Last July, JetBlue Airways Corp. (JBLU, Financial) reached an agreement with Spirit Airlines Inc. (SAVE, Financial) to acquire the company for $3.8 billion, creating the fifth-largest airline in the United States.
Even though the company had to tap capital markets in order to fund the transaction, the news sent JetBlue's shares higher due to the cost and revenue synergies expected from the combination.
The deal may be in jeopardy, however, as reports emerged on March 6 that two U.S. regulators are planning to block the transaction.
Then, on March 7, the U.S. Department of Justice filed an antitrust lawsuit alleging the deal would distort the competition in the ultra-low-cost airline industry. Further, the Department of Transportation is expected to block the transfer of Spirit’s airline operating certificate to JetBlue on the grounds the deal is not in the best interests of the public.
According to the terms of the agreement, failure to complete the transaction will result in JetBlue paying over $400 million to Spirit and its shareholders.
In a statement pledging to fight back against any regulatory action to block the deal, JetBlue CEO Robin Hayes said:
"Customers deserve a competitive airline marketplace and we will pursue this merger to ensure they get it, continuing to disrupt the legacy airlines with low fares and award-winning service that even the DOJ has applauded. We believe the DOJ has got it wrong on the law here and misses the point that this merger will create a national low-fare, high-quality competitor to the Big Four carriers which – thanks to their own DOJ-approved mergers – control about 80% of the U.S. market. There is too much at stake for the DOJ to prevent us from bringing the JetBlue difference to more customers in more markets."
Despite the potential for financial losses in the form of break-up fees, the market took this news in stride by sending JetBlue shares higher, which suggests investors may believe the company is better off without Spirit.
Balance sheet health in the spotlight
The proposed combination raised the eyebrows of many JetBlue investors since it will have an impact on the company’s balance sheet. At the time of the deal's announcement, JetBlue carried net debt of around $1.3 billion, but the combined business is expected to have net debt of close to $7 billion and elevated leverage ratios.
The muted market reaction to the expected regulatory scrutiny could be stemming from investors’ belief that the transaction will negatively impact JetBlue’s financial position before any synergies are realized, if at all.
JetBlue is dealing with multiple headwinds
JetBlue has been facing operational challenges, such as pilot and aircraft shortages, since the economy began reopening, and the proposed acquisition of Spirit was considered the best short-term solution to resolve these matters before legacy carriers start eating into its market share. Even before the pandemic, legacy carriers have been eyeing the discount airfare market by rolling out attractive offers. With JetBlue now facing operational difficulties, failure to complete this transaction could lead to irrevocable market share losses in the long run, which in turn could impact corporate earnings.
The post-pandemic environment has brought new challenges in the form of higher operating costs, tilting the odds in favor of well-established legacy carriers with deep pockets. Not only have energy prices risen sharply, but airlines have had to follow strict health guidelines to help prevent the spread of the Covid-19 virus. Challenging labor market conditions have also forced JetBlue to offer higher wages to pilots and other technical staff, which is continuing to exert pressure on operating margins. The improved efficiency of legacy airlines is coming to haunt JetBlue and other low-cost carriers as the industry giants are well-positioned to use their operating leverage as a competitive advantage in lucrative markets. Combining with Spirit would have opened the doors for JetBlue to thwart the threat of competition – at least in the short term – because of scale advantages.
The Northeast Alliance, a partnership formed by JetBlue and American Airlines Group Inc. (AAL, Financial) in 2021 to coordinate schedules in Boston and New York, has also been sued by the Justice Department, so the future of the partnership is at risk. The federal antitrust trial on this matter was concluded in November and the two companies are now awaiting a decision. If the court rules to dissolve the partnership, it will be a massive hit to JetBlue as the company has used it to offer better options to customers and to compete with the likes of United Airlines Holdings Inc. (UAL, Financial) and Delta Air Lines Inc. (DAL, Financial).
Takeaway
Even with the two regulators looking to block the combination, JetBlue sweetened its offer for Spirit shareholders multiple times last year as the deal is strategically important for the company to survive and thrive in the coming years. Failure to acquire the discount airline will not just result in financial penalties in the form of break-up fees, but also lost growth opportunities. With regulatory scrutiny and competitive pressures making life difficult for JetBlue, an investment in the company seems too risky in the current environment.
