The Lex Newsletter: US airline merger fight mirrors travel complexities

Dear reader,

Lex likes the idea of heading off on holiday this summer. But this writer doesn’t recommend studying the multitude of charges that make up the cost of a plane ticket.

No such luck for the shareholders of Spirit Airlines, the budget US carrier in the middle of a contested takeover battle now approaching a climax. It may be the most interesting M&A deal at the moment, this side of the Twitter boardroom.

On Thursday, Spirit shareholders are set to vote on a takeover by arch-rival Frontier, a transaction initially announced in February. The deal would give the combined company an equity value of more than $4bn.

Another US airline, JetBlue, however, crashed the proceedings in April with a blowout all-cash offer for Spirit. In normal circumstances, Frontier’s bid, reliant on realising cost synergies and subject to execution risk, would never have stood a chance against a full-priced takeout attempt such as JetBlue’s.

Yet, in reality, each offer for Spirit faces a decent chance of rejection by the US competition authorities. During the Biden administration, watchdogs have been extra-vigilant about allowing further industry consolidation.

As a result, the fight for Spirit is really being waged over termination fees, early prepayments and vague assurances by both Frontier and JetBlue that their respective bids are the ones that regulators would more likely prefer.

It would be perfectly reasonable for the Spirit board to reject both its suitors. Neither bid looks like a slam dunk to pass scrutiny and the distraction from a broken deal could be painful.

The deal that Spirit directors prefer, and which is up for a vote this week, calls for shareholders to receive roughly two shares of Frontier now worth about $19. In addition, there is a cash component worth $4.13 per share.

Those components would customarily not be paid out until the deal closes. However, because of the lengthy antitrust review that would follow, Frontier says it will pre-pay $2.22 immediately to Spirit shareholders. That cheque will come out of the $4.13 of cash owed to Spirit shareholders if the deal closes.

Lex should note that, as JetBlue and others point out, these cash payments are somewhat diluted. If the deal closes, the money comes from the combined NewCo, which Spirit shareholders would then half own.

If the deal does not land, then the $2.22 per share will be netted against the $350mn termination fee that Frontier has agreed to pay if the Biden administration successfully blocks the merger.

JetBlue has offered an even more convoluted set of cash flows. Not only would it offer a higher prepayment per share ($2.50) and more cash if the deal fails ($400mn), JetBlue promises to tack on a monthly cumulative fee from January 2023 for up to 18 months. This could add up to another $1.80 per share, whether the deal closes or collapses.

After totting up every optional payment, in the best-case scenario for Spirit shareholders JetBlue could pay them $34.15 per share, or a termination fee of $400mn (plus any added fee from the monthly tally).

If both these deals were equally likely to be rejected by regulators, the JetBlue deal is the better choice. The upfront payment is $2.50/share vs $2.22/share from Frontier. The gross termination fee of $430mn from JetBlue is larger than the $350mn that Frontier has agreed to pay.

Note that only Frontier has a signed merger agreement with Spirit and thus the shareholder vote this week. On the competition point, Spirit has pointed out that JetBlue is fighting with the US Department of Justice over an existing partnership with American Airlines.

Spirit shares are trading at about $23 per share, near the implied value of the Frontier bid but well below the JetBlue offer. That suggests that the market has doubts about JetBlue’s offer.

Whether Spirit gets a deal done and receives the full pay-off that comes with it will not be known for some time. Its shareholders will want to make the more than $2 per share on offer from Frontier last as long as possible.

May your holiday plans be less complex. Have a good week.

Sujeet Indap
Lex US editor