestic passengers that Chile has, 7 million compared to 2.2 million, although it has been discouraged by LAN's own straggle to enter that market, Rebolledo says.

LAN flies to Argentina, and the carrier plans to control assets there within a year. The deal with American Falcon should have been the doorway in for LAN. "We have to look for a partner that is disposed to support us in entering this market, since the restrictions and the capital investment must be principally Argentine," says de la Fuente.

Three's a crowd. Most airlines would envy LAN's problems. The airline has a 40% to 60% cost advantage over its regional competitors due to efficiency improvements on its routes and processes, according to a Merrill Lynch report. LAN's cargo business represents 40% of its sales, making the airline more like Asian carriers. The model is difficult for LAN's competitors to imitate and has given the airline the diversification that protects it against the pitfalls of such a low-margin industry.

LAN will maintain its dominant grip in Chile in part because it caters to business clients while Sky and Aerolineas del Sur will compete heavily on price, says Stephen Trent, vice president of Latin American equity research at Citigroup Smith Barney. Cargo is a natural hedge against high jet-fuel prices, while a rebound in the Southern Cone could help LAN maintain supremacy in its backyard. It has an 83% market share at home, Trent argues.

"If you look at the history of Chile's airline market, throe is a crowd," he says. "It's been LAN Chile and some other competitor because one of the two marginal players has disappeared. And I don't see anything that makes me believe that this will be any different."

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