JetBlue faces difficulties selling Spirit tender offer to investors

By Rajesh Kumar Singh

CHICAGO (Reuters) – Robin Hayes, the exuberant chief executive of JetBlue Airways Corp, was on an Amtrak train returning from Boston on Tuesday when news broke that his company had made a bid to acquire Spirit Airlines Inc.

Hayes said the company isn’t ready to go public with its bid for the ultra-low-cost carrier just yet, but the news leak has forced its hand. In a conference call the following morning, the reasons were clear as JetBlue struggled to convince investors of the rationale for its unsolicited $3.6 billion offer.

The New York-based carrier’s surprise move has baffled Wall Street as it seeks to combine two companies with very little in common other than fleets dominated by Airbus SE jets. As a result, the deal is expected to be very costly for JetBlue, raising questions about the supposed synergies.

JetBlue did not immediately respond to a request for comment.

Shares of the company have fallen about 19% since the news broke. JetBlue shares were down 4.2% at $11.92 on Thursday afternoon.

One of the biggest concerns for investors is the two carriers’ very different business models.

Spirit is a no-frills carrier that relies on discount fares at the lowest possible level, supplemented by charges for extras such as booking through a call center, a strategy known as unbundling.

The success of its business model is based on a low-cost structure that has allowed it to offer low base fares and maintain high profit margins.

In contrast, JetBlue is a premium leisure airline. Its offerings include free checked baggage, an assortment of complimentary dishes, and private suites.

Hayes promises lower rates after the deal closes. Keeping that promise, however, would be a tall order, analysts say.

JetBlue’s costs and fares are already higher than those of Spirit and other ultra-low-cost carriers. Since the company is expected to raise salaries for Spirit pilots to bring them into line with its salary structure, cost pressures are expected to worsen.

Savanthi Syth, an airline analyst at Raymond James, estimates salaries for Spirit pilots would need to increase by 7% to 51% to reach parity with JetBlue’s current fares.

The company also plans to upgrade the Spirit fleet to provide more legroom and a “superior” onboard experience for customers, which it says would be a multi-year investment. Industry experts say the move would leave the airline with fewer seats to fill with passengers, leading to lower productivity.

Equally daunting will be the task of integrating the culture of two airlines that have followed different service models. JetBlue told investors that cultural integration would be key to the deal’s success.

Aviation analyst Robert Mann believes JetBlue’s offer was “rushed into the market”. “Everyone is kind of between pulling their hair out and just throwing it back,” he said.

“A WINDOW OF OPPORTUNITY”

JetBlue, however, sees the deal as a way to expand its national footprint amid continued labor and aircraft shortages. He tried to buy Virgin America in 2016, but lost to Alaska Air Group Inc.

Hayes said the company has been considering how to continue growing for a long time. And once low-cost carrier Frontier Group Holdings Inc announced a deal in early February to merge with Spirit, it said it created “a window of opportunity that if you don’t act, it’s gone.”

The company is betting that a combination with Spirit would accelerate its growth in Florida and Los Angeles and open up opportunities in Las Vegas, Dallas, Houston, Chicago, Detroit, Atlanta and Miami.

Following the agreement, the two carriers will have a combined fleet of 455 aircraft, with deliveries of another 220 Airbus jets expected by 2027. It provides greater flexibility at a time when airlines cannot deliver new planes fast enough.

Henry Harteveldt, founder of travel consultancy Atmosphere Research Group, said the growing size would also allow JetBlue to attract pilots by offering them better careers.

“Obviously the airline wants to be more than just a national airline,” Harteveldt said. “So a JetBlue and Spirit combination would be attractive to pilots who want to work for a growing airline in the future.”

EXECUTION RISK

Despite these potential long-term benefits, industry experts say the deal carries many execution risks.

Veteran budget airline investor Bill Franke, who orchestrated Frontier’s combination with Spirit, once said that failing to stay disciplined about the business model and letting other costs fall infiltrating was the “way to hell” for the airlines.

Franke stuck to this formula in the deal with Spirit. The two carriers not only have no-frills business models, but also have very complementary networks and both use Airbus jets.

By comparison, JetBlue and Spirit have a high degree of concentration in South Florida, which should get regulators’ attention.

UBS analysts said while the merits of a Frontier-Spirit combination were simpler, JetBlue’s offer was a “headache”.

The prospect of a rapprochement between ultra-low-cost and hybrid business models recalls Wizz Air Holdings Plc’s unsuccessful overtures to Britain’s Easyjet Plc last year, which the latter rejected.

Wizz is also part of Franke’s investment stable, though his support for a move that apparently violates his own investment rule was unclear. Analysts at the time questioned the mix of airline types, in what turned out to be a precursor to the current debate over JetBlue’s strategy.

“It’s a bit half-baked, honestly,” said analyst Mann, referring to JetBlue’s offer.

(Reporting by Rajesh Kumar Singh in Chicago; Additional reporting by David Shepardson in Washington; Editing by Matthew Lewis)