New Frontier-Spirit Airline Is A Floor Raiser (NASDAQ:ULCC)

Introduction

A new airline has been created, with Frontier Group Holdings, Inc.’s (NASDAQ:ULCC) acquisition of fellow ultra-low-cost carrier Spirit Airlines, Inc. (SAVE). Announced on February 7th, Frontier is purchasing Spirit for $2.9 billion to create the largest ultra-low-cost carrier in the United States. But what will the combined company look like, and is it a good time to invest in Frontier with this pending acquisition? If all estimates pan out, and the industry rebounds to pre-pandemic levels, then Frontier is looking like a good value.

The Combined Company

With the two airlines combined, over 145 destinations and 650 routes would be under one company. Frontier itself will gain a larger presence in the East Coast, Caribbean, and South America. The combined businesses will still maintain the operation of a single aircraft family, which is key to running a low-cost airline. Overall, the acquisition creates an airline much better suited to compete against the big four in the United States.

Brief Overview

Looking at the combined financial statement for each company in 2021 shows that the total revenue of the new airline would be $5.291 billion, or about a third the size of Southwest Airlines. For 2021 the combined operating in net income would be -$174 million and -$575 million. 2021 was a poor year for both airlines separately. Because the airline industry is still working to rebound from the pandemic, it is important to look at the full potential during a good year. Looking at the numbers for a combined company in 2019 shows total revenue of $6.339 billion, operating income of $810 million, and net income of $586 million. Overall, a much rosier picture.

Airline Metrics

In 2021, it is important to note the profit and loss don’t show the whole picture of what the combined company operations would look like. For this, we need to look at airline metrics. Total available seat miles (ASMs) and revenue passenger miles (RPMs) for the combined entity would be 67.616 million and 52.504 million, respectively. This is about 50% of the levels of Southwest Airlines, showing the much larger operation the new Frontier Airlines will be.

The operating metrics for the new airline are what excite me the most. If we combined 2021 data and assume the $500 million in synergies are realized, then total revenue per available seat mile (TRASM) and cost per available seat mile (CASM) would be 7.83 cents and 7.34 cents. This means if synergies were realized, a combined company would have posted a 0.48 cent margin. If the synergies are realized, the combined airline would have had a margin of -0.26 cents. Applying the synergies to 2019 results would create a margin of 1.99 cents. What this shows is that the combined company would have posted been significantly more profitable in 2021 due to synergy.

Balance Sheet

For the acquisition, Frontier is offering 1.9126 shares per share of Spirit and $2.13 in cash. I will assume the cash is being paid with the use of debt. With these assumptions, the new Frontier would have a current ratio of 1.11x and a debt-to-equity of 3.99x. Therefore, this deal does not affect the leverage of the business to unsustainable levels and maintains liquidity. The combined airline has a rather healthy balance sheet.

Valuation

As of writing, Frontier trades at $11.25 per share. At this level, the current Frontier stock trades at a price to book value of the new airline of 1.75x. The book value is calculated using the above state share exchange rate. If you think the industry can fully regain to pre-pandemic levels, the current Frontier stock is trading at a price to earnings of 7.9x using the combined company 2019 EPS ($1.42). Altogether, the current valuation of Frontier looks good when looking at the prospects of the new Frontier.

Conclusion

Looking at everything together, the combined airline raise the floor for the new Frontier. If all synergies are realized, this acquisition would have helped during the poorer performing years of 2020 and 2021. In this way, while the acquisition should help in good years too, it is much more of a floor raiser than a ceiling raiser. Overall, the company increases in size to compete against the big four airlines, maintains a healthy balance sheet, and currently trades at a reasonable valuation.