US and European Mergers:
The Long View Mar/Apr 2024

The JetBlue/Spirit case

The complaint against the merger was brought by the antitrust division of the DoJ plus the antitrust authorities of several US States using the Clayton Act of 1914 (a law which has the overall aim of promoting fair competition and prohibiting predatory pricing and anti-competitive mergers). The main points of the complaint were as follows:

• Competition between JetBlue and Spirit benefits all types of travellers, but is particularly important for cost-conscious travellers.

• This merger would combine two head-to-head competitors (JetBlue having recognised that competition from Spirit lowers its fares more than competition from other LCCs).

• JetBlue’s acquisition of Spirit would also dampen competition with other airlines (Spirit having stated that it did not follow collective industry price increases while JetBlue had demonstrated its willingness to coordinate with other carriers, notably American through the proposed, and also rejected, Northeastern Alliance).

• The acquisition would stop the growth of Spirit which had doubled its network over the past 10 years and which had planned before the end of 2023, to expand at Fort Lauderdale, Orlando, and Los Angeles, which are JetBlue focus cities.

• JetBlue planned to reduce by 10-15% the number of seats on Spirit aircraft to match its own aircraft configuration, implying fewer passengers and higher prices.

• JetBlue’s acquisition of Spirit should not be considered in a vacuum — it would be the latest step in a strong trend toward consolidation, with the three Legacies — Delta, United, and American — along with Southwest, controlling close to 80% of the domestic industry. (JetBlue used to warn against this increasing consolidation but it reversed its message with the Spirit proposal, while Spirit had previously criticised the JetBlue/American alliance before accepting the JetBlue offer.)

• New entry or expansion by existing airlines into the relevant markets was unlikely to be timely or sufficient to fully offset the proposed acquisition’s anticompetitive effects.

• JetBlue contended that its acquisition of Spirit would yield synergies that would enable the airline to better compete against the Legacies but many of these purported synergies reflected the fundamental harm of this acquisition. For example, JetBlue executives acknowledged that synergy would come from charging passengers higher prices for a smaller number of available seats. Similarly, JetBlue would benefit from increasing its share of all traffic at key airports and so being able to charge a “premium” for its fares.

• Moreover, JetBlue’s acquisition of Spirit would not result in net cost efficiencies (JetBlue itself had estimated approximately $400m of costs from reconfiguring the Spirit fleet).

• JetBlue hadn’t provided evidence of pro-competitive efficiencies in the 500 relevant markets in which the two carriers competed.

• Remedies — including divestitures — must preserve all competition in all relevant markets threatened by JetBlue’s acquisition of Spirit. JetBlue had only indicated plans to divest Spirit gates, slots and ground handling at Boston, Newark, LaGuardia, and Fort Lauderdale which would be inadequate to replace the significant lost competition in hundreds of markets in the US, the Caribbean, and Latin America where they compete today.

So, a comprehensive list of objections which the judge — a William G. Young — remarkably totally agreed with.

Public opinion

Antitrust legislation does not operate in a socio-economic vacuum. JetBlue and Spirit experienced a public backlash against the airline mergers which had, more or less, been taken for granted until recently. Consumer groups, including the very influential National Consumers League, and free market lobbyists, like the American Economic Liberties Project, had formed an alliance opposing both JetBlue/Spirit and Alaska/Hawaiian.

So the upcoming Alaska acquisition of Hawaiian may well suffer the same fate even though there would appear to be less of an anti-competitive element in the overlap between the two route networks and the plan is to keep the two airlines operating as distinct brands.

The popular national newspaper USA Today, which carries regular coverage of the airline sector aimed at passengers, has published a series of outraged editorials:

“Airline mergers have harmed American air travelers on a breathtaking scale. A series of airline consolidations in the last two decades have left them with just four dominant carriers, which over time have raised prices and, with one notable exception, offered shamefully bad customer service.

“These too-big-to-fail airlines deliver astonishing returns to their shareholders, but they come at a high price. Passengers end up paying more and getting less because competition is all but eliminated. Research suggests that fares rise between 5% and 6% on overlapping or potentially overlapping routes, although the price increase has reportedly been higher after some of the latest mergers”.

