After months of back and forth, Spirit Airlines(SAVE -12.26%) finally agreed to merge with JetBlue(JBLU -3.93%) to create the fifth largest airline in the United States. However, the deal still needs to pass shareholder and regulatory hurdles. Notably, the agreement creates a merger arbitrage -- a short-term investing strategy of buying stocks of companies trading below their acquisition price.
Here's what you need to know about the acquisition and why Spirit Airlines stock is worth buying even after the merger announcement.
The details of the merger
As part of the merger agreement, Jet Blue will acquire Spirit for $33.50, valuing Spirit at an enterprise value of $7.6 billion. Notably, Spirit shareholders will receive a prepayment of $2.50 per share in cash upon approval once they vote to approve the merger and whether or not regulators ultimately approve the deal.
In addition to the $33.50 per-share acquisition price, JetBlue plans on paying a "ticking fee" -- a fee imposed to compensate for a lag time -- of $0.10 per month starting January 2023 with a maximum price of $34.15 per share. JetBlue would pay out this ticking fee each month before the deal closes.
If regulators do not approve the deal, JetBlue will pay Spirit shareholders a $400 million break-up fee less any amount already paid prior to termination. Considering Spirit has about 112.4 million shares outstanding, each shareholder would receive about $3.55 per share total if regulators nix the merger. But again, JetBlue would deduct the prepayment of $2.50 and any prepaid ticking fee from the $3.55 if the deal is blocked.
As of this writing, Spirit Airlines stock is trading for about $24.50 per share, or 36% below its initial acquisition price. If the ticking fee increases the buyout price to $34.15, the stock is trading at a discount of 39%.
Still, investors will require patience to benefit from the merger arbitrage, with both companies expecting the deal to close "no later than the first half of 2024," meaning it could take up to two years to realize the gains fully.
Anytime your money is tied up in a merger arbitrage play, you want to consider the opportunity cost. For comparison, the historical annualized average return of the S&P 500 is about 10.5%, which would be significantly lower than the spread of the Spirit Airlines acquisition, even if it does take two full years to actualize.
Is Spirit Airlines stock a buy today?
JetBlue's management team has "high confidence" that the deal will pass regulatory hurdles because the merger will decrease net fare for consumers. In addition, the airliner has retained an antitrust expert to guide the approval process as the Department of Justice (DOJ) considers the effect on the airline industry.
Even if the deal does fall through, Spirit shareholders will receive about a 14% payout based on its current stock price. Therefore, investors should consider holding or buying Spirit Airlines shares for a 30%-plus potential upside and limited downside over the next year or two.