A Case Study on

JetBlue Airways IPO

Valuation
A Case Study on JetBlue Airways IPO Valuation

Course (F-307): Investment Analysis & Portfolio Management

SUBMITTED TO:
PROFESSOR MD. SADIQUL ISLAM

DEPARTMENT OF FINANCE

UNIVERSITY OF DHAKA

SUBMITTED BY:

Name ID No.
Kazi Golam Rabbani Mowla 18-001
Md. Mahfujur Rahman 18-005
Zan Nesar Alim Qaderi 18-011
Saraf Tarannum 18-077

BBA (18TH BATCH)

SECTION: A
DEPARTMENT OF FINANCE
UNIVERSITY OF DHAKA

Date of Submission: 17 December, 2014

Letter of Transmittal
17 December, 2014

PROFESSOR MD. SADIQUL ISLAM

Department of Finance,
Faculty of Business Studies,
University of Dhaka

Subject: Submission of Term Paper.

Dear Sir,

It is an immense pleasure for us to submit the Project Report on CASE ANALYSIS

OF JetBlue Airways IPO Valuation (F-307: Investment Analysis & portfolio
Management) of BBA program under Department of Finance, University of Dhaka.

This report gave us an occasion to apply our theoretical expertise, sharpen our views,
ideas, and analytical skills, and bridge them with the real world of practical experience,
which will be a good head start for our future professional career. The experience that
we gathered through this project report was very interesting, joyful and valuable one.
This is an ideal ground for us to put in our theoretical knowledge in the practical
ground.

We would like to convey our special thanks and gratitude to you for patronizing our
effort & for giving us proper guidance and valuable advice. We have tried our best to
cover all the relevant fields. We are looking forward to receive your cordial approval of
our submission.

Yours Sincerely

Name ID No. Signature

KaziGolamRabbaniMowla 18-001
Md. MahfujurRahman 18-005
ZanNesarAlimQaderi 18-011
SarafTarannum 18-077
Executive Summary
JetBlue Airways Corporation (JBLU), incorporated in August 1998, is one of the fastest
growing airlines in USA that follows a low cost- low fare strategy. This case study is
describes the dilemma that JetBlue Airways faced while valuing its shares during its
IPO. In order to find solutions to the dilemma, a three step valuation process was
conducted.

The first step involved an economic analysis which clearly showed that the US
economy after the 9/11 attacks slowed down rapidly and the stock market collapsed.
The second step involved the industry analysis which revealed that the Airlines
Industry, according to the porters five forces analysis, in general is not a highly
profitable one. Moreover, the external economic, political factors also negatively
affected the profitability of the airlines industry.

The third and final step of the valuation process involved a company analysis. This
analysis revealed that JetBlue airways had a moderate level of business risk but a
very high level of financial risk. Moreover, the poor liquidity and solvency ratio was
also a reason for concern despite some good profitability and efficiency ratios.

On the context of the above three steps, we calculated the intrinsic value of JetBlues
stocks using the FCFF model and the relative Ratio technique. Using the result of this
techniques as the basis, we suggested JetBlue airways to price its shares between
$24 and $ 26 during IPO.

Moreover, in addition to raising funds through public offering JetBlue always can also
pursue some alternative courses of action. Namely, it can issue bonds or lease the
aircrafts. Both of these alternatives could prove to be more cost efficient than a public
offering.

All in All, JetBlue airways should most certainly go public in order to increase the level
of equity in its overall capital structure, thereby reducing its exposure to financial risk.
Moreover it should also invest heavily in developing its brand image as a long term
strategy.
Table of Contents
CHAPTER 1 .............................................................................................................................................. 6
Background of the Study......................................................................................................................... 6
CHAPTER 2 .............................................................................................................................................. 8
Introduction ............................................................................................................................................ 8
CHAPTER 3 .............................................................................................................................................. 9
Three step Valuation Process ................................................................................................................. 9
CHAPTER 4 ............................................................................................................................................ 10
Economic Analysis ................................................................................................................................. 10
CHAPTER 5 ............................................................................................................................................ 11
Industry Analysis ................................................................................................................................... 11
PESTEL Analysis ................................................................................................................................. 13
Porters Five Forces analysis ............................................................................................................. 15
CHAPTER 6 ............................................................................................................................................ 18
Company Analysis ................................................................................................................................. 18
Liquidity Ratio ........................................................................................................................... 21
Profitability Ratio ...................................................................................................................... 21
Efficiency Ratio .......................................................................................................................... 22
Solvency ratio ............................................................................................................................ 22
CHAPTER 7 ............................................................................................................................................ 23
Problem Statement ............................................................................................................................... 23
CHAPTER 8 ............................................................................................................................................ 23
Valuation ............................................................................................................................................... 23
CHAPTER 9 ............................................................................................................................................ 23
Alternative Courses of Action ............................................................................................................... 23
CHAPTER 10 .......................................................................................................................................... 23
Recommendation & Justification .......................................................................................................... 23
Appendix ............................................................................................................................................... 23
 CHAPTER 1
Background of the Study