Shareholders of the five airlines depicted in the graphs and would dispute the astonishing returns statement but the too-big-to-fail accusation seems to reflect a genuine discontent with the industry.

Just the wrong partners?

JetBlue of course was not the original partner for Spirit. In early 2022 Frontier and Spirit announced a merger plan, one that might have had a better chance of passing antitrust investigation because the claimed synergies looked more realistic.

Frontier/Spirit would have created a genuine new ULCC force in the US market. Spirit and Frontier had an intertwined history linked to the ULCC specialist investment fund, Indigo Partners, and the two airlines’ top management has worked at both carriers. The combined carrier would have had by some margin the lowest costs in the industry. Whereas the Frontier/Spirit message was positive — “Creating America’s most competitive ultra-low fare airline” — the JetBlue rationale always seemed defensive: “What we want to do is create a bigger JetBlue”, according to the then CEO.

In claiming $500m of “run rate operating synergies” from the proposed Frontier/Spirit merger, management were able, for once, to give some concrete examples of improved efficiencies.

Amalgamating the schedules would free up spare aircraft, ie aircraft needed to assure the schedule but which are not fully utilised. With improving aircraft utilisation, further aircraft would be freed up, saving an estimated at $145m (or $12m per aircraft which seemed reasonable). Another $35m was expected to come from additional traffic through new connecting possibilities.

There was also the opportunity afforded by the merger to match capacity more closely to demand. The two airlines underperformed on load factor compared to global ULCC benchmarks. Pre-pandemic Frontier’s load factor was 86% and Spirit’s 84%, significantly below Ryanair’s 96% (though calculated on seats sold rather than actual passengers). Pushing up the joint load factor of around 85% by 2-4 points would generate $220m of revenue synergies. The remaining $100m comes from procurement savings and overhead efficiencies.

Spirit’s board accurately anticipated the threat to a JetBlue/Spirit merger from an antitrust judgement and initially rejected JetBlue, pointing out that there would appear to be nowhere like the same degree of compatibility between operating models and that JetBlue’s CASM (adjusted) would be 50% higher than Frontier/Spirit.

But JetBlue pushed up its offer to $3.8bn, representing a 50% premium over the then share price, which persuaded Spirit’s board to change its mind. Otherwise, it would probably have faced shareholder lawsuits.

The financial community was enamoured of the JetBlue offer. JetBlue’s message in presentations to Wall Street was quite clear: the airline would restore its profitability through reducing competition and enhancing yields as a result of the Spirit take-over and its Northeast Alliance with American. Anticompetitive risks didn’t seem to concern Wall Street too much, which was understandable given the regulatory history of allowing larger scale mergers, but JetBlue’s message rebounded on it this time, with some of its presentational statements being used as evidence by the antitrust authorities.

The direct cost to JetBlue was $470m, representing the break-up payment it guaranteed Spirit shareholders if the deal failed on antitrust grounds. JetBlue’s net loss for 2023 was $310m. Spirit too has produced a substantial loss for 2023 — $163m — in contrast to years of strong profitability pre-pandemic.

Although JetBlue has accepted the federal court’s decision, having little choice, there appears to have been coordinated campaigning on the part of the US industry to attack the decision. Aviation Week editorialised: “Those celebrating district judge William G. Young’s decision — siding with the DoJ’s view that the combination would violate antitrust law — as a big win for the little guy, ignore or significantly downplay the consequences of Spirit limping along as a weak airline, or worse, collapsing altogether.” Similarly, the Wall Street Journal argued “[The DoJ] has essentially set up Spirit for failure”.

Yet Spirit did not make any “failing company” arguments to justify the proposed merger. Indeed, Spirit Airlines ended the first quarter 2024 with unrestricted liquidity of $1.2bn. Veteran airline equity analyst Mike Derchin takes a contrarian view, noting that the airline has one of the best management teams in the industry, which will no longer be distracted by trying to manage an unsuitable merger, and a proven operating model that requires tweaking, not a major overhaul.

