In February, ultra-low-cost airline leaders Spirit Airlines (SAVE 0.25%) and Frontier Group (ULCC -0.71%) agreed to merge to create the fifth-largest U.S. airline. However, JetBlue Airways (JBLU) jumped into the fray two months ago, offering to pay a big premium to buy Spirit Airlines.
After about a month of discussions between the two companies, Spirit Airlines' board rejected JetBlue's overtures and reiterated its support for the Frontier merger. For the past few weeks, JetBlue has been lobbying Spirit Airlines shareholders to vote against the Frontier merger. Meanwhile, it has launched a hostile takeover attempt, going directly to Spirit shareholders with a $30 per share tender offer, which it recently increased to $31.50.
Image source: Spirit Airlines.
This offer represents a 43% premium to Spirit Airlines stock's recent trading price. JetBlue also says that it would raise its offer to $33 if Spirit agrees to cooperate. Nevertheless, I have voted my Spirit Airlines shares in favor of the Frontier merger plan. Here's why.
High antitrust risk
As a Spirit Airlines shareholder, antitrust risk is the biggest reason I prefer the Frontier Airlines merger proposal over JetBlue's offer. JetBlue has said that it would merge Spirit into the JetBlue brand (and business model), which would eliminate the largest U.S. ultra-low-cost airline. That alone would likely give regulators pause, as JetBlue has much higher average fares than Spirit.
Furthermore, JetBlue and Spirit are the two largest airlines in Fort Lauderdale, Florida. Last year, they had a combined market share of over 50% there. No other airline held more than 13% of the market. While JetBlue has said it would divest some of Spirit's gates in Fort Lauderdale to promote competition, the combined airline would still dominate the airport, creating a virtual duopoly with American Airlines in the greater South Florida region.
Meanwhile, at Newark (New Jersey) Airport -- another of the busiest U.S. airports -- JetBlue and Spirit represent the main rivals to market leader United Airlines. Given that most other budget carriers have exited the Newark market, a JetBlue-Spirit combination could significantly reduce competition there, leading to higher fares.
JetBlue counters that Spirit and Frontier overlap on almost twice as many routes as JetBlue and Spirit. As a result, it argues that the Spirit-Frontier merger plan faces just as much antitrust risk as JetBlue's offer. But Spirit and Frontier typically overlap on busy routes with lots of other competition, whereas JetBlue and Spirit are the only airlines flying from Fort Lauderdale to numerous destinations.
JetBlue has acknowledged that U.S. antitrust regulators will likely sue to block the deal. It thinks it can win in court, but that would still delay the consummation of its tender offer until late 2023 or 2024. And if the merger is blocked, Spirit Airlines would at best get a $350 million breakup fee that wouldn't fully compensate it for two years of disruption and uncertainty.
Cash vs. stock
JetBlue is touting two major selling points for its acquisition offer over Frontier's merger plan. First, it has made an all-cash offer, whereas Frontier would mainly pay in stock. Second, its $31.50 per share tender offer far exceeds the current implied value of Frontier's offer (approximately $22).
However, for investors who are optimistic about airlines' recovery potential -- like me -- these aspects of JetBlue's offer are less appealing. Airline stocks have retreated significantly over the past year, due to concerns like soaring fuel prices and a labor shortage. Frontier Group stock has plummeted 49% over that period. Shares of JetBlue and Spirit haven't done much better.
Airline share price changes, data by YCharts.
If investors' concerns prove to be overblown (as I expect), airline valuations could recover over the next year or two. If Frontier shares were to reach $20 -- where they traded in the spring of 2021 -- the value of its merger proposal would jump to over $40 per share, easily eclipsing JetBlue's offer.
Choosing the better bet
Of course, Frontier Group stock could continue to struggle indefinitely. It's also possible that regulators could successfully block a Frontier-Spirit merger. Thus, spurning JetBlue's buyout offer in favor of the Frontier merger is no sure thing for Spirit Airlines shareholders.
That said, I think a Frontier-Spirit merger has a high likelihood of winning antitrust clearance. By contrast, I think a JetBlue-Spirit combination has a less than 50% chance of being approved. And even if JetBlue could win in court, Spirit Airlines shareholders wouldn't get their payment (other than a token $1.50 per share) until late 2023 or 2024. There's a good chance that the value of Frontier's offer would exceed $31.50 by then, driven by a recovery in its share price.
In short, Frontier Airlines' merger proposal seems like a better bet than JetBlue's alternative. The Frontier deal is more likely to be approved, and there is a strong likelihood that it will deliver greater value for Spirit Airlines shareholders in the long run.
