The US airline industry experienced a decade of manic mergers between 2005 and 2013, as nine airlines coalesced into the four megacarriers that dominate the industry today. However, since American airlines completed its merger with US Airways in late 2013, the consolidation trend has slowed, largely due to growing pushback from antitrust regulators. Only one significant transaction was concluded between 2014 and 2021: Alaska Airthe acquisition of Virgin America.
That could be about to change. On Monday, major ultra-low-cost carriers Spirit Airlines (NYSE: SAVE) and Frontier Group (NASDAQ: ULCC) announced its intention to merge. Let’s see what this means for the two low-cost airlines and their shareholders.
A merger in the making for nine years
Frontier President Bill Franke has been interested in the merger of Spirit and Frontier for nearly a decade. In 2013, when he was president of Spirit Airlines, he tried to convince the company to buy Frontier Airlines. When this did not happen, Franke resigned from Spirit’s board and his investment firm Indigo Partners bought Frontier while offloading its entire stake in Spirit.
Over the next few years, Franke and the Frontier Airlines management team (led by former Spirit Airlines executive Barry Biffle) remade Frontier in Spirit’s image, dramatically cutting costs to increase profitability. As the two airlines converge on similar business models, merger speculation has continued to swirl, but neither company has taken any concrete steps in that direction – until now.
Under the deal announced this week, Frontier Airlines will buy its rival for total consideration of $6.6 billion, including net debt and assumed lease liabilities. Spirit shareholders will receive $2.13 in cash and 1.9126 Frontier shares for each Spirit Airlines share they hold. That values Spirit Airlines shares at $25.83: a 19% premium to where they ended last week.
Assuming the merger is completed, Spirit Airlines shareholders will own 48.5% of the combined company, with Frontier Airlines shareholders owning the remaining 51.5%. This will allow the owners of both partners to share in the value creation potential of the merger.
Frontier Airlines and Spirit Airlines have good reason to partner. First, both carriers serve large route networks relative to their size: particularly Frontier, which flies to more than 100 destinations. By combining, low-cost airlines would have greater schedule depth: that is, more frequent flights and more connection options. This would help them compete in smaller markets. It would also facilitate recovery from operational disruptions.
Second, Spirit and Frontier have complementary geographic footprints. Spirit’s route network is heavily concentrated in the eastern United States, and the carrier has a strong position in Latin America and the Caribbean. In contrast, Frontier is based in Denver and has a much larger route network in the western United States.
Third, a Spirit Airlines-Frontier Airlines merger would give the combined company much more scale than either separately. This would unlock approximately $500 million in annual synergies through procurement savings, operational efficiencies and reduced overhead.
Thus, the merger will help both airlines continue to grow while expanding their margins. This indicates huge potential for long-term earnings growth. However, investors should be prepared for some short-term volatility, as airline merger integrations almost never go smoothly.
Will regulators approve?
Frontier Airlines and Spirit Airlines plan to complete their merger in the second half of 2022. To do so, they will need to convince antitrust regulators to approve the deal. It won’t be easy. Airlines have faced a growing pushback from industry consolidation in recent years amid fears that fewer competitors will lead to higher fares.
The executives of the two airlines do not agree with this argument. They claim the merger will make the merged company an even more powerful force in reducing airfares.
Indeed, Spirit and Frontier compete on less than 20% of their routes today, so a merger would not reduce competition in many markets. Additionally, while the combined company would become the fifth-largest US airline, it would still be significantly smaller than the top four. Finally, Spirit and Frontier have strong incentives to keep prices low to attract new customers, in order to continue their rapid growth.
Nevertheless, the shareholders of Frontier Airlines and Spirit Airlines cannot assume that the merger will materialize. Therefore, investors should only buy shares of either company if they are confident in the stand-alone business plans of these airlines.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.