Spirit Airlines (NYSE:SAVE) has been one of the most volatile airline stocks in 2020. On the one hand, Spirit is well positioned for an environment where demand is skewed toward bargain-hunting leisure travelers. On the other hand, its business plan is predicated upon rapid growth, and it has one of the weaker balance sheets in the industry due to its growth orientation.
This means that Spirit Airlines could return to profitability faster than most of its rivals once air travel demand rebounds in a meaningful way. However, this might not happen for many months (or even years), and the airline needs to survive in the meantime. As a result, Spirit Airlines announced plans to raise $600 million of new debt this week. And like several of its peers, it is turning to its loyalty program as a source of collateral.
Spirit's potential cash crunch
Spirit Airlines ended the second quarter with over $1.2 billion of cash and investments on hand. However, as of late July, it expected average daily cash burn of $3 million to $4 million during the third quarter. Based on the midpoint of that range, Spirit was in danger of violating some of its debt covenants by early next year.
While Spirit is eligible for up to $741 million of subsidized secured loans under the CARES Act, it only had about $600 million of traditional collateral available by the end of Q2. Given that the government will likely demand some margin of safety between the value of the collateral and the amount of any secured loan, the airline would need to find a lot of additional collateral to access the full $741 million.
Spirit is also in line for a substantial tax refund later this year, thanks to tax relief provided in the CARES Act. On the flip side, with the summer travel season winding down, demand is likely to decline sequentially in the months ahead, potentially leading to faster cash burn.
In short, Spirit Airlines was hardly in dire straits, but it didn't have much margin for error -- especially compared to peers that have raised enough capital to cover up to two years of cash burn.
Tapping its intangible assets
In the rush to shore up their balance sheets during 2020, several U.S. airlines have capitalized on the value of their loyalty programs and brands to raise cash. Now, Spirit Airlines is following suit.
On Monday, Spirit announced that it intends to raise $600 million of senior secured debt backed by its loyalty program, its $9 Fare Club membership program, and its brand. Spirit sought third-party appraisals for all three assets. The loyalty and $9 Fare Club programs were appraised at $1.9 billion combined, and the Spirit Airlines brand and related intellectual property were appraised at approximately $1 billion.
Despite the high estimated value of the collateral, Moody's rated Spirit's new debt offering three notches below investment-grade status, reasoning that if the carrier were to go out of business -- a worst-case scenario to be sure -- the collateral wouldn't be worth much. Still, the high valuation should reduce Spirit Airlines' borrowing costs. It will also enable Spirit to offer the government a second-lien claim on these assets as part of a CARES Act secured borrowing (if indeed the company still needs a federal loan).
Rays of hope
With an additional $600 million of cash rolling in, Spirit Airlines seems very unlikely to run low on cash. That's especially true because leisure travel may bounce back in a meaningful way by next summer, bolstering Spirit's bottom line. Furthermore, Spirit disclosed on Monday that revenue and expenses are both on track to come in better than expected this quarter, holding average daily cash burn near $3 million.
The carrier also noted that it will roll out long-awaited updates to the Free Spirit loyalty program and $9 Fare Club next January. And just last month, it extended its co-branded credit card agreement, securing better terms from Bank of America. Management expects the changes to boost annual cash flow from these programs to more than $200 million by 2024, up from $113 million last year.
If the COVID-19 pandemic takes a turn for the worse and it takes years to bring an effective vaccine to market, Spirit Airlines will undoubtedly face tough times ahead. But the airline's slowing cash burn and recent move to raise more cash should allow it to survive the pandemic-related downturn under most likely scenarios and return to growth thereafter.