Executives at Varig and TAM stopped short of calling the deal a merger -- but analysts said that's essentially what it is.
"If they go down the path to merge and in fact they don't merge, it would be an expensive exercise with no benefit for either side," said Michael Miller, president of the Florida-based aviation consulting firm Miller Air Group. "In a down airline market, where there is overcapacity in virtually every region of the world, it makes sense to consolidate."
Together, Varig and TAM will carry more than 29 million passengers with a combined fleet of 218 aircraft. The carriers -- which together control 70 percent of Brazil's domestic aviation market -- didn't release financial or management details of their new enterprise, or even its name. The deal is expected to be finalized within six months.
"With this agreement, the companies affirm their mutual interest in looking for a solution together that begins with the restructuring of Brazil's civil aviation sector," they said in a statement.
Daniel Mandelli Martin, president of TAM, told reporters that exactly how the companies will combine forces is still undefined.
"The important thing is that we began the process, and this process will mean better operations for both companies," he said.
It was just last week that Varig -- saddled with $764 million in debt -- had one of its biggest jets impounded in Paris for failure to make lease payments.
It has been rumored for months to be seeking a deal with TAM and has made strenuous efforts to win a government bail-out.
Earlier this month, the privately owned Varig was asked by regulators to restate its financial results for 2001 and the first half of 2002 after $400 million in accounting irregularities were discovered.
Some $250 million was found to have been incorrectly classified as tax credits that the government reserves for new businesses, and $150 million in pension fund liabilities were reported incorrectly, regulators say.
The new figures regulators have asked Varig to report could push losses for the first half of 2002 from $288 million up to $556 million, analysts say.
"This may actually be a negative for TAM, since Varig is really on the verge of bankruptcy," Miller said. "It could bring both of them down at the same time."
Marcelo Ribeiro, an analyst with Rio de Janeiro-based Pentagon brokerage house, agreed that this deal alone probably won't save the companies.
"They will reduce costs, but it will not solve the problems of the capital structure of the companies," he said. "They need to improve their balance sheets. They will need an equity infusion."
Flavio Souza, the president of Apvar, the pilot's union at Varig, said he was confident Thursday's action indicated the companies will become one.
"It looks much more like an acquisition," Souza said. "Every acquisition usually starts like an operational merger."
"If you look at Varig's debts and the financial status of the airline, you'll probably come to a conclusion that this will lead much more to an acquisition than an operational merger."
One hurdle is Brazilian legislation that prohibits an airline from holding more than 50 percent of the domestic market.
But the fact that there were several government representatives on hand for Thursday's announcement indicated to Miller that a behind-the-scenes deal might be afoot.
"That leads me to believe that (the government) has already been apprised of this, which also could be troubling. There could be some moves made that may not be healthy," Miller said.
Ribeiro said that the managing structure of the airlines might make a full merger difficult.
"The controllers have very different views," he said. "I also believe that Varig and TAM have a deep-rooted desire to keep operating independently."
More than 80 percent of Varig's stock is held by the employee-controlled Ruben Berta Foundation, which has come under fire for its mishandling of the company.
In November the foundation rejected a debt-renegotiation deal that would have given Varig breathing room on its debts. That sparked the resignation of the entire board of directors.
Airlines in Brazil have been severely hurt by the 35 percent depreciation in the local currency. While earning revenues in local currency, airlines must pay for fuel and jet leases in dollars.
Trading in both Varig and TAM's shares was suspended on the Sao Paulo stock exchange Thursday, pending the announcement.