Acquisition Overview
JetBlue, a New York based low-cost airline, has agreed to purchase Spirit Airlines in an all-cash deal worth $3.8bn. JetBlue seek to continue on their path of ‘disruption’ by challenging the dominance of the ‘Big Four’ airlines, American, Delta, Southwest, and United, over United States domestic flights. The acquisition has been pitched as a cost cutting manoeuvre that will allow for much lower prices for travellers, without sacrificing the high level of service that JetBlue is known for. Moreover, it is hoped that the addition of Spirit’s strong position in Florida will allow JetBlue to challenge in the traditional Big Four hubs, most notably Atlanta and Chicago, with a view to potentially continue Westwards, towards the lucrative Californian market. This deal is one of many ‘megamergers’ that have typified the airline industry over the past few years, a trend that analysts expect to spread to Europe in coming years. Despite the pleas of executives, the Biden administration has taken a strong line on antitrust and, as a result, the Department of Justice have sued to block JetBlue’s proposed acquisition of Spirit.
Deal Structure
It is anticipated that the funding for this deal will ultimately be provided through debt financing. In the meantime, a $3.5bn bridge loan has been arranged by Goldman Sachs and Bank of America to provide the majority of the capital required for the deal to close. JetBlue will pay either $33.50 per share or $34.15, depending on when the deal is completed, representing an enticing premium of approximately 38%. Industry consensus seems to be that JetBlue are overpaying, yet this was perhaps necessary to pull Spirit out of merger talks with Frontier, a rival American ultra-low-cost airline. $2.0 per share will be paid upfront, followed by monthly payments of ₵10 from January 2023 onwards. Aware of potential antitrust issues, JetBlue have committed to paying Spirit a $70m reverse breakup fee and will pay $400m to Spirit’s shareholders if the deal falls through.
The financial advisors for each side are Goldman Sachs (JetBlue), Barclays (Spirit), and Morgan Stanley (Spirit).
JetBlue Overview
As a relatively recent entrant into the airline industry, Jet Blue have succeeded on a platform of low passenger cost combined with good travel experience. It may come as a surprise given the low fares that JetBlue’s fleet of A-320s allows for the most legroom of all US coach-class seats, for example. Despite being the 6th largest airline in the US, JetBlue’s routes remain almost entirely based around the North East, particularly its primary hub John F. Kennedy (JFK) airport, with transatlantic flights limited to New York and Boston.
In addition to legal issues over JetBlue’s acquisition of Spirit, the airline is also being sued for their codeshare agreement with American – the so-called ‘Northeast alliance – which has, it is alleged, increased fares and decreased flight choices.
Founded: 1998
Number of employees: 22,000
EV: $5.74bn
LTM Revenue: $9.16bn
LTM EBITDA: $349mn
Market Cap: $2.75bn
Spirit Overview
The 7th largest airline in the US, in terms of passenger numbers, Spirit Airlines is an ultra-low-cost airline, headquartered in Florida. Inspired by Ryanair, amenities are not a part of Spirit’s appeal, with most additional services involving an extra charge. Although the airline placed improving operations as a key priority in 2016, Spirit has struggled to shake their reputation as ‘America’s most hated airline’, a perception that was not helped by a series of meltdowns in the summer of 2021. Regardless, Spirit’s low fares have proven attractive to customers who do not want to, or cannot, pay the increased prices of a more ‘traditional’ carrier.
Founded: 1964 (as Clippert Trucking Company)
Number of employees: 12,000
LTM Revenue: $5.07bn
LTM EBITDA: $67mn
Market Cap: $1.84bn
Industry Insight
The past few years have been turbulent for passenger airlines. The COVID-19 pandemic halted almost all air travel and many companies have only recently returned to any semblance of profitability. Similarly, the war in Ukraine has had a twofold impact. The recent surge in the price of jet fuel, due to issues of both availability and refining, has eaten away at profit margins while total revenue has decreased due to lower disposable incomes. US airlines had, generally, outcompeted rivals from the rest of the world, and so this levelling of the playing field has been unwelcome. The fate of airlines during the pandemic years was largely determined by the extent of government aid they received and so some airlines which had been floundering have emerged in an improved relative position. Moreover, rising interest rates have challenged traditional methods of raising funding, with structured secured debt products formerly being typical. Private equity has, at least temporarily, filled this void.
However, we cannot attribute all airline woes to immediate geopolitical and environmental factors, which have always had drastic effects on the industry. The past 15 years have seen a series of large deals in the airline industry – most recently, in the US, Alaska Airlines acquired Virgin America for $4bn – motivated by necessity. Despite a romanticised history of flying, flying has become a much less appealing option for American travellers. Increased security, and consequently wait times, following 9/11 has reduced the appeal of flying. Staff shortages have resulted in the deterioration of customer experience and increased costs, while salaries have been forced up. Moreover, the last quarter of the 20th century was a period of airline deregulation. A burst of new, efficient airlines came at the expense of traditional carriers, many of whom declared bankruptcy, including Pan American World Airways (1991), United (2002), and Delta (2005). As a result, cost-cutting became a fixation, as investment waned; shareholders were rewarded with stock buybacks while customer service quality stagnated. Consequently, airline growth was limited while the aforementioned decline in the appeal of flying was compounded.