Is this really a precedent?

Antitrust decisions are made in a political and economic context. How the Clayton Act or the anti-competitive clauses, notably Articles 85 and 86 which deal with collusion and monopoly power, of the Treaty of Rome are applied depends on how airline mergers are viewed and justified. Historically, the antitrust authorities took a generally permissive view of airline mergers, but times change.

Looking at the US chart, the first period of intense merger activity took place in the 1980s in response to The Airline Deregulation Act of 1978.

Under the regulated regime the various airlines had geographical route franchises, transcontinental for the Majors, regional for the smaller carriers.

To resolve this regulatory legacy, the industry was allowed, perhaps encouraged, to re-structure into larger units — for example, Atlanta-based Delta buying Salt Lake City-based Western Airlines — in the process frustrating the intentions of Alfred Kahn, the father of deregulation, who had hoped for some form of perfect competition among multiple airlines.

International operations were mainly provided by the two quasi-flag-carriers, Pan Am and TWA — both of which struggled badly in the deregulated world. Pan Am was forced to sell off its Atlantic operation to Delta and its Pacific and Latin American services to United. TWA was more resilient but eventually had to dispose of its Atlantic routes to American, which also absorbed Latin American services from Eastern.

The next big wave of mergers took place in the 2000s as a response to the regular financial crises of the US industry that followed September 11.

Despite some $15bn of government grants and loans, the Majors remained very fragile, and again the solution was mergers. But this time each merger was preceded by deep cost-cutting and restructuring under Chapter 11 bankruptcy protection.

Three major groupings of network carriers emerged — Delta / Northwest, United / Continental and American / USAirways — and in each case the larger airline completely subsumed the brand of the other carrier. Proponents of this merger wave pointed to a stabilisation of the US industry and generally improved profitability, while opponents observed that in all three cases the acquiring airline was higher cost than the one acquired.

These mergers were approved by the regulatory authorities under the Bush Administration with only minor remedies usually in terms of slot or gate disposals, but they still had to be justified using the official guidelines mandated by the DoJ.

There are usually two main categories of efficiencies or synergies that can be claimed by merging airlines:

• Cost efficiencies projected from, for example, better utilisation of joint airport or maintenance facilities, a reduction in overhead or integrating reservations systems

• Network benefits resulting from, for example, more convenient connections, improved offer of destinations, scheduling improvements that accrue to passengers (consumer surplus).

In the major mergers, cost benefits typically accounted for 20-30% of the billions of dollars of total synergies claimed, network benefits for 70-80%. The former may have sounded plausible before the merger but were very difficult to quantify afterwards, largely because it is difficult to determine what would have happened absent the merger. The latter tended to be even more nebulous.

In a willing suspension of disbelief, the real reason for merging — reducing competitive pressures — was avoided (at least until JetBlue tried to sell its takeover of Spirit to Wall Street).

Integration costs were invariably underestimated. For instance, Delta-Northwest originally estimated the costs of merging at $0.5-1.0bn; the outcome it reported added up to $1.5bn. United-Continental predicted $1.2bn and ended up with an estimated $1.6bn. In 2017 Alaska put the projected synergies of taking over Virgin America at $300m annually, but the pandemic ended all the revenue benefits while the added costs of a dual fleet turned out to be about $75m annually over a period of five years.

There have been various studies by academics and consultants attempting to find the pro-competitive benefits of mergers. The most telling argument has been the continuing decline in real yields in the US industry.

It was also asserted that mergers had given the industry much-needed stability and financial robustness. Southwest and the other LCCs were, according to one theory, guaranteed to enhance competition as they would move into any markets exited by the merging Legacies. (Ironically, one of the key arguments for Southwest taking over AirTran back in 2011 was that the merged carrier would provide much more potent competition for Delta at Atlanta, which was AirTran’s main base, but Southwest over the following 13 years consistently downsized its operation at this hub.)

