The world’s largest airline, American, spent 2015 demonstrating that it can inflict a financial toll on its ultralow-cost rivals.
American began matching the cheapest fares on competing nonstop routes and has promised to offer a new bare-bones fare in the new year to address competition from Spirit and Frontier airlines.
The fare fight took a toll. While Spirit remains wildly profitable, the airline’s share price dropped 47 percent in 2015 amid torrid expansion. Its revenue dipped due to extremely low fares in many of its most crucial markets, such as Dallas-Fort Worth, Chicago, Fort Lauderdale, and Los Angeles. On Tuesday, meanwhile, Spirit announced that Chief Executive Ben Baldanza had been replaced by industry veteran Robert Fornaro.
In Fornaro, Spirit now has a CEO with experience growing and then selling an airline, which he did with AirTran Airways. Southwest bought that Florida-based carrier in 2011 during the U.S. airline consolidation boom. The experience might come in handy now. “Spirit remans one of the most profitable airlines in the world but its shares are under pressure,” said Seth Kaplan, a managing partner of Airline Weekly, an industry journal. “There are concerns among investors that if fuel prices stop falling and unit revenues keep falling, then profits could come under pressure.”
Talk of a merger between Spirit and Frontier has percolated since 2013, when Indigo Partners, the private equity firm run by William Franke, a pioneer of the ultralow-cost airline movement in the U.S. and Europe, sold its 17 percent stake in Spirit and acquired Frontier. In August, Franke told the Wall Street Journal that in early 2013 he had pitched fellow Spirit board members about buying Frontier. After the board declined, Franke decided to acquire Frontier on his own while exiting Spirit.
Privately held Frontier is also contemplating an initial public offering in 2016 and has held early-stage talks with investment banks, Bloomberg News reported last month. Indigo paid $145 million for Frontier, including debt. Depressed revenue growth across the industry could make a Frontier sale more attractive for Indigo than a stock offering. (A Frontier spokesman, Jim Faulkner, said the airline and Indigo Partners declined to comment.)
A potential merger of Spirit and Frontier is more likely under Fornaro than under Baldanza, though not in the near term, Savanthi Syth, an analyst at Raymond James Financial, said in a note. Wolfe Research upgraded Spirit shares to outperform on Tuesday, citing a greater likelihood of a merger with Frontier under Fornaro. “Everybody has always thought [a Frontier merger] was a good idea,” Cowen analyst Helane Becker said in an interview. She said a deal is possible in the next two years.
Since Indigo’s departure, Baldanza had consistently rejected talk that Spirit would contemplate merging with Frontier, arguing that Spirit could follow its business plan and grow organically. He said Spirit’s growth in the U.S.—despite the surge in 2015—still constituted a fraction of the market share that ultralow-cost carriers enjoy in Europe as a percentage of the airline market.
Baldanza also argued that Spirit was not stealing traffic from larger airlines and served lower-income travelers who would either fly Spirit or not take a trip. But as Spirit grew, the bigger players began to respond more aggressively, particularly at American, which was determined to counter Spirit’s incursion at its flagship hub, Dallas-Fort Worth. In October, American executives forcefully defended their decision to match Spirit and Frontier fares on nonstop routes.
In 2014, Delta Air Lines began selling a “basic economy” fare to match Spirit on competing routes. United is also considering greater fare options including “deeply discounted fares that would simply include the ticket,” spokesman Rahsaan Johnson said Tuesday.
Beyond matching the cheapest fares on offer, the industry would also benefit from further airline consolidation, which keeps seat capacity restrained. “Although they don’t overlap too much, they are beating each other up in some markets,” Kaplan said of Frontier and Spirit. “They’re going to be bumping up against each other more and more. And everybody else would rather compete against only one of these ultralow-cost carriers rather than two.”
There are other links between the two no-frills, high-fees airlines. Frontier is run by Barry Biffle, a former Spirit executive who joined the company as part of Baldanza’s management team. Spirit and Frontier both fly Airbus fleets and use the New Skies reservation system from Navitaire, a unit of Accenture.
There’s also another possible reason this marriage could work: In the 1990s, Frontier painted the slogan “The Spirit of the West” on its wildlife-themed planes.
This article was written by Justin Bachman from Bloomberg and was legally licensed through the NewsCred publisher network.