How Was JetBlue’s Proposed Acquisition of Spirit Anti-Competitive?
The U.S. recently ruled that JetBlue’s proposed takeover of Spirit Airlines would be anticompetitive and would harm the consumer. The acquisition was terminated forcing JetBlue and Spirit to continue to operate independently. On the surface, the consolidation of two smaller carriers, in an industry dominated by four much larger carriers, does not seem to be problematic. This situation has an unusual interpretation of “anti-competitive” which was successfully used to block the transaction.
Background on Anti-Trust Law
The Clayton Act of 1914
This law aims to promote fair competition and prevent unfair business practices that could harm consumers. It prohibits certain actions that might restrict competition, like tying agreements, predatory pricing, and mergers that could lessen competition.
An illegal merger occurs when two companies join together in a way that may substantially lessen competition or tend to create a monopoly in a relevant market. This reduction in competition can harm consumers by potentially leading to higher prices or fewer choices for products or services. It can also harm workers by potentially leading to lower wages or fewer choices for employment. (From the Justice Department Website)
The FTC’s Typical Perspective
The FTC responsibility is to examine the current market structure and then predict how it will change if the combination takes place. Anti-competitive investigations are frequently launched when two relatively large market participants attempt to combine.
For example, the FTC has challenged the potential merger of Kroger and Albertsons- two grocery giants – as possibly having the effect of reducing competition. This merger between the #2 and #4 largest food retailers would create a huge grocery seller with an almost 12% share of the US market (behind Walmart’s 17% share). The potential reduction in competition is not difficult to understand when one company may now own two of the largest grocery stores in town.
2021 US Food & Grocery Market – GlobalData
- Walmart – 17.1%
- Kroger - 7.3%
- Costco - 5.7%
- Albertson’s - 4.5%
- Ahold - 4.3%
A merger of the #2 and #4 groceries would create a much stronger #2 and will reduce competition in the many areas currently served by a Kroger and an Albertson owned store. Kroger’s management has admitted this but argues their larger buying power will benefit consumers through lower prices.
While there has yet to be a ruling on the grocery deal, this transaction looks problematic within the traditional interpretation of the Clayton Act. It is still possible they will find a solution acceptable to the regulators through offering to divest a large number of stores.
The Proposed JetBlue Acquisition of Spirit
The most interesting aspect of the FTC’s perspective is the interpretation on the proposed JetBlue acquisition of Spirit on how it “may substantially lessen competition”. On the surface, the court ruling stopping the acquisition of Spirit Airlines by JetBlue appears confusing. How could merging two small, struggling carriers be deemed anti-competitive?
The market structure of commercial airlines is different and dominated by four huge carriers which together represent more than 2/3 of the market. JetBlue and Spirit are each relatively small carriers.
- Passenger Flights - The US Domestic Market Distribution
- American 17.5%
- Delta 17.3%
- Southwest 16.9%
- United 15.6%
- Alaska 6.2%
- Jet Blue 5.5%
- Spirit 4.9%
- Frontier 3.3%
- SkyWest 2.8%
- Hawaiian 1.9%
- Others 8.1%
(Domestic Revenue Passenger Miles) – Statistica - February 2022 – January 2023
Consolidating two small competitors is usually a common strategy to compete in a market dominated by several large providers. In fact, all the top four carriers grew to their current size through multiple strategic mergers and acquisitions. Why, in this case, did the FTC push to block this merger of two small struggling carriers?
The Market Power of Spirit Airlines
The case the government made and endorsed by the judge was interesting and not a perspective I have seen before. The FTC sees that Spirit – even as the seventh largest carrier with just 5% of the passengers – has demonstrated it can dramatically reduce fares in markets it serves. This is referred to as the “Spirit Effect”.
In a study conducted by Hopper, when Spirit (or Frontier) entered a market not served by a Ultra Low Cost Carrier (ULCC), it would offer fares at about half the current full fare airline. The full fare airline would then drop rates to Spirit’s rate, plus $50-$60 for bag and other fees charged by Spirit. This is not that surprising. The surprise was if Spirit later decided to leave that market, the fares would go up, but would not return to the previous level. This is the pricing competition the FTC wanted to protect. Their fear was Spirit pricing – and the Spirit Effect – would disappear in a consolidation with JetBlue.
Duty to Notify the FTC & Justice Department in Advance
The Hart-Scott-Rodino Antitrust Improvements Act of 1976
This Act, amending the Clayton Act, requires companies to file premerger notifications with the Federal Trade Commission and the Antitrust Division of the Justice Department for certain acquisitions. The Act establishes waiting periods that must elapse before such acquisitions may be consummated and authorizes the enforcement agencies to stay those periods until the companies provide certain additional information about the likelihood that the proposed transaction would substantially lessen competition in violation of Section 7 of the Clayton Act.
Where Do Spirit and JetBlue Go from Here?
Both Spirit and JetBlue are operating at significant losses with each carrier losing several hundred million dollars year after year. A major goal of the combination was to gain scale and efficiency and thus improve operating margins – a common business strategy. Now forced by the FTC to go forward independently, the possibility of bankruptcy has increased for both carriers. If JetBlue files bankruptcy, one of the big four airlines will most likely take it over. If Spirit files, Frontier will quickly act to be the acquiror. In addition, with stock prices of both companies at or near their all-time lows, it has become more likely for a buyer to initiate an acquisition now – not waiting for a bankruptcy filing. Every one of these results will reduce competition – exactly what the FTC was trying to prevent.
Conclusion
This ruling demonstrates the FTC believes a material reduction in competition does not just come from combining two large market participants. They successfully argued removing the Spirit Effect from the market would permit prices to be raised by the remaining carriers. A possible unintended consequence of the ruling is that by keeping JetBlue and Spirit independent, their operating losses may force each of them into bankruptcy, eliminating the competition they provide.
As mergers and acquisition advisors, we are now required to consider the potential anti- competitive effects of potential mergers not just based on the combination of two larger market participants, but we also must consider how the removal of smaller market participants could affect the aggregate market.
Disclaimer
This article is solely my opinion as an advisor to businesses contemplating merger and acquisitions transactions. Importantly, I am by no means an expert in the law.
By William Surman, Partner with CDI Global North America
