Spirit Airlines is following United Airlines’ lead in using loyalty program and intellectual property assets as collateral for new debt. The deal should enable Spirit to ride out up to two years of operations at diminished demand levels, and the company could bounce faster than pricier peers if the virus is brought under control, but its pricing reflects the longer-term implications of Spirit’s smaller size and budget-travel offering, said six sources.
Lead bookrunner Barclays circulated official talk for the USD 600m senior secured notes due 2025 today at 8.25%-8.5% including OID, tight of whispers in the high 8% area including one to two points of OID, nearly 300bps wider than United’s current trading levels, the sources added. Books are still expected to close tomorrow (2 September).
For comparison, United’s USD 3.8bn 6.5% senior secured notes due 2027 last traded today at 104.5 to yield 5.433%, up slightly from trades last week at 103.75 to yield 5.6%, according to MarketAxess. Those notes, which are backed by United’s MileagePlus loyalty program and intellectual property, are rated BBB- by Fitch, compared to Spirit’s BB+ rating.
Proceeds of Spirit’s notes will be used to add cash to the balance sheet, with pro forma liquidity totaling USD 2.2bn, according to marketing documents. Based on current cash burn levels of USD 3m-4m per day, which assume suppressed levels of demand and no workforce reductions, the company projects this will fund 18-24 months of operations.
Further liquidity could be generated by offering up other assets as collateral, sources noted. The company has an appraised USD 600m of unencumbered assets, consisting of A319 and A320 aircraft, ground service equipment, flight simulators and real estate to generate further liquidity, according to company documents.
As the Spirit debt is issued through a special purpose, recurring financing vehicle, the company is able to issue additional debt through the vehicle, three of the sources said. Sources expect Spirit to use the high yield market to bolster liquidity further down the line as needed.
However, Spirit’s deal documents contain a provision restricting incremental debt on the facility for two years, but following this period, the company can issue debt in line with the debt service coverage ratio, two of the sources said. If the company’s loyalty programs securing these deals increase in value, then the company is able to borrow against the additional proceeds.
Pro forma the new notes, the company is 10.8x levered through USD 3.26bn of total debt and USD 303m of adjusted EBITDAR. Net of the company’s pro forma cash balance of USD 2.2bn, total leverage comes to 3.5x.
Spirit caters mainly to the domestic leisure travel market—and within that, people who are looking for the lowest fare possible—whereas United’s clientele incorporates more business travelers, spread across international and domestic markets. In the long term, United is likely to be a more stable business, sources argued.
“While United’s reach is a drain for the business in a pandemic, we have to take into consideration that it’s a better bet long-term,” said one. “Spirit is a good bet for the pandemic, because of its exposure to leisure travelers. People are going to go visit their friends and family when they feel safe, as opposed to taking business trips.”
Subscribing to loyalty
The proposed bonds are backed by Spirit’s loyalty program and intellectual property, including the brand IP. Spirit’s loyalty program draws revenues from two sources: its co-branded loyalty credit card and the $9 Fare Club, according to company documents.
While the co-branded credit card is similar to other airlines, the $9 Fare Club is based on a subscription model. Consumers must opt-in to pay USD 59.95 for the first year and USD 69.95 for each following year to access the benefits of the program. However, since the COVID-19 pandemic began, revenues for the $9 Fare Club have fallen.
For the six months ended 30 June, cash proceeds generated from the program were USD 24.9m, compared to USD 63.7m in full-year 2019. Cash proceeds from the co-branded credit card were USD 27.7m for the six months ended 30 June, compared to USD 48.1m in full-year 2019.
Based on third-party valuations, the collateral package including both loyalty programs and the brand IP license is valued at USD 2.93bn. Sources estimate the value of the collateral package closer to 1x-2x debt coverage through the secured debt—equating to roughly USD 900m-USD 1bn. In a distressed scenario, sources expect secured creditors to receive 90%-100% of recovery.
Sources expect Fare Club revenues to remain at depressed levels through 2020, but anticipate that the second half of next year will see a marked improvement in air travel traffic and demand, especially if a vaccine is finalized. With the company’s focus on domestic travel, Spirit could see a faster short-term recovery than airlines with more international exposure, they said.
“Spirit even got a bump from leisure travel in second quarter, but then when the cases spiked again, those gains were mostly retraced,” one of the sources said. “As soon as cases are under control and specifically if there’s a common treatment or vaccine, Spirit will be one of the first to benefit.”
Fitch assumes base forecast revenues down as much as 60%-65% in the third quarter and down at least 30% in the fourth quarter for domestic-focused carriers and closer to 50% for carriers with international exposure, according to a 31 August ratings report.
Barclays declined to comment. Spirit Airlines did not respond to a request for comment.