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JetBlue

Airways
FINC 614: Financial Markets

Table of Contents
1-What is an IPO and why is it such a big deal?...............................................2
IPO Definition:............................................................................................... 2
IPO Timing:.................................................................................................... 2
What is difference between Venture Capital and IPO :..................................2
IPO Steps:..................................................................................................... 3
Why to underprice?....................................................................................... 3
Why is it such a big deal?.............................................................................. 3
2. Is this a good idea? What are the advantages and disadvantages of going
public? Explain why you come to the conclusion that you come to public.......3
Is this a good idea?....................................................................................... 4
Advantage of IPO:......................................................................................... 4
Disadvantage of IPO :....................................................................................4
Explain why you come to the conclusion that you come to public:...............4
3. Why JetBlue Airways can still remain profitable while most airline
companies facing decline after 911 terrorist attacks?......................................5
Industry Analysis:.......................................................................................... 5
New entrants barrier.................................................................................... 5
Competitors:................................................................................................. 6
JetBlue Competitive advantage.....................................................................6
Conclusion:................................................................................................... 6
4. What different approaches can be used to value JetBlues shares?.............7

Valuing IPOs by comparable:..................................................................7

Earnings Per Share EPS:..........................................................................7

Gordon Growth Model:............................................................................7

Discounted cash flow (DCF)....................................................................8

5. At what price would you recommend that JetBlue offer their shares? What
are the key drivers in the analysis?..................................................................8
The recommended share price:....................................................................8
The key drivers in the analysis:.....................................................................9

1-What is an IPO and why is it such a big deal?


IPO Definition:

An initial public offering, or IPO, is the first sale of stock by a company


to the public. It is the process by which companies go from private to
public and sell stocks shares in their firm.

i.e If a company wants to sell stock shares to the general public, it


conducts an IPO.

In another words it is a type of public offering in which shares of a


company usually are sold to institutional investors that in turn, sell to
the general public, on a securities exchange, for the first time.

By doing so, a company goes from the status of private (no general
shareholders) to public (a firm with general shareholders).

After the IPO, when shares trade freely in the open market, money
passes between public investors.

Details of the proposed offering are disclosed to potential purchasers in


the form of a lengthy document known as a prospectus.

Most companies undertake an IPO with the assistance of an investment


banking firm acting in the capacity of an underwriter.

IPO Timing:
A company can raise money by issuing either debt or equity. If the
company has never issued equity to the public, it's known as an IPO.

What is difference between Venture Capital and IPO :


Venture Capital (Also called risk capital) is a process where
money provided by investors to startup firms and small businesses with
perceived long-term growth potential.

This is a very important source of funding for startups that do not have
access to capital markets.
It typically entails high risk for the investor, but it has the potential for aboveaverage returns.

IPO Steps:

The company and investment bank agree to an underwriting deal.


The bank puts together a registration statement to be filed with the
SEC, this statement has detailed information about the offering and
company info such as financial statements, management background,
any legal problems, where the money is to be used, and who owns any
stock before the company goes public.
The SEC will investigate the company to make sure all the information
submitted to it is correct and that all relevant financial data has been
disclosed.
If everything is OK, the SEC will work with the company to set a date
for the IPO.
After SEC approval for the IPO, the underwriter must put together a
prospectus.

Why to underprice?
IPO underpricing is the increase in stock value from the initial offering
price to the first-day closing price.
Underpriced IPOs may leave money on the table for corporations, but on
the other hand underpricing is unavoidable.
Underpricing signals high interest to the market which increases the
demand. On the other hand, overpriced stocks will drop long-term as the
price stabilizes so underpricing may keep the issuers safe from investor
litigation.

Why is it such a big deal?

While going public can have many positive effects on a company and its
operations, these positive effects must be balanced against the disadvantages.
Going public drastically changes a companys culture and has an ongoing impact
on business operations.
Determining if going public is the right course for a company to pursue is a major
decision and must be carefully considered by management before this course is
taken.

2. Is this a good idea? What are the advantages and


disadvantages of going public? Explain why you come
to the conclusion that you come to public
Is this a good idea?
This decision is not an easy one although going public can have many
advantages for the company but those advantages must be compared
against the possible disadvantages and based on this comparison results
company to decide if this is a good deal or not.

Advantage of IPO:

Enlarging and diversifying equity base


Enabling cheaper access to capital
Increasing exposure, prestige, and public image
Attracting and retaining better management and employees through liquid
equity participation
Facilitating acquisitions (potentially in return for shares of stock)
Creating multiple financing opportunities: equity, convertible debt, cheaper
bank loans, etc.

Disadvantage of IPO :

The costs associated with the process


Significant legal, accounting and marketing costs, many of which are
ongoing
Requirement to disclose financial and business information
Meaningful time, effort and attention required of management
Risk that required funding will not be raised
Public dissemination of information which may be useful to competitors,
suppliers and customers.
Loss of control and stronger agency problems due to new shareholders
Increased risk of litigation, including private securities class actions and
shareholder derivative actions

Explain why you come to the conclusion that you come to


public:
Going public raises cash, and usually a lot of it, being publicly traded
also opens many financial doors:

Because of the increased inspection, public companies can


usually get better rates when they issue debt.
As long as there is market demand, a public company can
always issue more stock.

Mergers and acquisitions are easier to do because stock can be


issued as part of the deal.
Trading in the open markets means liquidity. This makes it
possible to implement things like employee stock ownership
plans, which help to attract top talent.
It carries a considerable amount of prestige. In the past, only
private companies with strong fundamentals could qualify for an
IPO and it wasn't easy to get listed.

