Spirit Airlines: Victim of a Structurally Flawed Industry

December 17, 1903. Two brothers from Ohio stood on a beach in Kitty Hawk, North Carolina, watching the first successful flight in human history. Over the course of 59 seconds, their creation, called the "Flying Machine," covered 852 feet and gave birth to a new age of travel. This technological revolution didn't stop here, though. Eleven years later, passengers began paying $5 to fly commercially from St. Petersburg to Tampa, and upon this, a new age was set: the birth of the airline industry.

Since this moment, the industry has had its highs and its lows. Currently, a new low is emerging for the industry due to the recent closure of the Strait of Hormuz. Due to this, headlines such as a possible JetBlue bankruptcy and a permanent end to the operations of Spirit Airlines have emerged. These failures are nothing new to the industry though. Since 1978, the year the industry was deregulated, most companies have dealt with bankruptcy. The most notable recent wave was post-9/11, when carriers such as United, Delta, Northwest, and US Airways went under. Fast forward to today, and the industry is entering a new shock and people have started to notice some of the glaring problems the industry faces.

The question isn't whether the industry is struggling. The real question is whether the aviation industry is victim to the normal business cycle, or if something structural is happening that almost guarantees distress when times get tough. While the Strait of Hormuz Crisis may have lit the fuse, the powder keg was always there, and in this, we'll be investigating these questions with a case study to better understand airliners.

The Current State of the Industry

On February 28, the Strait of Hormuz was effectively closed, and with it, 20% of the world's oil supply was shut down. Subsequently, jet fuel spiked by over 100%, causing most airliners to erase 25% or more of their market capitalization.

This matters because airplanes use fuel to operate, with these fuel expenses being the 2nd largest after salaries under operating expenses. Seen in the chart above, costs have doubled in the short course of two months.

Tools do exist however to mitigate the effects of these shocks, with the main one being hedging. Therefore, why does this oil shock affect US airliners so much? This is because domestically, the practice has been abandoned.

What Happened to Hedging?

There's a list of reasons why hedging is gone, but ultimately, it boils down to the costs associated with hedging and previous failures over the past few decades.

The first major catalyst came in 2008 when oil went from $90 per barrel in January to $140 per barrel by July due to rising demand from China and India and the simultaneous weakening of the USD. In response to this, airliners hedged their fuel costs, but by December, prices declined to $30 per barrel as the Global Financial Crisis emerged. The result was a loss of $2.3 billion in a single quarter due to companies having already locked in their future prices near oil's peak. Despite this, many airliners continued to hedge.

For the next decade, energy prices stayed stable, and companies began to realize that the costs of their hedging programs were burdensome for profitability since they had to pay large premiums on the oil they were buying. Additionally, as companies began to drop their hedging programs, executives in the industry began to realize a "natural hedge" had emerged since they could now just pass on prices to consumers.

Transferring this to the Current Environment

Because of this "natural hedge", airliners are using it to make up for increased costs that have come from the rise in jet fuel, with analysts at Citi estimating a 15-20% jump in prices to offset increased input costs. The way this strategy works is through targeted increases in yield. The plan moving forward now is to recapture of 50% of these losses in Q2, 75% in Q3, and 100% in Q4 of 2026.

While many of the large players can take on these costs and make up for them through pricing and economies of scale, smaller operators are threatened with bankruptcy or even going entirely out of business. This represents a "K-shape" competitive landscape in the industry between the Big 4 (Delta, United, American, Southwest) and smaller players.

The problems the lower half of the K reopens a debate the industry has spent decades trying to bury: Does aviation need to be regulated? Not in terms of safety, but instead, whether a free market can sustain a healthy and balanced industry. We'll look at a case study of Spirit Airlines to help better understand this.