Origin of the Report

In the way of attending the BBA Program in one of the finest university round the globe
we are to get acquainted with the best knowledge and techniques. In such case,
regarding the Course (F-307): Investment Analysis & Portfolio Management
requirement, we were assigned to prepare a report on IPO Valuation. This report was
assigned to us by our honorable course teacher Prof. MD. Sadiqul Islam, Professor,
Department Of Finance, University Of Dhaka, to assess our understanding of the
Investment analysis and valuation of firm.

Methodology of the Study

The study requires a systematic procedure from the selection of the topic to final report
preparation. To perform the study data sources are to be selected and collected, they
are to be classified, interpreted and presented in a systematic manner and key points
are to be found out.

Selection of the Study: This topic was assigned by our honorable course
instructor and the company was selected by all of our group members.
Identifying the Data Sources & Data Collection: Essential data sources were
needed to be identified and collected to prepare the report.
Classification, analysis, interpretation and presentation of Data: To
classify, analyze, interpret and presentation of we used some analytical and
graphical tools to understand them clearly.
Findings of the study & report preparation: After scrutinizing the data
problems of the study are pointed out and they are shown under concerned
heads and the final report is prepared.
 Objectives of the Report

It is important to define our perceived objectives behind preparing this paper to make
this a meaningful effort. The objectives of the study are given bellow:

Review the institutional aspects of the equity issuance transaction.

Explore the costs and benefits associated with public share offerings.

Develop an appreciation for the challenges of valuing unseasoned firms.

Hone corporate valuation skills, particularly using market multiples.

Evaluate the received explanations of various finance anomalies, such as the

IPO underpricing phenomenon.

Limitations of the Study

This report has the following limitations-

Use of forecasted data

Key variables of the valuation techniques applied in this report were assumed.

Discounting rates were estimated from given range and in some cases we had
to assume the key variables of discounting rate estimations.

Lack of market data.

 CHAPTER 2
Introduction

Company Overview

JetBlue Airways Corporation (JBLU), incorporated in August 1998, is now the fifth
largest passenger carrier in the U.S. based on revenue passenger miles. It followed
the strategy of providing low-cost travel unique flying experience. According to David
Neeleman, the founder of JetBlue Airways, this is the airline that would bring humanity
back to air travel.

Management Team

The management team of JetBlue Airways was pretty much impressive. Ex-
Continental Airlines vice president, David Barger was new president and COO of
JetBlue. John Owen, who was the executive vice president of Southeast Airline, filed
the position of CFO at JetBlue. For the good management team, Neeleman could
manage to raise a big fund from investors for JetBlue.

Services

Within seven months of incorporation, JetBlue secured its first fleet of Airbus A- 320
aircrafts. The company continued to grow rapidly through early 2002 and operated 24
aircrafts flying 108 flights per day to destinations. JetBlue offered passengers a unique
flying experience by providing new aircrafts, simple and low fares, leather seats free
live TV and high quality customer service. Its operating strategy had produced the
lowest cost per available seat per mile of any of the major U.S. airlines. JetBlue
management believed in leveraging advanced technology like using laptop computer
in cockpit and to access manuals in electronic format during the flight. It was first airline
that provide bulletproof doors and security cameras against hazards. By this way,
JetBlue established a significant strong brand name in airlines industry.

CHAPTER 3
Three step Valuation Process

The three step valuation process is one of the most commonly used technique in
identifying the intrinsic value of a share in order to assist in the investment decision
of an individual.

The top down, 3 step valuation process involves the following:

Economic Analysis

Industry
Analysis

Company
Analysis
Advocates of this process believe that both the economy or market and the industry
affect have a significant impact on the total returns for individual stocks. It believes
that only after a thorough analysis of a global industry will someone be in a position to
properly evaluate the securities issued by individual firms within the better industries.

CHAPTER 4
Economic Analysis

The first step of three step valuation process is the economic analysis. The case
provides very little information regarding the US economy.