The resilience failure

Above all, it is clear that the merger process failed to provide the merged carriers with the resilience to cope with the shock of the pandemic. The federal government provided about $55bn in the form of direct aid, loans, and grants to the airline industry during the pandemic, $45bn of which went to the four airlines — Delta, American United and Southwest — that had been allowed to grow through mergers in the previous decade to a combined domestic market share of 80%.

Euro-consolidation

The first wave of M&A in Europe took place in the 2000s and was tied into the deregulatory/liberalisation policy that had been officially enacted in 1987, the repercussions of September 11, the privatisation processes, and the incipient threat from new entrants like easyJet and Ryanair.

For the Eurocrats in DG4 and DG7 (now DGMOVE and DGCOMP) the key to success of liberalisation was Air France. If the French flag-carrier could be seen to have accepted and adapted to the free market model à la BA, Lufthansa and the other flag-carriers would follow (with the manageable exceptions of recalcitrants like Alitalia and Olympic).

Air France was permitted to take over UTA and Air Inter in 1990 (following on from BA/BCal) in an attempt to eliminate “franco-français” competition, but to secure its global position Air France needed a merger partner from another European country. Air France/Lufthansa was contemplated but quickly abandoned in favour of KLM.

KLM, with its sixth freedom hub at Amsterdam was a true innovator, having signed a ground-breaking code-share alliance with Northwest in 1993. Its search for a European partner included Alitalia (hopeless cultural incompatibility) and Alcazar (a proposed merger of KLM, Austrian, SAS and Swissair which fortunately never got off the ground but provided the model for the multi-airline grouping SAir that ended with the bankruptcies of Swissair and Sabena). KLM’s perceived problem was that it was running out of growth opportunities at Amsterdam, it was limited in the new waves it could add to its hub system.

The Air France/KLM transaction, completed in 2004, was in some ways a political merger with the two carriers retaining their national brand identities and capacity growth at the two main hubs being determined by contract. One result has been ongoing friction and fraction between the French and Dutch managements. As the graph shows, KLM has produced better operating results in all but two of the past 14 years, contributing more than 100% of the accumulated profit, despite its smaller size.

The subsequent history of European M&A has revolved around the building of the three groups. Lufthansa bought out the significant airlines in its sphere of influence — Austrian, Swiss and SN Brussels — but could not make British Midland work. Under the IAG holding company, BA linked up with Iberia, Vueling and Aer Lingus. (The IAG set-up, whereby each airline is obliged to compete for capital, may be the most efficient structure for a multi-airline grouping.)

In processing the proposed mergers the national competition authorities and the EC tended to focus on direct route competition between the merging carriers rather than examining hub competition, which facilitated the approval of these combinations.

There is still some intra-Europe consolidation to come from the residual independent European flag-carriers: SAS will probably be bought by Air France-KLM while TAP Air Portugal may become part of the Lufthansa Group. However, as in the US, the regulatory authorities’ attitude towards M&A seem to have been negatively influenced by the scale of state aid demanded by the Legacies to survive the pandemic — Air France-KLM and the Lufthansa Group together applied for about €16bn of various forms of state aid (some of which was later annulled).

The EC is currently taking a harder line with IAG and its proposed purchase of Air Europa, focusing on anti-competitive repercussions on Spanish domestic routes and Atlantic services where Iberia, Vueling or BA compete directly with Air Europa.

The EC is also holding up Lufthansa’s takeover of ITA, Alitalia’s successor airline, because of particular concerns about anti-competitive features in both the Italy-Germany and inter-continental markets. A substantial divestment of slots at Milan Linate, by far ITA’s most profitable airport, will be needed to finalise the transaction.

Virtual anti-competitiveness

There are also questions over competition on the North Atlantic.

A regular complaint from network airlines is that the industry is artificially constrained from building multinational corporations like other industries.

In fact, since 2009, the North Atlantic market has become increasingly consolidated and divided up among three multinational groups: the antitrust immunised joint ventures of Air-France-KLM with Delta (having taken over Northwest); the Lufthansa Group with United (having taken over Continental) plus Air Canada; British Airways, Iberia and Aer Lingus with American (having taken over USAirways).

