As Spirit Airlines shareholders prepare to vote, both contending carriers have hiked their breakage fees, the M&A equivalent of wedding insurance.
Jless than a week remains before Spirit Airlines shareholders vote on whether to accept a takeover bid from fellow low-cost carrier Frontier Airlines or reject it and open the door to a more lucrative and hostile offer from JetBlue Airways.
Frontier claimed that the merger of two “complementary businesses” would “create America’s most competitive ultra-low-cost airline for the benefit of consumers.” JetBlue, meanwhile, argued that acquiring Spirit would allow it to compete with the so-called “big four” US carriers – American, Delta, United, Southwest – which together control nearly 80% of the market.
Ahead of the June 10 vote, there is evidence that some Spirit investors were cold-eyed about the Frontier deal. While Frontier and JetBlue have gone tit for tat over the past few weeks, gradually upping the ante in their appeals to Spirit investors, the latest round of offers concerns breakage fees.
Think of these fees as the M&A equivalent of wedding insurance, says antitrust expert Florian Ederer, associate professor of economics at the Yale School of Management. “If the shareholders vote in favor of a deal and then later the deal doesn’t go through because of an antitrust scrutiny, the shareholders are compensated,” he says, similarly to the family of the bride could be covered by wedding insurance if one of the lovebirds changed their mind.
A severance fee is very common in large merger negotiations, Ederer says, especially when antitrust concerns are present. A classic example from over a decade ago is the $6 billion break-up fee associated with AT&T’s failed acquisition of T-Mobile. More recently, a $1 billion break-up fee is involved if Elon Musk’s acquisition of Twitter doesn’t go through.
Last Tuesday, Reuters reported that proxy advisory firm Institutional Shareholder Services had urged Spirit shareholders to reject the Frontier deal because there was no break fee. Two days later, Frontier agreed to pay a $250 million break fee in its $2.9 billion bid to acquire Spirit, which would create America’s fifth-largest airline.
Then, this morning, JetBlue responded by raising its $200 million break fee to $350 million in its $3.3 billion hostile bid. JetBlue also added a sweetener: an upfront payment of about $164 million payable as a cash dividend “promptly after” a vote approving a carrier merger.
Spirit’s board is legally bound to try to get the best possible value for its shareholders, Ederer says. The Severance Fee is designed to protect Spirit shareholders for the time, resources and costs already invested in the acquisition process.
“It’s a murky area,” Ederer says. At first glance, JetBlue’s offering is more solid. “But Spirit’s board could argue that the Frontier deal is better because the great synergies that exist between the two ultra-low-cost airlines, Frontier and Spirit, and the combination of assets, will ultimately lead to a better long-term return.They might argue that this is something that shareholders are not yet seeing, but will eventually be vindicated.
Still, Ederer thinks that argument may have an uphill battle. “I think the Spirit and Frontier merger is a bigger antitrust issue than the Spirit and JetBlue merger,” Ederer says. “That’s because, although JetBlue is a low-cost carrier, it’s not necessarily an ultra-low-cost carrier like Spirit and Frontier. So I would say there’s less risk than acquiring JetBlue-Spirit is blocked.
If the JetBlue-Spirit merger is approved, regulators will likely have a caveat, Ederer says, demanding JetBlue back out of a partnership that allows its frequent flyers to earn and redeem miles and points on American Airlines. .
“It might be an easy fix for antitrust regulators,” Ederer says, “to say, ‘Look, we’re letting this acquisition go, but you’re going to have to let go of your Northeast Alliance with American Airlines. “”