However, it is evident that the economy wasnt faring well. By April 2002, the U.S
economy had been stalling. After the 9/11 attacks, the amount of infrastructural
damage to the US was massive. The entire world trade center collapsed.

The stock Market indexes plummeted as the investors confidence level diminished.
Since the stock market index is one of the leading indicators of the economy this meant
the economy is suffering. The most to be damaged was the airlines sector. Moreover,
the subsequent war against terrorism of the USA laid a heavy toll on their economic
situation as well.

The Federal Reserve attempted to stimulate the economic activity by reducing interest
rates to their lowest level in a generation.
 CHAPTER 5
Industry Analysis

Industry Overview

Airline industry was always enliven until the 9/11 attacks which compounded financial
troubles. Share prices of airlines and airplane manufacturers plummeted after the
attacks. Some airlines had gone on the brink of bankruptcy, shut down operations
almost immediately afterwards. To help the industry, the federal government provided
an aid package to the industry, including $10 billion in loan guarantees, along with $5
billion for short-term assistance.

Though airlines industry was in the doldrums, JetBlue remained profitable and growing
aggressively. Certainly few people at this time considered the airline industry to be an
extremely profitable venture among them David Neeleman was one who saw
opportunity where others saw despair. As a result, in 2002, less than a year after the
attacks that shook the industry to its core; JetBlue Airways had its Initial Public Offering
(IPO) and went public.

Nature of the Industry

An insightful analysis when predicting industry sales and trends in profitability is to

view the industry over time and divide its development into stages similar to those that
humans progress through: birth, adolescence, adulthood, middle age and old age. The
number of stages in industry life cycle analysis can vary. A five stage model would
include:

1. Pioneering Development
2. Rapid accelerating
3. Mature Growth
 4. Stabilization and market maturity
5. Deceleration of growth and decline

The figure shows the growth path of sales during each stage. The vertical scale in logs
reflects rates of growth whereas arithmetic horizontal scale has different widths
representing different, unequal time periods. To estimate industry sales, one must
predict the length of time for each stage. Besides being useful when estimating sales,
this industry life cycle analysis also provides insights into profit margins and earnings
growth, although these profit measures may not parallel the sales growth. The profit
margin series typically peaks very early in the total cycle and then leaves off and
declines as competition is attracted by the early success of the industry.

In JetBlue Airways, the company was in the stage two which indicated that it was in
the rapid accelerating growth. In this stage the company was in high demand and had
a high profit margin. After this stage the company would go in maturity stage where
the growth rate would become substantially lower than the accelerating growth stage
and the profit margin began to decline the normal level.
PESTEL Analysis

Originally known as PEST Analysis, this is a macro environmental framework used to

understand the impact of the external factors on the organization and is used as
strategic analytical technique. PEST stands for "Political, Economic, Social, and
Technological factors. Later Legal and Environmental factors were also added by
some analysts and thus evolved the term PESTLE Analysis.

Political Factors

Factors effecting the organizations in terms of government regulations and legal

issues are defined both formal and informal rules under which the firm must operate.
In JetBlue Airways Corporation, the terrorist attack in September 11, 2001 was the
most affected incident in airlines industry. Political stability is very important for the
economic growth of a company. From the analysis of historical economic information
we can predict the political environment. Because we know that there is a positive
relationship between economic efficiency and political stability. Regulatory factors like
tax policy, environmental regulation or other legal issues are important.
Economic Factors

Economic factors act as a driving force for any industry. Improved purchasing power
for JetBlue helped to initiate newer services in different locations. So the company
grew rapidly in the industry. Because of the rising interest rate, the inflation was also
rising which causes rise in oil price. But the rise in oil prices effect adversely to JetBlue
because it also rises the fare which is conflicted to its principle of low fare.

Social Factors

JetBlue create greater customer awareness by providing lower fare than any other
companies. It was trying to follow the cost leadership approach in airlines industry. It
also increased entertainment level to the customers by providing leather seat, free
Live TV at every seat, pre-assigned seating etc. After the terrorist attack, JetBlue gave
highest priority to the security level of customers by setting up security cameras and
also reinforce bulletproof doors in cockpit.

Technological Factors

Technological factor is very important for the industry too. The rate of technology
change is an important factor here. JetBlue always leveraging advanced technology
like providing e-tickets to the customers which means any customer can buy tickets
via internet instantly. Besides all their pilots use laptop computers in cockpit to
calculate the weight and balance of the aircraft. JetBlue was the first airline that provide
bulletproof door and security camera to ensure travelers security.

