By Yair Trachtenberg, Ismael Fathy Martínez, Nikita Bezverkhniy, Markus Walter, and Julia Donato (ESADE), Justin Leung, Ryan Chan, and Jack Lee (Hong Kong University of Science and Technology)
Photo: Forsaken Films (Unsplash)
Overview of the deal
Acquirer: Frontier Airlines
Target: Spirit Airlines
Total Transaction Size: $6.6B
Closed date: Second-half 2022
Acquirer advisor(s): Citigroup Global Markets
Target advisor(s): Barclays, Morgan Stanley
Spirit Airlines (NYSE: SAVE) and Frontier Group Holdings, Inc. (NASDAQ: ULCC), the parent company of Frontier Airlines, announced plans to merge in a deal valued at $6.6 billion, and the combined entity would create one of the largest and most competitive low-cost carrier airlines in the world. It will also become the fifth largest airline in the United States, behind the “Big 4” airlines - American, Delta, United, and Southwest.
Originally two separate leaders in the ultra-low-cost carrier (ULCC) segment and direct competitors, the key advantage will eliminate their top competition, each other. With more aircraft and manpower, the combined entity will expand its route network with additional flights and new destinations across the United States, Latin America, and the Caribbean at lower prices and higher service reliability. Amid recent surging fuel prices and operational disruption due to the pandemic, the entity will benefit tremendously from cost synergies, especially considering the historically low-profit margins in the industry.
Under the terms of the deal, Frontier Airlines will obtain a 51.5% controlling stake, and Spirit shareholders, who will receive 1.9126 shares of Frontier with $2.13 in cash for each share, will own 48.5%.
“Everybody wins through this transaction. Customers are going to win with a billion dollars in savings, our shareholders win with $500 million in synergies, and our team members win with 10000 more direct jobs in the next couple years.” - Barry Biffle, CEO (Frontier)
Company Details (Acquirer - Frontier Airlines)
Frontier Airlines is an American ultra-low-cost carrier headquartered in Denver, Colorado. Frontier operates extensive services across the US and Central America, with flights to over 100 destinations throughout the United States and 31 international destinations. Acquired from Republic Airways Holdings in 2013, the carrier is a subsidiary and operating brand of Indigo Partners, LLC. The firm maintains a hub at Denver International Airport with numerous focus cities across the US.
Founded in 1994, headquartered in Denver, Colorado, USA
CEO: Barry L. Biffle
Number of employees: 5502
Market Cap: $2.455B (as of 27/03/2022)
EV: $4.36B
LTM Revenue: $2.06B
LTM EBITDA: -$434M
LTM EV/Revenue: 2.1x
LTM EV/EBITDA: -10.0x
Company Details (Target - Spirit Airlines)
Spirit Airlines, Inc. is a low-cost airline company headquartered in Miramar, Florida, that provides travel to its consumers. It operates in markets such as South Florida, the Caribbean, Latin America, and the United States Northeast and Northern Midwest regions. The company also provides travel insurance, carry-on and checked baggage, online booking, and other services. Ned Homfeld created the company in 1964.
Founded in 1983, headquartered in Miramar, Florida, USA
CEO: Edward M. Christie
Number of employees: 8.938 (2020)
Market Cap: 2.37B$ (as of 27/03/2022)
EV: 6.01B$
LTM Revenue: 3.23B$
LTM EBITDA: -134.1M
LTM EV/Revenue: 1.86x
LTM EV/EBITDA: -44.2x
Projections and Assumptions
Short-term consequences
The Frontier-Spirit merger would be the first merger of large U.S. airlines since Alaska acquired Virgin America in 2016. However, with airlines being one of the most scrutinized industries by antitrust regulators and Biden’s strong opposition to oligopolies, uncertainties of the deal are still considerable. The merger would create the U.S. fifth largest airline, securing 8.6% of the U.S. domestic market if approved, surpassing mid-size competitors like Alaska and JetBlue. The deal is crucial for the airlines to consolidate their market position and raise margins as they change from competitors to collaborators. More importantly, the airline industry is still recovering from the pandemic. Less competition and potential route overlap aid both Frontier and Spirit to better utilize their resources before achieving pre-pandemic demand. The merger also allows instant consolidation of loyal passenger bases, drawing Frontier customers to Spirit’s destinations and vice versa.
The merger announcement spurred up Spirit’s stock price by 17% to $25.46, nearly reaching the implied value of $25.83 paid by Frontier to Spirit. On the other hand, Frontier’s stock price has risen by 3.5% to $12.82.
The deal is estimated to be closed in the second half of the year. At this point, the new entity has not disclosed its branding, management, and headquarters location.
Long-term Upsides
The merger aims to save consumers an annual amount of $1 Billion by becoming an “aggressive ultra-low fare competitor” and expanding its services. Therefore, both companies expect to benefit from significant cost/ revenue synergies which emerge from leveraging their complementary networks. Once the firms complete full integration, they anticipate their annual run-rate operating synergies to be worth $500 million. Further savings of $400 million in one-time costs will occur through scaling efficiencies. By the end of 2024, Frontier and Spirit are looking at a strengthened financial profile with approximately $2.4 billion in cash balance.
An article by Mckinsey indicates that growth prospects for the air transportation industry are very uncertain. The post-pandemic recovery of the air travel industry relies on its recovery from the economic fallout and the recovery of demand, which will only occur by 2024.
There are also further upsides from an environmental perspective. Their combined fleet will impact their agenda of becoming the ‘world’s greenest airline’ with hopes of making air travel possible in the most carbon-efficient way. This claim is due to advanced engine technology, which is fuel-efficient and has a lower noise footprint.
Risks and Uncertainties
Following the announcement by Frontier Airlines on their acquisition of rival budget airline Spirit, there has been an instant fear of it falling under scrutiny by antitrust enforcers. It is rumored to have a high likelihood of it happening. This is not something new, as we have seen an administration that increasingly takes mergers to court due to the suspicion of their plans to clear their competitive scheme and have higher control over pricing power. An example of this is when the Justice Department sued to block the alliance between American Airlines and JetBlue Airways specifically with the same intention. The merger would create the biggest ultra-low-cost airline in the U.S. and the fifth-largest airline. The primary risks from the transaction are higher ticket prices, lower customer service, and reduced worker leverage. If we look at public opinion, we come across some concerns related to its problematic customer service. However, according to aviation analytics firm Cirium, the merger would not be sufficiently deterministic in terms of impact on competitors for passengers since they only combine 18% of their routes. This is even though the deal muscles out smaller competing firms from the market segment that was once competitive.
“This merger is completely different than everything else you've seen in the industry for the last 20 years” - (Barry Biffle, CEO of Frontier)