3. Why JetBlue Airways can still remain profitable


while most airline companies facing decline after 911
terrorist attacks?
Industry Analysis:

Air transport has always been considered as a very special sector in


the international context.
It facilitates global economic and social growth, international and
domestic tourism, world trade growth
It has been a dominant factor in the process of globalization.
In 2008, US$ 535 billion was generated compared to US$ 307 in 2001.
This growth has been attributed to globalization of the industry driven
by market
deregulation and open skies agreement.
Deregulation nurtured the growth of Low Cost Carriers in the domestic
market.

New entrants barrier


1. Fleet Costs
Purchasing a fleet of airplanes is a significant barrier to entry for many
newcomers in the airline industry. Prices for a single airplane range from
around $11 million for a small Embraer prop plane designed for regional
service to more than $320 million for a Boeing 777.
2. Fuel
Fuel is the largest barrier to entry for many industry newcomers. According to
a 2012 report in the New York Times, fuel costs account for up to 50 percent
of an airlines expenses.
3. Government Regulations

Airlines are subject to a significant range of government regulations, and


complying with all of them can be a barrier to entry for some airline
entrepreneurs. Regulatory requirements cost the airline industry as a whole
more than $1.5 billion annually.
4. Competition
Government deregulation aside, new airlines can experience a considerable
barrier to entry just trying to get a gate at a major airport. According to the
New York Times, a small number of major airlines control most of the gates at
large hub airports, making it difficult for new airlines to get a foothold in
these markets.
5. Pilots
Staffing an airline requires qualified talent in the pilots seat. A 2014 article in
the Wall Street Journal details an ongoing pilot shortage, and notes that new
pilots tend to prefer a career with an established company rather than a
riskier startup.

Competitors:
JetBlue Direct Competitor
LUV = Southwest Airlines Co.
UAL = United Continental Holdings, Inc.
AAL = American Airlines Group Inc

JetBlue Competitive advantage


1. Differentiated Product & Culture JetBlue offers the most legroom in
coach, free TV, snacks and Fly-Fi on its flights. Combined with award
winning service from their dedicated employees, whom JetBlue refer to
as Crewmembers, they believe that they offer the most compelling
product in the sky.
2. Competitive Costs The cost structure is lower than their larger
network competitors. This enables them to offer attractive fares, grow
their network, and still focus on profitability and shareholder returns.

3. High Value Geography They operate from six focus cities in some of
the largest travel markets in the United States. JetBlue plan to continue
to grow its network, with most of their flights touching at least one of
these focus cities.

Conclusion:
Because of the industry nature and the various completive advantages
JetBlue owns (especially low-fare strategy) they were able to remain
profitable after 11 September attack.

4. What different approaches can be used to value


JetBlues shares?
Valuing IPOs by comparable:
In this method of comparable, we find a value relevant attribute such
as earnings. Then find comparable firms, with similar value to
attribute ratios (e.g., P/E ratio) for the firm whose value we are trying
to compute.
Finally, apply the average (or median) ratio derived from the selected
comparable firms to the attribute value of the firm whose market

(Price/attribute) *
(attribute of the company) = value estimate of
the company
value we are trying to compute:

Earnings Per Share EPS:


Is the net income available to common shareholders of the company divided by the
number of outstanding shares.
The most important thing to look for in the EPS figure:
1. The overall quality of earnings.
2. Make sure the company is not trying to manipulate their EPS numbers to
make it look like they are more profitable.

3. Also, look at the growth in EPS over the past several quarters / years to
understand how volatile EPS is

Gordon Growth Model:


A model for determining the intrinsic value of a stock, based on a
future series of dividends that grow at a constant rate.
Given a dividend per share that is payable in one year, and the
assumption that the dividend grows at a constant rate in perpetuity,
the model solves for the present value of the infinite series of future
dividends.
Gordon Growth Model

Where:
D = Expected dividend per share one year from now
k = Required rate of return for equity investor
G = Growth rate in dividends (in perpetuity)

Discounted cash flow (DCF)


A valuation method used to estimate the attractiveness of an
investment opportunity.
DCF analysis uses future free cash flow projections and discounts
them (most often using the weighted average cost of capital (WACC),
to arrive at a present value, which is then used to evaluate the
potential for investment.
The formula for calculating DCF is usually given something like this:
PV = CF1 / (1+k) + CF2 / (1+k)2 + [TCF / (k - g)] / (1+k)n-1
Where:
PV = present value
CFi = cash flow in year i
k = discount rate
TCF = the terminal year cash flow
g = growth rate assumption in perpetuity beyond terminal year
n = the number of periods in the valuation model including the
terminal year

5. At what price would you recommend that JetBlue


offer their shares? What are the key drivers in the
analysis?
The recommended share price:
We can use the formula of the geometric mean to estimate the share
price of JetBlue:

x=n p 1p 2p 3p 4
Share price =

5 2224252745

Share price = 27.61


So JetBlue could have sold its shares at the initial price of $27.61

The key drivers in the analysis:

Direct Valuation:
By examination of firm financial statements, such as, cash flows, sales
and assets.

Valuing IPOs by comparable:


In this method of comparable, we find a value relevant attribute such
as earnings. Then find comparable firms, with similar value to
attribute ratios (e.g., P/E ratio) for the firm whose value we are trying
to compute.

Price Revisions:
Cross-sectional regressions to be done on initial price adjustment and
underpricing in examining how the information on nonfinancial
fundamentals is incorporated into valuation at different IPO stages.

Long-term Performance:
long-term (three-year) examination of IPO performance.