Frontier-Spirit Merger Shakes up U.S. ULCC Market
The ultra-low-cost-carrier model in the U.S. got a big boost last week. Frontier Airlines and Spirit Airlines unveiled plans to merge in a deal that would create a U.S. budget juggernaut to be reckoned with.
The merger would create the fifth-largest carrier in the U.S. serving 145 destinations in 19 countries with 283 aircraft. Frontier shareholders, particularly its majority owner Indigo Partners, would own 51.5 percent of the resulting company despite Spirit being the larger airline. The merger has been approved by the boards of both carriers after talks began late last year, but is subject to the approval of a Biden administration increasingly wary of consolidation. The airlines hope to close the transaction in the second half of 2022.
The transaction is valued at $6.6 billion, including the $2.9 billion equity value of Spirit as well as net debt and operating lease liabilities. Spirit shareholders would receive 1.9126 shares of Frontier plus $2.13 in cash for each of their shares. And the airlines forecast $500 million in annual revenue synergies after $400 million in merger-related integration expenses.
Frontier operated 110 A320 family aircraft and Spirit 173 aircraft at the end of December, according to the carriers’ respective fleet plans. Frontier had firm orders for 58 A320neos and 176 A321neos, and Spirit for 31 A319neos, 63 A320neos, and 26 A321neos — a combined total of 354 aircraft — at the time, Airbus data show.
A Spirit-Frontier deal has long been seen as likely. Only the timing came as a surprise. The carriers come from the Indigo flock, which built Spirit into the airline it is before selling the company in 2013 when it acquired Frontier. Both fly complementary fleets of A320-family jets and aim to stimulate leisure travel with cheap, point-to-point flights.
Frontier and Spirit would jump ahead of Alaska Airlines and JetBlue Airways in the U.S. if the combination is approved. They would have a 6.5 percent share of U.S. passengers based on 2019 numbers, according to U.S. Bureau of Transportation Statistics (BTS) data. Their share grew to 8.3 percent of the market during the first 10 months of 2021, the latest BTS data show. The airline would remain behind American Airlines, Delta Air Lines, Southwest Airlines, and United Airlines, which together control more than three-quarters of the U.S. market. It is the first major airline merger in the U.S. since the combination of Alaska and Virgin America in 2016.
“This transaction is centered around creating an aggressive ultra-low fare competitor to serve our guests … and increase competitive pressure, resulting in more consumer-friendly fares for the flying public,” said Spirit CEO Ted Christie.
The deal comes at a time when the ULCC model is ascendant. In January, Airlines for America (A4A) Chief Economist John Heimlich highlighted the sector’s market share gains to roughly 15 percent of U.S. air travelers in the first half of 2021 from just 11 percent in 2019. He called this a “significant shift” in the market and coming at the expense of the legacy and hybrid carriers in the market. Other U.S. ULCCs include Allegiant Air and Sun Country Airlines, as well as startup Avelo Airlines.
Both Frontier and Spirit have recovered faster from the coronavirus pandemic than many of their competitors owing to the strength of leisure traffic. The airlines’ combined passenger traffic numbers were down just 2 percent in the final quarter of 2021. And their combined capacity was up 7 percent year-over-two-years.
Frontier and Spirit’s proposed combination will come under the U.S. Justice Department’s (DOJ) microscope. The department, along with the Federal Trade Commission, has taken a firmer line against mergers in large industries since the Biden administration took office in 2021. Speaking in January, President Biden spoke out against monopolies in key industries and said “capitalism without competition is not capitalism, it’s exploitation.” A Spirit-Frontier merger, while creating a stronger budget airline, would also eliminate one competitor from the already highly-consolidated U.S. airline market.
“This is not about reducing competition and raising fares, this is about getting more low-fares to more people in more places,” Frontier CEO Barry Biffle said during an investor call last week. “We’re excited to tell our story to [regulators] and we think it will be well received.”
