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No one likes making the wrong choice when deciding on an expensive trip. On Monday, a US federal judge nixed JetBlue’s all-cash buyout for Spirit Airlines, with an equity value of $3.8bn. The court decided that Spirit’s ultra-discount model was too important in the airfare marketplace to sacrifice in the deal. Instead of getting about $34 per share, Spirit equity holders have a piece of paper trading for $6.
Adding to the anguish, Spirit directors had a choice in 2022. The airline had initially signed up to a stock merger with Frontier Group, a similar deep discounter like Spirit. But the board, under heavy pressure from hedge funds, went for broke by taking a premium bid from JetBlue hoping against hope that it could push a deal past the US Department of Justice and eventually the judiciary. That wager has imploded spectacularly. It serves as a cold lesson in modern corporate governance and capital markets.
According to the court’s reasoning, JetBlue’s objective in buying Spirit was mostly about acquiring planes, pilots, routes and other infrastructure, rather than preserving its business model. The jilted Frontier had previously warned that the only way to make the JetBlue/Spirit combination work was to reduce Spirit’s capacity.
As for JetBlue, it has been searching for a way to keep up with the big four US carriers — American, United, Delta and Southwest — who through their own dealmaking now control 80 per cent of the domestic US market. Its shares rallied slightly on Tuesday after the ruling.
JetBlue will pay $470mn in total reverse termination fees through various interesting mechanisms. The Florida-based airline has already paid Spirit shareholders $2.50 a share upon the target’s successful shareholder approval vote. It separately has paid a 10 cent per month “ticking fee” to Spirit shareholders for a year. Spirit itself will only get $70mn.
Thanks to 2022’s deal wrangling, much of Spirit’s shareholder register now comprises merger arbitrage investors. These firms probably would not have supported a Frontier merger. Instead they wanted to play the long odds of a JetBlue all-cash takeover, along with the various interim payouts.
In the intervening two years, the US airline industry has suffered from the plateauing of the post-pandemic travel surge. At the same time, labour and operating costs have soared, creating greater impetus for consolidation.
Spirit’s market capitalisation is down to $700mn against a net debt load of $5.5bn, including leases. It could very well face bankruptcy. The Biden administration and others cheering the JetBlue decision should reflect on that possibility. Spirit’s cleanest remaining route might be the one originally forsaken: a tie-up with Frontier.
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