Budget airlines bring a smile to customers looking for some savings. This brings good fortune to companies. However, Spirit Airlines, once a standout in the ultra-low-cost carrier sector, has now filed for bankruptcy protection on November 18, 2024. After years of growth, Spirit’s low-cost model has faltered, leaving behind significant debts and unhappy shareholders. At stake is a hefty amount of equity capital - $800K - that may never be repaid, with the airline expected to face a full collapse by 2025. However, an emergency exit door remains open: corporate restructuring.
Spirit Airlines did not always look like it would navigate turbulent skies. Indeed, its business model was viewed as a high-flying growth opportunity in 2014 by Morgan Stanley, an endorsement which reflected the significant confidence investors had in Spirit’s prospects (in line with the Efficient Market Hypothesis). Over the years, the airline became accredited as one of the most affordable options in air travel such that it received the 2023 award for the best value airline.
What resulted in its downfall? A classic case: revenue fallout and uncontrolled expenses. COVID-19 blew its revenue as consumer demand plummeted. While the 2022 recovery led to an overall rebound in the industry, Spirit failed to stimulate any earnings growth. Meanwhile, competition in the low-cost market surged. Rival budget carriers offered cheaper tickets, while legacy airlines increasingly catered to travelers willing to pay extra for premium services, diminishing Spirit's pioneering edge. Its inability to suppress expenses, soaring inflation and the 4.5% rise in labour costs created operational inefficiencies, aggregating to a $2.5bn loss with these factors combined, over the four years. It had accrued debts exceeding $1bn, coupled with the fact its merger initiatives failed to materialise. Most notably, the $3.8bn merger with JetBlue would have alleviated its gloomy outlook but was rejected on its anti-competitive basis.
Spirit filed for Chapter 11 protection in New York seeking to reduce its significant debts. The goal is to clean up the balance sheet by addressing the debt’s overhang which should create more financial flexibility in the longer term. The restructuring plan aims to make Spirit more sustainable, at least in terms of debt management, while attracting an influx of fresh investments from those that are optimistic about its upcoming take-off. Part of the restructuring agreement therefore includes existing bondholders committing an extra slice of $350 million equity investments; undeniably, this will create a positive impact on its cash and liquidity levels. It also envisions reducing its debt load by $795mn via a debt/equity swap transaction. Other existing bondholders will provide $300mn in debt in possession financing which shows that creditors have some hope about the success rate of Spirit once it relaunches. Spirit has assured all its employees and current customers that the bankruptcy filing will not alter any of their stake in the business.
However, shareholders are not so fortunate. Current ordinary shareholders will bear the full brunt of the bankruptcy. The airline's stock will be delisted from the New York Stock Exchange, and existing shareholders will lose their investments, as they have no place in the company’s future structure. This scenario effectively illustrates the high risk to reward ratio on ordinary stocks and starkly emphasises the criticality of a balanced and diversified portfolio for investors.
The case of Spirit highlights that the low-cost model may no longer be effective, with changing consumer preferences creating a more complex landscape. More travelers are willing to pay extra for added comfort, and legacy airlines have adapted, offering premium services that challenge Spirit’s value proposition. The model may have reached its saturation peak. Looking forward, it would be worthy to see how new spirits recalibrate its strategic focus to adapt to the evolving market, and reclaim the skies that it once conquered, if it can.
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