JBLU - Updating Spirit/JetBlue Merger Probabilities As Trial Concludes

2023-12-05 23:59:13 ET

Summary

• The Spirit/JetBlue trial is concluding, with the judge expected to rule at some point after December 13, 2023.
• I see the chance of a JetBlue/Spirit victory as around 65% compared to market implied odds of 40%.
• This may be another case of overreach on anti-trust by the current administration, but there is a limited track record of airline deals happening without a DoJ settlement.

The Spirit (SAVE)/JetBlue (JBLU) trial saw final arguments today (December 5, 2023), with the judge setting a deadline of December 13, 2023, for final submissions and then ruling at some point after that.

Here I want to update the probabilities, and also compare the market's assessment of this merger with the recently announced Alaska/Hawaiian merger. I think Spirit remains a reasonable, if risky, bet at current levels.

A Quick Overview Of The Trial

The Department of Justice has been aggressive in blocking the merger, arguing that:

• Any consumer harm is unacceptable.
• It would not be considered a settlement.
• The potential demise of the Spirit business model is a loss for consumers.

Not allowing consumer harm to any degree seems a novel legal argument, and one the judge is unlikely to accept. It does not appear to align with the intent of the Clayton Act, which is not to entirely outlaw any consumer harm at any point (an impossible bar to clear) but to prohibit exercise of market power and monopoly practices via M&A. Specifically the relevant test of the Clayton Act is : "substantially to lessen competition, or to tend to create a monopoly." Clearly, the Department of Justice is narrowing that definition considerably.

However, the Department of Justice's lack of willingness to consider a settlement likely does change the probabilities here to some degree.

JetBlue's Arguments

Regarding the defense, JetBlue/Spirit the key points in their favor are (note these are the factors I see the judge considering, not a 1-to-1 match for the arguments JetBlue used):

• They want to grow and continue to compete and innovate against the big 4 airlines. They need Spirit's planes and slots to do this, a bigger JetBlue is great for competition.
• The JetBlue model is just as valuable to consumers as Spirit (i.e. a better flying experience should cost more i.e. an aircraft with 100 seats shouldn't cost the same as one with 130 seats)
• Spirit may have going concern risk without a merger
• Basic fares are now a core part of the industry, even among the big 4, the ULCC (Ultra Low Cost Carrier) model is entrenched, even without ULCCs
• Combined share is low at 10.6% of U.S. passenger miles
• JetBlue has already taken actions to make the merger acceptable i.e. no more Northeast Alliance (albeit against their will) and slot divestment.

Historic Airline Merger Outcomes

Then looking at past airline merger cases can be helpful:

Looking at these five cases shows why the market is worried. Historically, in 4 of the 5 cases, the Department of Justice has been in the driving seat, choosing to allow a combination typically after a settlement. Then in the only case that went to court, the Department of Justice prevailed.

Recent Antitrust Losses

However, under the Biden administration anti-trust has been pursued aggressively and many cases have been lost e.g. U.S. Sugar, United Healthcare, Illumina, Microsoft/Activision, and Meta. So the government's track record in court may not be quite as robust as historical precedent suggests and the government may be over-reaching in some cases. In fact, honestly, the government's track record of court victories is terrible, though they've made clear that's not the goal here.

Comparing Hawaiian and Spirit

Author's analysis - assumed break price of $5 for Hawaiian and $6 for Spirit.

The comparison of the implied probabilities of closing for Spirit and Hawaiian is pretty alarming at first glance. If the court blocks Spirit, then it would likely block Hawaiian on a similar logic.

The key thing is a change of administration, assuming the process of preparing for any trial (if there is a dispute) takes 12+ months, a Republican administration likely wouldn't bring an Alaska/Hawaiian tie-up to trial, though, of course they could.

So the Hawaiian analysis looks something like (if the Spirit probability carries over given similar broad market shares and degrees of overlap)...

So what the market is really saying is not that Hawaiian is that different, but that the Hawaiian decision could fall under a Republican administration that would perhaps drop the antitrust case (if there were one to drop). Still, at the margin, Hawaiian's approval odds may be a little overstated here (70% vs. 65%) especially if a trial comes very rapidly.

Risks

• Without a merger, Spirit may be financially distressed based on recent operating results. There's some risk that Spirit can't continue as a going concern without a merger.
• Even if JetBlue prevails in court, there is some risk that the deal is recut as the offer was made in a much more favorable environment for airlines, though clauses in the merger agreement may prevent this.
• Most obviously, JetBlue could simply lose in court, even if my odds are stated correctly, there's a material chance of losing money here.

Conclusion

There isn't much precedent for airline antitrust cases going to court and winning in recent years. Settling or abandoning the merger is more common. However, the current administration has been losing a lot of antitrust cases recently, often due to ambitious legal arguments that don't hold up in court.

It does feel like JetBlue has taken reasonable steps to mitigate the issues in acquiring Spirit through slot divestitures and the forced dissolution of the Northeast alliance. Plus the government's potentially narrow definition of consumer harm does not necessarily reflect the intent of the Clayton Act. There's also a lot of very recent precedent from 2021 to 2023 that just because the government is arguing something on antitrust grounds, does not mean that argument will hold up in court given their awful recent track record in antitrust cases. This is quite different from the broader history of antitrust.

It's hard to handicap the outcome of the trial, but it does appear that the market's implied 40% chance of success for Spirit closing is too low. I think a more reasonable estimate might be 65% now that the trial has concluded. That's bolstered by the fundamental strength of JetBlue's arguments in court, questions posed by a thoughtful judge and the current administration's recent very weak track record in antitrust cases. However, this is moderated by the fact that airline deals have historically hinged on settlements with the DoJ, which the DoJ appears very reluctant to do here, so we're in unchartered waters to some extent.

Lastly, I think that shorting Hawaiian as a way to hedge the Spirit risk could be overstated as I suspect the Hawaiian outcome may depend as much on who wins the 2024 election, and that administration's attitude to antitrust, rather than legal nuances from the Spirit case.

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