gorodenkoff
Spirit Airlines, Inc. (NYSE:SAVE) plunged 51% after JetBlue Airways Corporation (JBLU) was blocked from acquiring it. The full ruling can be read here. The judge argues that allowing the merger would likely lessen competition in the airline industry for a subset of customers, which violates the Clayton Act. The decision is very readable and clearly explains the court’s rationale and considerations.
Meanwhile, I’ve been caught with my hand too far in the cookie jar as 1) I’ve argued the merger was likely to close, and 2) tried to benefit from a late ruling. I didn’t expect this ruling, AND it was timely.
This ruling is an important victory for the government not just with respect to this case. It is rocket fuel for further antitrust action.
An important question is whether JetBlue and Spirit Airlines are going to try and appeal. They may initiate an appeal, but I’m not so sure JetBlue will want to win it because Spirit isn’t performing that well. If they’re going down that route, I think it’s likely going to take price cuts to the deal. It may take a long time as well.
With a lot of trepidation, because I’m not a lawyer, and I’ve been wrong so far, I’ll say it appears there are weaknesses in the ruling. In addition, the Northeast Alliance between JetBlue and American Airlines Group Inc. (AAL) was also taken down by a federal judge in 2023. American Airlines is appealing that ruling. So, there are some fireworks going on between the government and the airlines. Both believe they’re right, and they may fight for it.
I’ll go over some key points from the ruling that stand out to me because they could be highly relevant to future antitrust cases and to try and infer how likely an appeal is.
I’ll start at the end by quoting from the end of the ruling, as it embodies its spirit (emphasis mine):
the Court rules that the proposed acquisition violates Section 7 of the Clayton Act. Spirit is a small airline. But there are those who love it. To those dedicated customers of Spirit, this one’s for you. Why? Because the Clayton Act, a 109-year-old statute requires this result — a statute that continues to deliver for the American people.
The judge came to this decision because, in his own words (emphasis mine):
Throughout trial, the Government invoked the experience of the average Spirit consumer: a college student in Boston hoping to visit her parents in San Juan, Puerto Rico; a large Boston family planning a vacation to Miami that can only afford the trip at Spirit’s prices. It is this large category consumers, those who must rely on Spirit, that this merger would harm; the Defendant Airlines, though exceedingly well represented, simply cannot demonstrate that these consumers would avoid harm. Even if other ULCCs entered former Spirit routes at an unprecedented rate of growth (which, given the current restraints on airline growth, is unlikely), their entry is unlikely to be sufficient to protect every consumer, in every relevant market from harm.
This evocative picture is backed up by references to case law to back up the ruling. Take note of the reference to unprecedented growth rates (I’ll get to these later). But at the heart of the matter here is that the judge believes the defendant airlines cannot demonstrate that a subset of customers would avoid harm if the merger were to go through. Even though JetBlue is considered, even by the government, to lower average fares on routes more effectively than Spirit. I think the parties could appeal this, but if it stands, this is the antitrust fuel the government has been looking for. It seems like a very low bar to meet for the government going forward.
In another part of the ruling, the judge lays out how the defendants successfully demonstrated the pro-competitive effect (emphasis mine):
The Defendant Airlines have demonstrated that an expansion of all aspects of JetBlue’s business — including network, fleet, and loyalty program — would allow for more vigorous competition with the Big Four, which carry most passengers in the country. The size of an airline, the number of routes it serves, the number of options it offers to consumers — all of these aspects add to an airline’s relevance to consumers, and
were JetBlue to become more relevant, it would immediately place more pressure on its greatest competitors, the Big Four. This pressure would benefit consumers. The Defendant Airlines have also demonstrated that the product JetBlue offers, though more expensive on average, is higher quality, and provides consumers with an enhanced flying experience. Were JetBlue to expand via the proposed acquisition, not only would that product become more widely available to more consumers, but the increased revenue available could also allow JetBlue to innovate further and create an even stronger customer experience. Overall, the Defendant Airlines have successfully met their relatively low burden to rebut the Government’s prima facie case.
So even though the judge writes the merger is likely pro-competitive as a whole, the harm to a subset of consumers outweighs that. In the end, I was left with the impression the judge supported his ruling not so much through the government’s case but mostly through his reading and interpretation of case law.