Mergers, then, seem to be the obvious answer to this issue. Scale is especially beneficial in the aviation industry. The industry’s hegemons are able to negotiate better deals on crucial goods, most obviously fuel and aircraft, and large networks offer more options to passengers than any variation of the ‘hub-and-spoke’ model can. Codeshare agreements and alliances can have similar, though lesser, effects yet do not present the same opportunities for network expansion as mergers. Although this trend has been most prevalent in North America, many, including Ryanair CEO Michael O’Leary, believe that Europe’s airline industry will shrink to a select few airlines. Despite the apparent advantages for the industry, the Biden administration has taken a harsh approach to consolidation in general, recently blocking Lockheed Martin’s $4.4bn acquisition of Aerojet Rocketdyne. Finally, the Democratic Party’s commitment to combatting climate change will undoubtedly affect the airline industry. At present, airlines are exempt from California’s carbon tax, for example, though pressure is mounting for increased taxation on these heavy emitters. Environmental regulations will only tighten, further decreasing margins.
Megamergers will be crucial for the survival of the airline industry. Although it is hard to imagine the largest providers failing, as there are too many vested interests wrapped up in their continued operation for that to realistically happen, the industry as a whole will need to cut costs in order to deal with environmental, personnel, and demand issues following the shock of recent events.
Strategic Rationale
JetBlue have positioned their acquisition of Spirit as a measure to increase the availability of good customer service at an affordable price. Refitting Spirit’s current fleet, above all improving legroom, will surely increase customer satisfaction on routes that are presently notorious for unpleasant flying experience. It is imperative that the Department of Justice comes to share this view in order for the deal to be completed. JetBlue have maintained that prices will drop for consumers, yet the removal of an ultra-low-cost competitor will reduce options in a number of important hubs. Although only 11% of JetBlue and Spirit’s routes overlap, it is hard to look beyond key hubs where there is considerable competition. Fort Lauderdale, for instance, has been scrutinised as the combined airline will constitute a majority of flights to and from the Florida city.
If the immediate legal obstacles to the deal can be overcome, the benefit to JetBlue is obvious. The $600-700m gained in synergies will help the airline to maintain profitability despite rising expenses. Equally importantly, both Spirit and JetBlue operate Airbus fleets. Given the low availability of new planes, this merger is one of the few ways that JetBlue can bolster their fleet. The acquisition of Spirit’s staff is also an important factor. As mentioned, airlines are facing an acute shortage of staff. The addition of Airbus-trained employees will allow JetBlue to increase capacity with minimal training, without having to attract new staff. This will allow JetBlue to accelerate their key strategic target of 1700 daily flights with minimal pain points.
Longer-term, JetBlue’s willingness to overpay for Spirit can be explained by the airline’s ultimate goal to challenge the Big Four. With the acquisition of Spirit, JetBlue’s market share would jump to 9%, placing them in the league of the Big Four who constitute a combined 80%. JetBlue, therefore, would be placed in a much better position to challenge in key interior hubs beyond the North East which will be essential for future growth. Geographically diversifying their portfolio would reduce JetBlue’s susceptibility to climactic and, on the state level, political issues. The North-East is plagued by snowstorms while the Democratic strongholds of New York and Massachusetts seem likelier than most to increase environmental restrictions.
The importance of scale for airlines cannot be understated and JetBlue’s acquisition of Spirit could allow them to considerably upsize the size of their operation, increasing efficiency. This would materially impact profitability, delivering value to JetBlue’s shareholders. The plan is bold, relying upon a favourable domino effect, beginning in Florida, the Mid-West, and the South-East, and concluding with Californian relevance.
Long-Term Prospects
Some analysts are sceptical that the projected synergies will ever be realised, or at least in a short enough timeframe. Further, legal issues may prevent the deal from ever being completed, an issue compounded by the Department of Justice’s action against American and JetBlue’s Northeastern Alliance. At this early stage, it is hard to comment on the outcome of the suit and it all depends on the DOJ’s acceptance of JetBlue’s argument that fares will be decreased, and that competition will actually be enhanced. Regardless, non-Big Four airlines will need to show a similar degree of ambition in order to survive long-term. Despite legal issues and doubts over the future prospects of the firm, JetBlue’s acquisition of Spirit may propel the former into the upper echelons of American air carriers. Megamergers have been, and likely will continue to be, necessary for airline survival: this is simply a particularly aspirational case.
Written by Thomas West (St John’s College, University of Oxford)
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