Spirit Investors' Flight to M&A May See Delays, Turbulence

Investors jumped into shares of Spirit Airlines  (SAVE) , hoping the company's surprise CEO change announced Tuesday is a precursor to a merger announcement. They're likely in for a long wait.

Shares of Spirit climbed nearly 7% on Monday after the Miramar, Fla.-based airline said that long-time leader Ben Baldanza would be replaced by board member Bob Fornaro, effective immediately. Fornaro is the former CEO of AirTran Holdings and has held previous roles at US Airways and Northwest Airlines.

There's plenty of logic to the deal speculation, with privately held Frontier Airlines the most logical target. Denver-based Frontier is currently owned by Indigo Partners LLC, the former lead shareholder of Spirit, and the two airlines have a similar operating philosophy as deep discounters who offer low fares for the seat but charge extra for any and all perks beyond that seat.

As Wolfe Research LLC analyst Hunter Keay wrote Tuesday "a Frontier merger always made sense" for Spirit, noting a tie-up would provide both airlines with more scale and leverage to compete against larger rivals.

But Baldanza's departure likely has more to do with family priorities and Wall Street unrest than it does an imminent transaction. Spirit said little about why the change was made but did note that Baldanza had "recently" moved his family to the Washington, D.C., area, a region where he lived previously and where there are family connections.

Spirit has been a laggard in the last year, with its shares even after the Tuesday rally trading at just half of the $80 apiece price hit last February. Analysts and investors alike had increasingly grown uncomfortable with Baldanza's aggressive growth plan that had negatively impacted yields and cut into load factors.

Fornaro earned a reputation on Wall Street as a steady hand while CEO of AirTran, navigating the discounter against stiff competition against Delta Air Lines  (DAL) at its Atlanta hub. Many in the industry expect him to slow capacity growth at Spirit, potentially deferring new aircraft on order or even returning current jets to lessors.

"We believe a further reduction in capacity growth would be well received by the market as it would enable current markets to mature," Cowen & Co.'s Helane Becker wrote.

As for dealmaking, Fornaro did engineer AirTran's $1.4 billion sale to Southwest Airlines  (LUV) and would likely be more open to a merger than Baldanza, who sources say resisted consolidation talk while at Spirit.


Indigo, the private equity firm run by one-time America West Airlines chairman and CEO William A. Franke, has done remarkable work at Frontier since acquiring the near-dead company from Republic Airways Holdings  (RJET) in 2013, transforming the one-time money-loser into a Spirit-like ultra-low cost carrier that reported a net profit of $54 million in the second quarter of 2015 with an operating margin of nearly 20%.

Spirit and Frontier both fly Airbus jets, meaning they could avoid significant new maintenance expenses in a merger, and fly complementary route networks with little overlap. Combined they would offer a near national footprint with service to most major business centers along with an extensive network in the Caribbean.

But Frontier's next stop is likely an initial public offering, where Indigo, which paid Republic about $36 million in cash and assumed nearly $100 million in debt, figures to profit handsomely. While Franke has been an advocate of consolidation among discounters, exiting Spirit only after that airline decided against bidding for Frontier, it is far from certain the septuagenarian investor would currently prefer Spirit equity to IPO cash.

Indigo's interest in dealmaking could depend on the health of the IPO markets in the coming months. The ideal time for a Frontier offering would have likely been a year ago, before industry-wide revenue growth began to stall but alas also before the Frontier turnaround was well-established. If the market appetite for Frontier shares proves to be tepid, a merger with Spirit might be more appealing.

Beyond Frontier other Airbus operators including JetBlue Airways  (JBLU) and Virgin America  (VA) are likely to be linked to Spirit, but neither would be an obvious strategic fit with Spirit focused on low prices and both JetBlue and Virgin America trying to differentiate themselves with superior cabin experiences and service. A wild card is Allegiant Travel  (ALGT) , a smaller discounter known for flying to out-of-the-way markets.

There's good reason to believe consolidation among discounters is inevitable. As all of these airlines seek independent growth they are going to inevitably brush up on each other and find it increasingly hard to cherry pick easy-to-exploit routes. A larger footprint would also make it easier to attract business customers, which tend to generate higher margins than leisure fares.

Although Spirit under Fornaro seems more likely to do a deal than it was under Baldanza, investors looking for a quick payday should be advised that airline M&A, like airline schedules, can be unpredictable. It's quite possible those momentum investors, like travelers trying to get out of LaGuardia during a summer storm, could be in for a substantial wait.

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