Just a few months ago, LATAM Airlines (NYSE: LTM) and American Airlines (NASDAQ:AAL) seemed to be on track to finalize a joint venture agreement covering travel between the U.S. and South America by the end of 2019. But in late May, Chile's Supreme Court blocked the two carriers from cooperating in Chile, citing the dominant market position they would have.

Initially, LATAM and American said they would proceed with their joint venture plans for the rest of South America, leaving Chile out. (LATAM is also the biggest airline in Brazil and has smaller subsidiaries in several other countries.)

However, Delta Air Lines (NYSE:DAL) saw this setback for the American Airlines-LATAM joint venture as a can't-miss opportunity. Last Thursday, Delta announced that it would buy a 20% stake in LATAM for $1.9 billion as a prelude to forming a full joint venture with South America's largest airline. This move will further entrench Delta's position as the most profitable of the three U.S. legacy carriers.

A Delta Air Lines plane landing on a runway

Delta will take a 20% stake in LATAM Airlines and the two carriers plan to form a joint venture. Image source: Delta Air Lines.

A comprehensive agreement

Under the deal announced last week, Delta Air Lines and LATAM Airlines will form a comprehensive strategic partnership. Later this year, they will begin codesharing, allowing customers to make seamless connections between the two airlines. Delta and LATAM will also apply for antitrust immunity so they can form a joint venture. That would allow them to coordinate schedules and pricing to maximize the profitability of existing routes and make new routes viable. The two carriers would share the revenue and costs from the joint venture, encouraging close cooperation.

Whereas American Airlines and LATAM are the top two airlines for flights between the U.S. and Latin America -- which ultimately caused their joint venture plan to be blocked in Chile -- Delta is currently the No. 4 airline between the U.S. and South America. As a result, the chance of a regulatory challenge is much lower. Delta's management believes it will take 12 to 24 months to receive regulatory approval and implement the joint venture.

The agreement also calls for Delta to buy four Airbus A350s from LATAM and take over 10 of the latter's A350 orders. This will help LATAM rationalize its fleet and reduce future capex. Delta will receive these 14 widebodies between late 2020 and 2025.

An Airbus A350 flying in front of a cloud

Delta Air Lines will take over 10 A350 orders from LATAM. Image source: Airbus.

Finally, Delta will solidify the partnership by spending $1.9 billion to buy 20% of LATAM through a public tender offer at $16 a share, a huge premium to the recent stock price. This will entitle it to representation on LATAM's board. Delta also expects to invest about $350 million to ease LATAM's transition away from the oneworld alliance (anchored by the likes of American Airlines, British Airways, Cathay Pacific, Qantas, and Japan Airlines). LATAM does not plan to join Delta's SkyTeam alliance, though. Going forward, it will be an unaligned carrier.

What this means for Delta

Delta Air Lines' management thinks that partnering with LATAM will be worth every penny it is spending. The carrier already has a leading position in the transatlantic market, thanks to joint venture arrangements with Air France-KLM and Virgin Atlantic. It is a strong No. 2 across the Pacific, helped by joint ventures with Korean Air and Virgin Australia and a partnership with China Eastern Airlines. By contrast, it has a comparatively weak market position in South America today.

Last year, Latin America accounted for just a quarter of Delta's international revenue. Within the region, Delta's business is heavily weighted toward flights to Mexico (where it has a joint venture with Aeromexico) and the Caribbean. Between the U.S. and South America, Delta trails American Airlines, LATAM, and United Airlines in market share.

By forming a joint venture with the region's largest airline, Delta thinks it can grow its top line in Latin America by $1 billion over the next five years. Additionally, because LATAM will be able to provide connecting traffic in key markets like Sao Paulo and Santiago, Delta expects its margins in the region to go from below average to above average.

Delta's rivals are falling further behind

American Airlines tried to put on a brave face about the Delta-LATAM announcement. It stated that its current partnership with LATAM provides less than $20 million of incremental revenue annually and that there would have been limited upside from forming a joint venture that excluded Chile.

However, this understates the likely impact of LATAM's decision to partner with Delta. Latin America is the one region of the world where American Airlines is unquestionably stronger than Delta today. Once the latter has access to LATAM's full network, that will no longer be the case. As a result, Delta Air Lines will have an even more compelling case to make to businesses and frequent flyers to switch their loyalty to Delta.

For the same reason, the planned Delta-LATAM joint venture could also hurt United, which would fall back to last place among the three U.S. legacy carriers in terms of service to Latin America. Thus, while Delta Air Lines is paying a high price to pry LATAM away from American Airlines and the oneworld alliance, the long-term gains for Delta could be substantial.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.