Low-cost airline consolidation as Frontier acquires Spirit

In a transaction worth 6.6 billion USD, the low-cost airline Frontier has agreed to purchase rival airline Spirit, with Spirit shareholders receiving a 19 per cent premium compared to the value of their shareholding before the announcement. Spirit shares were only trading up by 13% in midday trading, however, representing uncertainty about whether the deal will be completed. The companies hope to complete the transaction in the second half of this year, subject to regulatory approval. The current Chairman of Frontier, Bill Franke, will chair the newly formed company. He is an experienced investor in low-cost air travel, having made investments in and overseen other low-cost airlines such as Chilean airline Jetsmart, Hungary’s Wizz Air and Mexico’s Volaris. The name of the newly formed company and the management team are yet to be announced. If approved, this transaction would be the first airline merger to occur since Alaska Air purchased Virgin America in 2016.

The two businesses hope that the merger will allow the newly formed business to compete with the ‘Big Four’ US airlines: American, Delta, Southwest and United. They state that the cost synergies of the deal would allow the business to offer lower costs to consumers while also offering a greater diversity of locations and to locations underserved by airlines. Ted Christie, president and CEO of Spirit, says that “This transaction is centred around creating an aggressive ultra-low fare competitor… and increase competitive pressure, resulting in more consumer-friendly fares for the flying public.”

The deal will likely be subject to heavy scrutiny from competition regulators, who have expressed their intention of preventing mergers from taking place in the industry. However, much of their criticism has been directed towards the Big Four airlines, whose prices have been higher due to lack of competition, even when costs such as oil prices have not risen in the same way. The Big Four are estimated to control approximately 80% of the market for flights in the US. Therefore, this transaction may receive positive attention from regulators despite their previous statement, since a larger low-cost airline would create greater competition between the dominant airlines. Savanthi Syth, an airlines analyst at Raymond James, described how the Biden administration’s approach to mergers may have an impact on the success of the transaction: “in a normal environment we would not expect any regulatory hurdles but given the Biden’s administration’s ‘big is bad’ approach… we would expect some objection.” Nevertheless, research from Deutsche Bank predicts that the transaction will be approved by regulators, given that the merger is likely to be viewed as positive for the consumer.

Both Frontier and Spirit have undergone significant expansion in recent times. Frontier has targeted the routes and locations served by traditional airlines with lower prices to gain market share. Spirit has also followed the strategy of targeting the so-called ‘hub’ locations of traditional carriers. It is easy to notice the cost synergies that the new company will be able to realise, as the two businesses provide services on 520 overlapping routes, out of an approximate 2,800. Barry Biffle, CEO of Frontier, described how “Spirit is very strong in the East. Frontier is very strong in the West”, demonstrating the compatibility of the two businesses in terms of the consolidation. Both companies also only operate Airbus aircraft for their services, meaning that crucial business areas such as maintenance and plane purchasing will require little change from the two previous business operations. Low-cost airlines have also been able to demonstrate a stronger recovery from the pandemic than the Big Four airlines. This is because low-cost carriers receive much of their business from leisure travellers sensitive to ticket prices, whereas business travellers – the core customer base for the major airlines – have been slower to return to travel. This has meant that the total revenue of Spirit and Frontier for the final quarter of 2021 was only 2% lower than pre-pandemic conditions in 2019, which is closer to these previous levels than major airlines.

The operational benefits of a merger between Spirit and Frontier are obvious: cost synergies, a similar fleet and ownership of a market share in different areas of the US. These factors would allow the newly formed company to provide meaningful competition within the legacy airlines business, which would be welcomed by regulators. However, their concern about mergers creating potential monopolies may come to hamper this transaction, which appears to be the main cause of unease for investors. Therefore, it may be that the US government, as well as Frontier and Spirit, will decide the success of this transaction.

By Archie MacKechnie

Sector Head: Hortense Comon

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