Spirit's Rise

The company found its origins in the Ultra-Low-Cost-Carrier (ULCC) segment of the airline industry in 2007 after Oaktree Capital Management took a majority stake in the company. Soon enough, the company went public in 2011, quickly rising to become the #1 player in low-cost air travel. By the mid- to late-2010s, revenue grew double-digits year after year, peaking at $2.5B in 2019 at 9% net margins, far above the industry average of 4-5%. The sky seemed limitless for Spirit. Unfortunately, it was not, and everything came crashing down (in a financial sense).

The Fall

When COVID was announced, Spirit met the beginning of its end. While the industry received $54B through the CARES Act to keep it afloat, Spirit was positioned much worse than its peers. The high-leverage business model the company had was accompanied by a Debt/EBITDA ratio that was over double that of its peers in 2023. This was because low-cost carriers like Spirit financed their aircraft order books through debt, meaning large, fixed cost obligations. Additionally, ULCCs carried lower cash reserves than peers to maximize ROIC, meaning revenue could not collapse sharply. This high-leverage model, combined with COVID, made survival difficult. However, Spirit managed to make it out for the time being.

The slight caveat? Spirit took on $1.1 billion in debt, with a huge maturity wall in 2025-2026. However, recovery began. Revenue rose 57% in 2022 to a record $5 billion, but the company was still unprofitable, in part because its debt carried 8% interest rates. Soon enough, distress began, which was signaled when its bonds fell to 50 cents on the dollar in 2024.

There were alternate routes to safety besides internal cost-cutting, though, with M&A being the main alternative path. Due to Spirit's large debt burden, competitors saw an opportunity to acquire a dominant player in the ULCC segment at a cheap valuation.

M&A Attempts

The first attempt at M&A was launched by Frontier in February 2022, which valued Spirit at $2.9B. This would create the 5th largest US carrier, with a valuation of $6.6 billion. However, as this was being evaluated by management, JetBlue in April came in with a $3.6 billion unsolicited bid (later revised up to $3.8 billion). Spirit accepted this, rejecting Frontier in the process. Despite Spirit's precarious cash position, investors viewed this acquisition as an opportunity for the company to lower its cost structure and survive the COVID scare.

Most people were unbothered by this and saw it as a normal business practice. After all, consolidation had been happening for decades in the industry. However, one individual was heavily opposed to it: Lina Khan. She and the DOJ cited that the merger would "lead to higher fares, fewer seats, and harm millions of consumers," a take that seemingly aged very poorly.

With M&A off the table now, Spirit was in freefall, with bankruptcy up next. The first Chapter 11 came in November 2024, resulting in $795 million in debt being restructured and requiring bondholders to inject more capital into the company. By March 2025, Spirit emerged from bankruptcy. What followed? $246 million in losses between March and August, which included full usage of a $275 million revolving credit line and a default of a lease with AerCap for jets. Chapter 11 came again.

The Final Straw

By February 2026, the company was still in restructuring, and then the war with Iran came. Jet fuel doubled in the snap of a finger and operating expenses grew by $100 million in one month. The final dagger had arrived, and the company was forced to drain the rest of its remaining liquidity and cancel all restructuring efforts.

The only option now was a bailout, something which historically has happened in the industry. Spirit requested a $500 million rescue package in exchange for a 90% government equity stake. However, talks collapsed on May 1, with creditors from Citadel, Ares, and Cyrus Capital recommending that the company opt to wind down operations instead.

And just like that, Spirit ceased to exist. While that may have been a bit, it highlights a few key things. Firstly, the theme of consolidation, and secondly, the theme of government bailouts. While these were mentioned briefly, they open up the debate previously touched upon: whether increased regulation is necessary?

The Precedent for Airline Regulation

Between 1938 and 1978, the airline industry was regulated by the Civil Aeronautics Board, which made the industry "a communist's dream," according to some. What happened was that this agency oversaw a dozen domestic carriers, and their job was to assign routes and set fare rates for domestic carriers.

However, in 1978, the industry was deregulated under the promise that "competition would lower fares, allow for more airlines to enter the market, and offer a greater variety of flight options for consumers." This was far from the truth.

