The Game Theory Behind Whether JetBlue Drops Its American Airlines Partnership

Spirit’s board almost has to take JetBlue’s offer now unless Frontier comes up with more cash. The federal government then has to make a choice whether to sign off on it in order to kill the JetBlue-American Airlines Northeast Alliance. If they make that offer, JetBlue almost has to take it.

Frontier winds up with divested slots and gates in the Northeast anyway. JetBlue massively overpays. American loses its New York strategy. And the big winners wind up Delta and United, who face less competition for New York (and Boston).

Spirit Airlines shareholders meet June 30 to decide on a dance partner. They have an agreement in place to be acquired by Frontier Airlines. Frontier is a Bill Franke airline, Franke led Spirit’s move to become an ultra low cost carrier. He still has loyalists on the Spirit board. This deal creates a larger ultra low cost carrier, with more planes operating under a model of lowest fares.

JetBlue is offering more money. A lot more money. Frontier’s deal is mostly stock, worth just over $20 a share based on Tuesday’s closing price. JetBlue is offering $33.50 a share. That means about two-thirds more money to Spirit’s shareholders if they take the JetBlue deal.

However Spirit rightly believes there’s going to be a whole lot of federal scrutiny of JetBlue acquiring them. That’s why they said they rejected the initial proposal which involved more money – a deal with Frontier that’s likely to close is better than a deal with JetBlue that doesn’t.

Since then, though:

  • JetBlue has sweetened the offer. They are offering a $1.50 per share breakup fee. If the government kills the deal, Spirit shareholders get $1.50 a share and keep their company. And JetBlue has committed to give up Spirit’s assets in New York and Boston so as not to grow there and offset key regulator concerns. They also agree to address South Florida.

  • The market clearly believes there’s a better deal out there than Frontier is offering. Frontier’s $20 a share bid is less than Spirit’s share price at Tuesday’s close by about 10%.

JetBlue is already overpaying for the assets. They are buying slots and gates in congested airports, but commit to give up (sell off or lease) the most valuable of those. They are buying planes and pilots to grow. But the assets are worth more to Frontier than to JetBlue. Frontier and Spirit have had much higher operating margins than JetBlue.

The JetBlue deal takes highly productive assets and transfers them to a less profitable business model. And in the process they add costs to the Spirit operation, too – raises for employees in many cases as well as capital spending to revamp the interiors of Spirit planes. If JetBlue wins it’s a classic ‘winners curse’ situation.

There’s little question that the deal will draw regulatory scrutiny even when JetBlue agrees to divest assets in New York and Boston and South Florida. The federal government isn’t going to like losing on the two largest ultra low cost carriers to a merger. They’re going to fear that means higher fares (which it probably would).

Whether the federal government has a strong enough case to win in court isn’t the point. They have a strong enough hand to extract concessions. And JetBlue has committed $350 million to Spirit if they fail to close the merger. So they’re going in ready to meet a lot of government demands rather than write that check.

Already the federal government is suing to stop JetBlue and American Airlines from cooperating in their Northeast Alliance, in a deal that the government just signed off on last year. The two airlines entered into a settlement with the government that gives up slots in New York and guarantees seat growth and thus lower fares (upon penalty of losing even more slots).

That case goes to trial in September and JetBlue says ‘it’ll be resolved one way or another before the Spirit acquisition will be’ so it’s irrelevant. Not so at all.

A JetBlue-Spirit deal puts the government in the drivers seat on the American Airlines-JetBlue alliance. If the Feds put it to JetBlue “you can have the Spirit merger if you drop the Northeast Alliance” JetBlue probably says yes. They seem to prefer the Spirit deal anyway and have already pre-committed $350 million as a credible commitment that they’ll meet whatever terms the feds extract.

Of course the Biden administration might not do that. They might not be ok with the Northeast Alliance or with this merger and they might think they can stop both. But if they aren’t certain of their case against the Northeast Alliance it’s a play where they get a big scalp. They might think they have to choose one or the other, and their case isn’t a slam dunk in either provided JetBlue divests assets as they’re committing to.

That suggests the biggest loser in this deal isn’t Frontier. As Cranky Flier points out Frontier could wind up with much of the divested JetBlue assets anyway since they’d be the remaining major ultra low cost carrier so giving the airline those gates and slots would ensure they continue being used the way Spirit had been using them (in terms of business model).

Instead the biggest loser would be American, whose New York presence rests heavily on the deal with JetBlue.

  • American is too small in New York to compete effectively against Delta and United on their own
  • They’ve tried using New York gates and slots to bring customers to New York rather than focusing their efforts on New Yorkers. They’ve tried selling a scaled down ’boutique operation’. Neither had made New York especially profitable for them.
  • The JetBlue deal lets them sell flights to customers together, creating a viable competitor against Delta and United
  • And American has learned that their loyalty program and credit card uptake rises as they become relevant in the market.
  • But without JetBlue they have no ‘Plan B’.

Without the Northeast Alliance American Airlines loses in New York. And the biggest winners, therefore, are Delta and United – not JetBlue, which is massively overpaying for assets that will become less profitable under their stewardship.

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