The U.S. airline industry experienced a decade of merger mania between 2005 and 2013, as nine airlines combined into the four megacarriers that dominate the industry today. However, since American Airlines completed its merger with US Airways in late 2013, the consolidation drive has cooled off, largely due to growing pushback by antitrust regulators. Only one significant deal was completed between 2014 and 2021: Alaska Air's acquisition of Virgin America.
That might be about to change. On Monday, leading ultra-low cost carriers Spirit Airlines (SAVE -2.90%) and Frontier Group (ULCC -5.36%) announced plans to merge. Let's see what this means for the two budget airlines and their shareholders.
A merger nine years in the making
Frontier's chairman, Bill Franke, has been interested in merging Spirit and Frontier for nearly a decade. In 2013, while serving as chairman at Spirit Airlines, he tried to convince the company to buy Frontier Airlines. When that didn't happen, Franke resigned from Spirit's board and his Indigo Partners investment firm bought Frontier while unloading its entire stake in Spirit.
In the following years, Franke and the Frontier Airlines leadership team (headed by former Spirit Airlines executive Barry Biffle) remade Frontier in Spirit's image, reducing its costs dramatically to boost its profitability. With both airlines converging on similar business models, merger speculation continued to swirl, but neither company made any concrete moves in that direction -- until now.
Under the deal announced this week, Frontier Airlines will buy its rival for total consideration of $6.6 billion, including assumed net debt and lease liabilities. Spirit shareholders will receive $2.13 of cash and 1.9126 Frontier shares for each Spirit Airlines share they own. This values Spirit Airlines shares at $25.83: a 19% premium to where they ended last week.
Image source: Spirit Airlines.
Assuming the merger is completed, Spirit Airlines shareholders will own 48.5% of the combined company, with Frontier Airlines shareholders holding the other 51.5%. That will allow both partners' owners to share in the merger's value creation potential.
Better together
Frontier Airlines and Spirit Airlines have good reasons for pairing up. First, both carriers serve expansive route networks relative to their size: especially Frontier, which flies to well over 100 destinations. By combining, the budget airlines would have greater schedule depth: i.e., more frequent flights and more connection options. This would help them compete in smaller markets. It would also make it easier to recover from operational disruptions.
Second, Spirit and Frontier have complementary geographical footprints. Spirit's route network is heavily concentrated in the eastern U.S., and the carrier has a strong position in Latin America and the Caribbean. By contrast, Frontier is based in Denver and has a much stronger route network in the western U.S.
Third, a Spirit Airlines-Frontier Airlines merger would give the combined company much more scale than either one has separately. That would unlock an estimated $500 million of annual synergies from procurement savings, operational efficiencies, and lower overhead.
Image source: Frontier Airlines.
Thus, the merger will help both airlines continue to grow while expanding their margins. That points to massive long-term earnings growth potential. However, investors must be prepared for some short-term volatility, as airline merger integrations hardly ever go smoothly.
Will regulators sign off?
Frontier Airlines and Spirit Airlines expect to close their merger in the second half of 2022. To do so, they will need to convince antitrust regulators to approve the deal. That won't be easy. Airlines have faced growing pushback over industry consolidation in recent years, due to fears that reducing the number of competitors will lead to higher fares.
Executives of both airlines disagree with that argument. They assert that merging will make the combined company an even more potent force holding down airfares.
Indeed, Spirit and Frontier compete on less than 20% of their routes today, so a merger wouldn't reduce competition in many markets. Furthermore, while the combined company would become the fifth largest U.S. airline, it would still be much smaller than the top four. Lastly, Spirit and Frontier have a strong incentive to keep fares low to attract new customers, so that they can continue growing rapidly.
Nevertheless, Frontier Airlines and Spirit Airlines shareholders can't assume that the merger will go through. As a result, investors should only buy shares of either company if they are confident in these airlines' stand-alone business plans.