What happened instead was that many carriers exited the industry, either via M&A or bankruptcy. Fast forward to today, and this explains why the Big 4 control 66% of all US flights. This trend of consolidation shouldn't have been unexpected, though. Rather, government officials should have foreseen this as a structural trait of the industry, which is encouraged by four main factors: economies of scale, network effects, destructive competition, and the scarcity of airports.

Economies of Scale

This principle is basic. The bigger an airline gets, the cheaper each flight becomes to operate. This is because fixed costs such as IT systems, pilot training, maintenance, and legal expenses get more spread across more revenue, hence the incentive to consolidate. Additionally, airliners can buy their fuel in larger quantities, increasing bargaining power. Thus, it makes sense as to why airlines are encouraged to consolidate over time.

Network Effects

Next is network effects. The importance of having scale directly ties into this incentive. The idea is that the more cities an airline serves, the more useful it becomes to passengers since they can get them to more places, thus making larger carriers more appealing to consumers. This becomes even more important when you consider the loyalty programs these companies have and how they tie you into using only one airline. This means from a consumer perspective, you would rather be in a program that can offer a large variety of flights, which helps fight against new entrants and smaller players. Thus, another reason why bigger airliners are better and more resilient to shocks.

Destructive Competition

The 3rd concept is destructive competition. This is based on limiting new entrants. The way it works is that when a smaller airline enters a new route, the larger players will drop prices and add flights on that specific route. While this hurts the profitability of the route in the short term for the larger player, they can subsidize themselves by taking profits from more profitable routes and waiting until the smaller carrier goes away. Thus, they prevent a new entrant from taking market share and discourage future attempts. Once again, another reason why smaller airliners are at a disadvantage.

Scarcity of Airports

The 4th concept, scarcity of airports, ties into discouraging new entrants. This concept has to do with the fact that existing airliners have an incumbent advantage since they have leases on space at airports. Because of this, they can overbook space at airports either to prevent competitors from accessing gate space or to upcharge on the lease, hurting others in an industry that has thin margins. Thus, new entrants have little incentive to expand into new airports.

Taking this all together, you get a few things. Firstly, an industry that is centered around a few major players, and secondly, an industry that still needs bailouts whenever there is a disaster. This hurts consumers in multiple ways, including fewer flights to smaller airports and a tax burden, since consumers fund these bailouts through federal taxes being paid. Knowing this, and especially knowing the past success of the pre-1978 deregulation, should public policy revert to being more involved with the industry, and is this a risk that should be priced in?

Options for the Government

If this were to be a risk investors should consider, the options there would include nationalization, a public option, regulated competition, and partial regulation.

Nationalization would involve a single national champion that would serve the entire country. The pro of this would be economies of scale, but the con would be less competition and less innovation.

The public option route would see a subsidized public carrier that would operate along with private players, with a legal duty to serve smaller cities that the private market won't. Private carriers would likely consolidate into a monopoly or duopoly over time, but the public option would provide a competitive check. It would require heavy subsidies because it would be obligated to serve unprofitable routes and would benefit consumers.

The regulated competition route would revert to the pre-1978 route, when roughly a dozen airlines operated under the Civil Aeronautics Board. This would see assigned routes for carriers and set fares to keep the industry stable, consistently profitable, and reliably serving both large and small markets without requiring periodic bailouts.

Lastly, the partial regulation option would keep the current market structure but impose targeted fixes such as a duty-to-serve requirement on the largest airlines for smaller communities, and a mandatory rainy-day fund built up during profitable years, so taxpayers don't bear the next crisis.

Final Thoughts

Taking from this, an interesting debate arises. While the US is a capitalist country, maybe there should be questions around certain industries, especially ones like airlines. Moving forward, it is unlikely risks like this will be priced unless there is a major ideological shift in Washington, but this public policy-oriented framework provides a basis for understanding the structural weaknesses of the industry and general trends when investing in it.