Frontier and Spirit executives repeatedly touted the merger’s consumer benefits during the call. They forecast $1 billion in annual consumer savings from the additional flight options and strong competitive position of the resulting airline in the marketplace. And Biffle said the merged carrier could serve more smaller cities with limited or no budget competition today, including Eugene, Ore., Ithaca, N.Y., and Worcester, Mass.
“Them merging is not going to increase their ability to pick up passengers,” said Shakeel Adam, managing director at airline advisors Aviado Partners, on the potential network expansion. By his measure, if the combined carrier could serve any of the three cities named, so could Frontier and Spirit today given the point-to-point nature of their networks.
Biffle acknowledged that the airlines will need DOJ approval for their merger. The regulator, in a recent signal of its pro-competition stance, challenged American and JetBlue’s Northeast Alliance in court in September.
Jonathan Kanter, who leads the antitrust division at Justice, has taken a firm stance against mergers that could reduce competition. In January, he said the department would “seek a simple injunction to block” any transaction it deemed would “lessen competition.”
While there was initial widespread skepticism over whether the DOJ would green light the Frontier-Spirit merger, Wall Street analysts view the deal as likely to get approval. Savanthi Syth, an analyst at Raymond James, initially wrote that the merger would likely raise “some objection” from antitrust officials but, later the same day, updated her view saying she did not expect any “deal-breaker” requirements from regulators.
“Justice is going to put them through the wringer,” said Kenneth Quinn, a partner at Clyde & Co. who specializes in regulatory and antitrust aviation legal matters, but added that they will be “hard pressed to challenge this transaction.” He cited Frontier and Spirit’s limited network overlap and their large operations at airports with few barriers to entry.
Multiple sources familiar with the regulatory approvals process expressed views that any acquisition involving the Big 4 — American, Delta, Southwest, or United — would be dead on arrival in Washington, D.C., but that the combination of two smaller airlines would likely make it through.
The merger agreement gives the parties until February 5, 2023, plus automatic extensions to February 5, 2024, to secure regulatory approval of the deal. If the deal collapses, Spirit must pay Frontier a $94 million cash termination fee.
William Franke, the chair of Frontier’s board and managing partner at Indigo, will lead a committee to determine the resulting airline’s leadership, as well as its name and where it will be headquartered. Speaking last week, Franke said the committee would undergo a “thoughtful [and] careful” analysis to determining these items, and unveil their decisions closer to the transaction’s close date.
“They’re both exceptionally good CEOs,” Franke said referring to Biffle and Christie. “It’s not an easy process but we’ll go through it.”
Executives of both airlines said that the merger would not result in any job losses. They promised 10,000 new “direct” jobs — or ones at the new carrier rather than a contractor — by 2026 if approved. And in separate letters to flight attendants and pilots at Frontier, executives said the carriers planned to maintain and expand all of their current crew bases.
Frontier employed 5,502 staff, and Spirit 10,433 people at the end of December, BTS data show. That represents an 11 percent year-over-two-years increase for the former, and a 16 percent increase for the latter.
Adam questioned the airlines’ promise to keep all current staff. One of the key synergies of any merger is the ability to reduce redundant staffing, for example management positions or front line airport staff, he said.
Labor costs are one concern raised about the deal. U.S. airlines already face a pilot shortage that is unlikely to let up this year and, with the significant growth planned, Frontier and Spirit are likely to face pressure to raise pay rates to attract new staff. First officers start at $58 an hour at both carriers, which is at least 31 percent less than at the Big 4, according to data from Cowen & Co. “Competing for the same pilot pool means wage rates are likely to increase,” wrote Cowen analyst Helane Becker on the merger.
Sara Nelson, president of the Association of Flight Attendants-CWA union that represents cabin crew members at both Frontier and Spirit, said last week that the union’s focus would be “on a review to determine whether we support this merger based on making sure it would benefit flight attendants.”
“Once you see what it does for both sides it becomes obvious: This is a very complementary transaction,” said Christie.