By Parker Davis
More On JetBlue’s Strategic, Financial Rationale for Spirit Airlines Offer
On Tuesday, news leaked that JetBlue had made a $3.6 billion takeover offer for Spirit Airlines, the Miramar, Fla.-based ultra-low-cost carrier that in February agreed to terms for a merger with close competitor Frontier Airlines.
The early announcement — in addition to a formal release from the airline after the market closed — led to a flurry of speculation as to what the airline saw in Spirit that led it to top Frontier’s offer. Frontier and Spirit have remarkably similar business models that rely on bare-bones base offerings augmented with fees for just about any auxiliary service, while JetBlue has touted its free WiFi, onboard entertainment and food and beverage offerings as hallmarks of its differentiated, though still low cost, product.
In addition, questions abounded as to whether JetBlue would be able to overcome scrutiny from the Department of Justice, which is already suing the airline and Fort Worth, Texas-based competitor American Airlines over renewed cooperation out of New York City and Boston that the carriers have taken to calling the Northeast Alliance.
One New Strategy
JetBlue has sought in recent years to continue to differentiate itself from the big four U.S. legacy carriers by offering lower cost tickets while still providing some complimentary perks to passengers. On routes it has entered to compete directly with its larger competitors, it has largely found a foothold by undercutting those carriers and looking to capture more price-sensitive travelers. It offers its cheapest tickets through its Blue Basic fare, its few-frills option that the carrier said comprises a “significant” portion of sales.
That strategy is not entirely different from ultra-low-cost carriers like Spirit and Frontier, and on a call Wednesday morning with analysts and members of the media, JetBlue CEO Robin Hayes looked to underline those similarities but stressed the proposed merger would benefit current Spirit customers when they took a flight on the combined airline.
The airline said in on the call that it would retrofit Spirit’s aircraft to resemble JetBlue’s, a move that would decrease the number of seats on the airline’s aircraft by 10-15%, according to JetBlue executives. As such, the airline would move away from Spirit’s ultra-dense configuration — from 180-182 seats on the Airbus A320 according to SeatGuru — to JetBlue’s, which is markedly less so. (The carrier features 162 seats on its most crowded version of the same aircraft.)
This transition would mean the airline would more likely shift entirely toward the JetBlue model, in many ways eschewing the ultra-low-cost structure that has brought Spirit both success and notoriety. This, of course, is in direct competition with Frontier’s plan, which would see a combined carrier devoted entirely to the future of the ultra-low-cost model.
Creating a New Competitor
JetBlue continues to put outsized focus on making clear its offer would create a more competitive marketplace for the routes on which it would operate. Similar to Frontier and Spirit’s previously agreed-upon merger, the combination of JetBlue and Spirit would create the U.S.’s fifth largest airline as measured by total seats.
In addition, and perhaps most crucial to JetBlue given its current hopes for growth, the combined airline would boast a substantially larger fleet and order book moving forward.
According to projections from the airline, it expects to have 346 aircraft — 100 Airbus A220s in addition 246 from the Airbus A320 family — by 2027. That includes a current order book of 156 aircraft and a desire to retire 60 Embraer E190 regional jets currently in the fleet. Those aircraft currently operate many of the airline’s high frequency routes in the Northeast, but JetBlue currently plans to phase them out between 2023 and 2026, replacing them with the A220.
Spirit brings to the table an order book that also includes 156 aircraft across the Airbus A320 family, which would help the projected fleet for a combined airline jump to 675 aircraft by 2027, 48% more than their combined operating fleets at the end of 2021. That growth dwarfs the 22% jump JetBlue is expecting on its own over the next six years and is at the front of the airline’s mind in its $3.6 billion offer. Airline executives noted multiple times on Wednesday’s call the difficulty in securing narrowbody aircraft in the short-term given high demand for the types worldwide.
A combined airline would also serve over 130 destinations, combining JetBlue’s current network of 98 destinations with Spirit’s 84.
JetBlue thinks the new airline’s size will be a critical piece of its mission to compete at a large scale with the four largest U.S. carriers. But as it faces a somewhat hostile Department of Justice, it is also looking at price competition as a likely sticking point for regulators to approve the deal.
Hayes said the airline would not be willing to give up its Northeast Alliance with American Airlines to appease the DOJ to help push the merger through. Hayes stressed that the airline’s entry into new markets has lowered ticket prices across the board, while the same is not true for ultra-low-cost carriers like Frontier and Spirit. The airline has not made data supporting that claim publicly available though said it would continue to work with regulators to illustrate that point should its proposal be accepted.
Frontier released a statement yesterday claiming just the opposite, likely hoping those concerns will prove to be a sticking point in Spirit’s board as it considers what is, purely in terms of valuation, a significantly better offer.
“Unlike the compelling Spirit-Frontier combination, an acquisition of Spirit by JetBlue, a high-fare carrier, would lead to more expensive travel for consumers,” a Frontier spokesperson said in a statement. “In particular, the significant East Coast overlap between JetBlue and Spirit would reduce competition and limit options for consumers. It is surprising that JetBlue would consider such a merger at this time given that the Department of Justice is currently suing to block their pending alliance with American Airlines.”
Hayes also said the airline is looking to growth at legacy airline hubs such as Dallas and Atlanta — two markets among many where Spirit has pushed its expansion in years past — as a key source of increased competition.
The airline also said the proposal includes a breakup fee JetBlue would pay to Spirit in the event antitrust regulators disallow the deal.
The Financial Question
JetBlue is already offering approximately 40% more than Frontier was slated to pay in its agreement with Spirit. But the airline has said this price is justified by the potential synergies — both lower costs and higher revenues — it sees in a combined carrier. JetBlue said today it projects these at $600-$700 million per year, approximately 4.5% of combined annual revenues. That would make it the third most-successful recent major U.S. airline merger with regard to synergies, behind only the America West-U.S. Airways and Delta-Northwest Airlines combinations.
Importantly, however, JetBlue CFO Ursula Hurley said on the airline’s call today that approximately $650 million figure is expected to materialize with all of Spirit’s aircraft operating in the JetBlue configuration, a process that could take years to complete.
Hurley said the airline expects to achieve 33% of those synergies in the first year of combination, a stark comparison to Frontier’s model, which actually accounted for negative synergies in the first year on account of increased integration costs. Because of those synergies, however, JetBlue was able to say it expects a merger with Spirit to be accretive in the first year after closing, meaning earnings per share would be higher than adding the two airline’s independent projections.
Even as the integration is ongoing, the airline will have to contend with higher costs. For the fiscal year ending December 2021, Spirit’s cost per available seat mile (CASM) totaled 6.74 cents excluding fuel and special items — those are often excluded to give a picture of what the airline’s base operations cost given fuel’s price variability and the unpredictable nature of one-time charges. JetBlue’s, however, sat at 10.11 cents, meaning the combined carrier may have to stomach a 50% jump in costs over time as it brings Spirit’s old aircraft into its fleet. (Frontier’s CASM excluding fuel was 5.96 cents for the same period.)
The airline said it expects debt to be approximately three times earnings before interest, taxes, depreciation and amortization — a common measure of operational profitability — upon closing, with that figure decreasing in the years to follow. It also said it would evaluate the cheapest financing path should the proposal be accepted and did not rule out raising equity to help raise cash for the deal.