JetBlue / Spirit Airlines Update
A few months ago, I wrote about the potential JetBlue / Spirit Airlines merger, which the Department of Justice was challenging on antitrust grounds. At the time, I didn’t have a strong opinion on the likely outcome of the trial, but believed that the odds for approval were priced far too pessimistically.
Shares were trading at $9.60, implying a probability of approval of merely 18%. This was arguably far too low based on the base rates alone. Shares subsequently appreciated to ~$15, which essentially priced the odds at a coin flip. Since, again, I didn’t have a strong opinion on the likely trial outcome and didn’t want to tempt fate, this seemed like a reasonable time to sell, and I closed out the position.
The trial concluded a few weeks ago, and the ruling is due any day now. After reading the closing briefs from each side, I’m leaning more towards a win for JetBlue, and have updated my odds on the fair value of SAVE 0.00%↑ accordingly:
The updated valuation includes a few new, rough assumptions:
Based on the trial, the probability of approval has likely improved (see below)
Based on some broader macroeconomic updates (no immediate recession, interest rates falling nearly 100bps, Alaska Airlines’s bid for Hawaiian), my standalone valuation of Spirit Airlines has slightly increased
At a 20% potential return, uncorrelated with the broader market, I think this still represents a fairly attractive opportunity, and have reopened a position.
Trial Thoughts
Let me preface this by saying, again, I am not a lawyer, and the below is just my uninformed, layman’s reading of the case notes. But, after reading the post-trial briefs from both JetBlue and the DOJ, it seems pretty clear to me that JetBlue has a far stronger case.
The DOJ case appears riddled with contradictions (sometimes claiming specific routes - origin and destination (O&D) pairs - are the only market definition that matters, while at other times alleging nationwide harm) and allegations that were clearly disproved at trial. For example, the DOJ claims that:
There are several reasons why the Court cannot count on Frontier, Allegiant, or any other ULCC to replace Spirit: (a) other ULCCs, which lack the scale of Spirit, would not be able to grow rapidly enough to replace Spirit in a timely and sufficient manner; (b) other ULCCs’ network strategies are inconsistent with timely and sufficient entry into the relevant markets; and (c) ULCCs lack the planes and pilots to enter with sufficient speed and scale.
However, these assertions were contradicted by the DOJ’s own witnesses during trial, including the CEO of Frontier Airlines:
“If Spirit were to pull out, we don’t have to guess at the demand. So this would make this the easiest thing to go do. I mean – and we wouldn’t be alone, right? The airline market is extremely efficient. . . . I mean, the scavengers would, you know, clean up this carcass within weeks.” [emphasis added]
I’d encourage anyone interested to read the full briefs and formulate their own opinion, but in my estimation the DOJ has failed even to demonstrate likely harm in the 35 allegedly most anti-competitive routes (out of 6,000 total) most central to its case.
The DOJ brief also seems to lack a certain level of logical coherency, which severely undermines its credibility in my eyes. An example of this incoherence is entertainingly highlighted by JetBlue:
As noted above, the Government ignores this settled law and claims Defendants may rebut only through “significant evidence that mandates the conclusion the merger does not threaten a substantial lessening of competition.” Tr. 12/5/23 (Gov’t Closing) 55:10-20. This standard does not exist [see footnote]
[footnote] It appears the Government has invented this “standard” by grafting unrelated phrases from two separate cases that predated Baker Hughes and the modern advent of its framework. [emphasis added]
I don’t know if inventing standards by “grafting” together “unrelated phrases” from “two separate cases” has precedent in established case law, but on the surface it doesn’t seem to be a very compelling strategy.
To be honest, after following the trial and reading the closing briefs, I’m not even sure why the government continues to pursue this case. Although I put the odds of a JetBlue win at 65% to be cautious, I think the odds are actually a fair bit higher. I also think the fair value of Spirit is closer to $30 on approval, but used a more conservative value on rumors that JetBlue may try to recut the deal (even though it seems like they would have a pretty high bar to clear).
I also don’t understand the DOJ’s unwillingness to settle by way of divestitures (which JetBlue has already offered) in the most contentious markets. The only thing I can think of is that they are proceeding out of political expediency or bureaucratic inertia.1
As a taxpayer, this makes me angry, but as an investor, I’m grateful for the potential opportunity.
Note: As mentioned, the verdict for the trial is due any day now. In the event of a ruling against JetBlue, SAVE 0.00%↑ stock could easily fall by more than 50% instantaneously. I personally like the odds, but there is still a material probability of a negative ruling. This is not investment advice. Please do your own due diligence.