These groups, under the alliance brands of SkyTeam, Star and oneworld, are virtually merged entities, with the US and European partners making joint decisions on fares, schedules and capacity, sharing revenues and costs on a “metal-neutral” basis.

They produce their own consolidated but confidential accounts. There is no financial visibility for the anti-trust regulators in this sector. What once might have been seen as illegal collusion is protected through the anti-trust immunity provisions of the joint ventures.

European LCCs merger experiences

European LCCs have not had large-scale involvement with takeovers since the early 2000s when easyJet and Ryanair were beginning to emerge as major players in the industry. What happened then might still have some cautionary lessons for the LCC sector.

In 2002 the former BA lower-cost subsidiary Go was being offered for sale by its new owner, the investment fund 3i, and easyJet was the clear favourite to buy it.

But within easyJet there were two schools of thought: the sceptics who, having conducted financial due diligence on Go, reckoned that the airline would run out of cash within 12 months and this competitor would simply disappear, and the strategists who reckoned that easyJet should seize this growth opportunity as a step-change into new markets.

Management were persuaded that they should buy Go for £374m, partly because they believed that Ryanair would make a move for the airline in order to gain access to higher-yielding markets. In the event, integrating Go proved to be very problematic, and easyJet was obliged to issue a profit warning the following year.

The airline would have exposed itself to an intense competitive threat from Ryanair had Ryanair itself not made a mistake by buying Buzz (the KLM subsidiary, not the current Polish Ryanair operation of the same name). The price was only about €20m but integrating the BAe146 operation and KLM management was very time-consuming and expensive; in the end Ryanair simply shut Buzz down.

Ryanair experimented again in 2017 with a minority purchase of LaudaMotion based at Vienna, increasing its ownership to 100% by 2017, with the aim of gaining experience operating A320s in addition to its standard 737 fleet, so enhancing its negotiating power with the two OEMs.

But intense competition at Vienna and then the pandemic put paid to that plan, and it is unclear whether Michael O’Leary will persist with the Lauda operation or return the A320s to the lessors in four years’ time, reverting to an all 737 fleet.

O’Leary has stated many times that consolidation in the LCC sector is inevitable but this consolidation inevitably involves just easyJet/Wizz (though easyJet rebuffed an offer from Wizzair in 2021) or some combination of these two LCCs and a Legacy. Having achieved such success through organic growth, having had unprofitable experiences with airline purchases, and having had its attempt to buy newly privatised Aer Lingus in 2015 blocked by the EC because of the anti-competitive effect on Dublin-London services, Ryanair is expected to avoid any M&A.

Yet there is the faint possibility of a bid for Wizzair. The speculative reasoning is as follows:

• The purchase price might be right. Wizzair’s stock market capitalisation is about €2.2bn whereas Ryanair’s is €23.4bn. Expressed in terms of valuation per passenger (which are similar in terms of unit revenue) Wizz is €44 or a third of Ryanair’s €129. Overall unit operating costs for the two carriers are similar and their operating models are compatible.

• This would give Ryanair a dual Boeing/Airbus fleet, something that it has been seeking for some time in order to maximise competition between the two manufacturers. Access to Wizzair’s order backlog of 350 Neos would solve most of the MAX supply problems impacting Ryanair.

• Anti-competitive objections could be countered by the fact that there is limited network overlap on city-pair markets.

The future

From this long view of airline rationalisation, which is often irrational, a few observations:

• The antitrust authorities are becoming more sceptical, asking more difficult questions and potentially frustrating takeovers. But this will change when the airline industry hits its next crisis or recession, and M&A is again promoted as an airline saviour.
• Airline managers who pursue mergers and takeovers should promise their shareholders a post hoc cost/benefit analysis of the transaction. But they probably won’t.
• There may be some good reasons for mergers among LCCs or ULCCs. But there are also compelling arguments against: a hypothetical example, the impact of a take-over announcement on Ryanair’s share price and MOL’s €100m bonus agreement.