Something else that stood out to me was the way the judge interpreted the threat to competition in this market:
The parties need not be each other’s closest competitors to raise a threat to competition; being close competitors is enough for an acquisition to result in upward pricing pressure. Anthem, 236 F. Supp. 3d at 216 (“Anthem’s insistence that United, not Cigna, is its ‘closest’ competitor, is beside the point. The acquired firm need not be the other’s closest competitor to have an anti-competitive effect; the merging parties only need to be close competitors.”)
This merger would have given JetBlue further scale advantages to compete with the big four; American Airlines, Delta Air Lines (DAL), United Airlines (UAL), and Southwest Airlines (LUV). To me, it appears the ruling very carefully applies the Clayton standards, but offsetting effects are not considered to the extent I would have expected.
Then, there are some peculiar things in the ruling. One expert witness for the defending airlines, Mr. Scheff, is described as follows (emphasis mine):
Mr. Scheff has more than thirty years of experience in the airline industry, working for both domestic and international airlines. His expertise is in network planning, fleet planning, demand forecasting, and operations research.
This person reviewed publicly available and proprietary airline data, deposition testimony, discovery materials, and financial filings from both JetBlue and Spirit. Scheff’s job apparently was to evaluate whether the companies, after the merger, would have more seats available for departure. The judge completely disqualified his testimony like this (emphasis mine):
Scheff’s analysis provides the Court with a potential plan for JetBlue post-merger, because Mr. Scheff cannot cite any evidence to support the likelihood of such plans, his testimony lacks credibility, and therefore must be given no weight.
If these plans improved productivity credibly, isn’t it likely they would be implemented? Should JetBlue lay out its competitive plans in detail? This comes across like you’re allowed to play in a soft invitation-only poker game with four huge fish but only if you’ll play with your cards turned over.
The judge burns a witness for the government pretty hard. For example:
It would be a stretch to refer to such testimony as “expert.”
He basically says this wasn’t a great witness, except for the part I’m going to hinge my judgment on. That part was useful. The judge then relies on this analysis to support the idea that some consumers will be hurt:
As Dr. Chipty’s analysis demonstrates, it would take five years for other ULCCs to replace Spirit’s capacity nationally. Were other ULCCs to attempt to replace Spirit’s capacity specifically on Spirit routes (and thereby serve Spirit customers), it would take over fifteen years to do so. To replace just half of Spirit’s capacity on its Boston routes, Allegiant, which is receiving Spirit divestitures at Boston(BOS), would have to grow by 412%. That number rises to 757% for Miami(MIA). Allegiant’s average annual growth rate from 2013-2022 was 10%; it is not only unlikely, but practically impossible that its growth rate would increase to the 249% annual rate Dr. Chipty estimates would be necessary. Frontier’s average growth rate is not much higher; at 12.8%, the odds of Frontier growing even over 100% are minimal. Even with other, new ULCCs growing and expanding and legacy airline expanding their basic offerings, there is simply no way such astronomical need could be supplied. The Government, therefore, has proven by a fair preponderance of the evidence that the merger would substantially lessen competition in a relevant market.
Here, annual growth rates in the presence of an ULCC are compared to the hypothetical growth rates required to fill the demand that would be up for grabs if that competitor left. It is very hard to grow (somewhat profitably) by taking market share. It is not hard to fill a demand that’s not being served anymore. Nor do I think it will require this kind of growth rate from the big four, who’ll be happy to fill in any profitable gaps in demand.
Conclusion
The ruling against the merger of JetBlue and Spirit Airlines is a potential game changer in antitrust law. Despite JetBlue’s argument of a pro-competitive effect and potential for increased competition against the Big Four airlines, the court’s decision heavily weighed the potential harm to a specific subset of consumers within certain markets who rely on Spirit’s low-cost offerings. The ruling’s emphasis on consumer harm, even when offset by larger advantages to other consumers, sets a precedent that could influence future antitrust cases. It lowers the threshold for successfully blocking mergers, and fewer companies will even try when faced with such a standard.
Spirit’s share price declined to $7. I’m mostly long call spreads and calendar put and call spreads. For the most part, these are worthless or ended up neutral. I’m unwinding the neutral positions. I’m hanging on to the worthless positions to save on trading costs. If I had equity exposure in Spirit Airlines, Inc. shares, I would likely hold for now and wait for the company’s responses. There is a lot of pressure on the shares because this is an arbitrage that many traders are paying attention to because of the huge spread. Then, there is a possibility the parties will be serious about appealing, and there also is a possibility Spirit succeeds in improving its profitability.
