Following a few intriguing moves in the past month, Spirit Airlines' (NASDAQ: SAVE ) cheap-ticket, high-fee model could be in for serious competition in a few years.
Spirit chairman William Franke, who pioneered the airline's highly profitable approach to flying, resigned his post after his Indigo Partners group sold a substantial stake in the airline. But Franke and Indigo turned right around and bought Frontier Airlines, a subsidiary of Republic Airways (NASDAQOTH: RJETQ ) The deal won't close until December, and given the time it takes to turn around an airline, Spirit and Allegiant Travel (NASDAQ: ALGT ) shouldn't sweat Frontier's competition for now. However, with a strong operator at its helm, other ultra-low-cost carriers could face a tougher rival in the future.
Republic dumps Frontier
Republic bought Frontier out of bankruptcy back in 2009, but it hasn't been able to turn the struggling airline into a winner even with record load factors. Indigo Partners is paying $36 million in cash for Frontier, and assuming more than $100 million of its debt.
Republic will now focus on far more profitable fixed-fee flights, operated under airline partner brands. Frontier's low-cost model didn't seem to fit in with Republic, considering the latter airline was unable to generate strong profits even with high load factors. Analysts expect Republic to earn roughly $1.60 this year, thanks in part to extra drag from Frontier's dismal numbers.
Impact on other ULCCs
For the time being, it doesn't appear that Frontier could have a major impact on Spirit or Allegiant, though additional competition in that sector wouldn't be good. When airlines compete head to head on price, the results typically haven't been stellar for the industry.
Analyst Hunter Keay of Wolfe Research noted that Frontier and Spirit only have an overlap of 3% on flights. The key for now is that Frontier still routes most of its flights through Denver, an ultra-competitive city in which both United Airlines and Southwest hold at least 25% market shares. Consider it evidence that stiff competition can lead to lower profits.
In addition, Frontier recently returned six Airbus planes to their lessors. Even if Indigo Partners chips in extra funding, it will take Frontier time to secure additional planes and routes. Analyst Keay found that it took Indigo nearly four years to transition Spirit into a ULCC with expanded departure cities. Naturally, Indigo might chose to avoid Spirit routes, but given Spirit's rapid growth, at some point the airlines must cross paths.
Frontier isn't small
For Q2 2013, Frontier generated revenues of $327.6 million for the quarter, even though that revenue fell 11.6% year over year. The company is actually larger than Allegiant, and only slightly smaller than Spirit Airlines. Franke's pinned his hopes of taking Frontier from $36 million to Spirit's $2.5 billion market cap on that vast difference in value.
Frontier is already moving toward the high fee concept; it's implementing a charge of up to $100 for carry-on bags on tickets purchased somewhere other than Frontier's website. The airline must make some changes considering it generated a record load factor of 93% in August, yet the 1.0 million passengers served for the month clearly weren't profitable enough to generate any value for Republic.
The air travel market is substantial, but don't expect the Frontier sale to impact the results of Allegiant and Spirit over the next couple of years. The ULCC airlines have been the fastest growers in the last couple of years, so it shouldn't surprise long-term investors that competition is picking up in this space. The good news is that it will take time to implement changes at Frontier. The bad news is that William Franke and Indigo Partners will likely make Frontier into a fierce competitor eventually.