What happened
On Monday, Spirit Airlines (SAVE +0.00%) announced plans to combine with Frontier Group Holdings (ULCC +5.75%) to create a new U.S. discount titan. Investors are excited about the deal, sending Spirit shares up 27% for the week as of Friday morning trading.
So what
Frontier and Spirit have similar "ultra-low cost" business models, offering rock-bottom fares but few frills. And while there is some overlap, combining Frontier's western focus with Spirit's heavy East Coast and Caribbean exposure creates a more national carrier. The combined airline would be the fifth largest in the U.S.
Image source: Spirit Airlines.
Frontier is technically the acquirer here, and post-deal Frontier shareholders would control 51% of the combination. That means Spirit shareholders are getting the premium. Terms of the deal call for Spirit shareholders to receive 1.9126 shares of Frontier and $2.13 in cash for each share they own, giving Spirit an implied value that was about 20% above the stock's pre-deal close last week.
The resulting company would have the industry's lowest costs, and a combined 350-plane order that should help it to grow at a compound annualized rate of 12% through 2026.
Now what
The deal is subject to regulatory approval, which isn't a given in this current environment. The Department of Justice last year cast a skeptical eye on a proposed joint venture between American Airlines Group and JetBlue Airways, fearing a loss of competition.
But the DOJ's argument against the joint venture was, in part, that it makes JetBlue less likely to merge with another discounter to create a stronger discount brand. That's exactly what Spirit and Frontier intend to do, and given the combined airlines would still only control about 7% of the U.S. industry I think that the government will eventually give the deal the green light.
As a current Spirit shareholder, I'm excited about the opportunity to both get part of my investment back through the cash payoff but also keep exposure to the potential upside from the deal through the Frontier shares. The airlines are likely to face a lot of turbulence up ahead as they attempt to get the deal past regulators and begin the integration process, but for long-term focused investors there is a lot to like about this combination.
