Last July, Spirit Airlines (SAVE 1.12%) agreed to be acquired by JetBlue Airways (JBLU 0.28%). On the day its board of directors approved the deal, Spirit Airlines shares closed above $25. Since then, the stock has been in freefall, recently reaching a new multiyear low below $15.
Spirit Airlines stock trades for less than half of the planned acquisition price. While the federal government wants to block the merger, a recent decision in a separate antitrust case to block JetBlue's partnership with American Airlines (AAL 0.68%) makes it more likely that the Spirit-JetBlue merger will ultimately be approved. Moreover, moderating jet fuel prices bode well for Spirit's stand-alone profitability.
Trading at a deep discount
JetBlue has agreed to buy Spirit Airlines for $33.50 per share in cash, including $2.50 prepaid last year and an additional $0.10 per share (up to $1.80) paid each month until the deal is closed or terminated. The total payment can increase to as much as $34.15 if closing is delayed until next July.
Spirit Airlines stock has consistently traded at a steep discount to the deal price, reflecting the risk that regulators would scuttle the merger. Indeed, as expected, the U.S. Department of Justice (DOJ) sued to block the transaction in March. The Department of Transportation is also investigating the deal.
Still, the discount has expanded dramatically in recent months. As recently as January, Spirit Airlines stock was trading for around $20. It has lost a quarter of its value since then. This makes the stock look deeply undervalued.
The antitrust case just got a bit easier
Earlier this month, a federal judge sided with the DOJ in its challenge to JetBlue's Northeast Alliance (NEA) with American Airlines. Under that partnership, first announced in July 2020, the two airlines largely operate as a single entity in New York and Boston. They pool their gates and slots, sell tickets for each other's flights, and share revenue on flights to and from those key markets. Unless JetBlue and American successfully appeal the judge's decision, they will have to unwind the alliance in the next few weeks.
JetBlue's partnership with American Airlines was a key point raised by the DOJ in its complaint challenging the JetBlue-Spirit Airlines merger. The DOJ argues that the NEA essentially makes JetBlue a vassal of American Airlines. As such, the NEA and a JetBlue-Spirit merger together would have shielded the largest domestic airline from competition from two of its most significant low-fare rivals.
By contrast, if JetBlue and American walk away from the NEA, JetBlue is likely to resume its prior competitive positioning as a maverick in the U.S. airline industry. While that wouldn't fully address all of the DOJ's concerns, it would give JetBlue and Spirit a good chance of negotiating a settlement with regulators or prevailing at trial.
If the merger ultimately gains approval, Spirit Airlines shareholders would be in line for a $29.85 per share payout next year -- plus $0.10 monthly payments until then. Spirit Airlines stock is currently priced as if the JetBlue deal has no chance of being approved, which seems far too pessimistic.
Image source: Spirit Airlines.
Plenty of upside without a merger
Even if the DOJ succeeds in blocking the JetBlue merger, Spirit Airlines stock is likely to be worth far more than $15 in a few years. Last year, Spirit reported an adjusted loss of $1.74 per share, as strong demand couldn't make up for sky-high fuel prices, rising labor costs, and other inefficiencies.
Fortunately, jet fuel prices have moderated this year. For the current quarter, Spirit expects to pay about $2.60 per gallon on average, down from $3.64 in the prior-year period. That will allow the airline to post a modest profit, even though pilot staffing constraints and a shortage of spare engines are limiting aircraft utilization, thereby driving up non-fuel unit costs.
The engine availability issues are set to dissipate over the next year or so. And while hiring and training enough pilots remains a challenge, Spirit Airlines is on the right track after slowing its growth rate and raising pilot pay by an average of 34%. That should allow Spirit to return to its historical utilization and efficiency levels by next summer. The carrier is also modernizing its fleet, which should noticeably improve fuel efficiency over the next two years, while helping to further reduce non-fuel unit costs.
As a stand-alone company, Spirit is on pace to grow revenue to more than $7 billion by 2025. At a modest 8% adjusted pre-tax margin -- compared to the 11.9% it achieved in 2018 and 2019 -- it would generate earnings per share of roughly $4 by then. That would justify a share price well above today's level, making Spirit Airlines stock look drastically undervalued today.