Environmental Factors

Factors refer to ecological and environmental aspects such as weather, climate, and
climate change. Aviation industry is affected because of bad weather, Govt. and other
parties are now cautious about environmental pollution and its solution.

Legal Factors

Factors influence the companys operation, its costs, and the demand for its products.
Factors include:

Consumer law, Anti-trust law, Air-safety laws, employment laws etc.

 Porters Five Forces analysis

Porter five forces analysis is a framework for industry analysis and business strategy
development. It derives five forces that determine the competitive intensity and
attractiveness or overall industry profitability.

A summary of the porters five forces are as follows:

Forces Level
Threat of new entrants
1. Huge Capital requirement 2. Low Product Differentiation Low
2. Govt. Barrier
Rivalry among existing firms
High
1. High Number of Competitors 2. Low Growth
Threat of substitutes
High
1. Numerous Airlines 2. Lower switching cost
Bargaining power of the buyer
1. Low Degree of Product Differentiation High
2. High Available option 3. No Loyalty
Bargaining power of the supplier
1. Number of Suppliers High
2. High Threat of Increase in Fuel Price
A detailed Porters five forces analysis of the airlines industry of USA is as follows:

1. Threat of New Entrants

In respect of number of competitors, one must determine the likelihood of firms

entering the industry.

Huge Capital requirement: In airlines industry, very high cost or capital

required for entry which depress other companies to enter. Again there is low
profit margin.
Low Product Differentiation: It is difficult to differentiate product & services in
airlines so customer depends on brand image and loyalty.
Govt. Barrier: Deregulation made it possible for new entrance.

So, in case of JetBlue, threat of new entrants is lower.

2. Threat of Substitute product or services

Numerous Airlines: There are numerous other airlines like Southwest, Delta,
United etc. are direct substitutes of JetBlue.
Lower switching cost: Besides switching costs among other airlines are low
as well as switching costs among other transportation options are high for short
distance like train, boat, car etc.

So the threat of substitute is high for JetBlue.

3. Rivalry among existing competitors

High Number of Competitors: There are numerous competitors for JetBlue

like Southwest, Delta, United, Midwest etc.
Low Growth: In times of low or moderate industry growth, the competitors fight
to nab customers from the other in order to keep their capacity utilizations at
acceptable levels. The industry is extremely sensitive to economic cycles.

So, it can be concluded that there is high degree of rivalry among the competitors is
existent.
 4. Bargaining power of Buyers

Buyers can influence the profitability of aviation companies because they can bid down
prices or demand higher quality or more services by showing a propensity to switch
among competitors.

Low Degree of Product Differentiation: Customer can get standard product

and services from other airlines which make them switch over JetBlue.
High Available option: They have several available options with what airline
they choose to fly because of no switching cost. Customer can research easily
using the internet.
No Loyalty: For lowering the risk JetBlue can provide customer incentives such
as True blue which allow customers to earn rewards, book flight in an easier
manner and to stay on top of the upcoming sales.

So we can say that, the risk of bargaining power of buyers in JetBlue is high.

Bargaining power of Suppliers

Number of Suppliers: There are only two suppliers in aviation industry; Airbus
& Boeing. So the suppliers can alter companys return if they increase prices or
reduce the quality of product or services they provide. There is little or no
chance to bargain with suppliers.
High Threat of Increase in Fuel Price: Fuel suppliers have a considerable
amount of power because they control how much money is spent on the fuel
used to fly the planes. The volume of fuel supplied to the airlines is extremely
important because JetBlue has prescheduled flights that require a certain
amount of fuel.

So we can say that, the risk of bargaining power of supplier is also high.
 CHAPTER 6
Company Analysis

Company Analysis is the last step of the three step valuation process. This step
basically involves identifying the strategy that a firm pursues and the effectiveness of
that strategy in context of the economic and industrial situation. Finally, it involves
calculating the intrinsic value of a firms stock using a variety of techniques such as
the DDM, FCFF, FCFE and Relative valuation techniques etc.

Economic and Industrial Influences on JetBlue Airlines

.

The company analysis of JetBlue airlines cannot be done in vacuum. It has to be done
keeping in mind the affect that the various economic and industrial factors will have on
it.

As we have seen from our economic analysis, the US economy was in a downward
spiral after the 2011 attacks. This would have surely had a negative impact on their
GDP and thus the disposable income of the people. Falling disposable income would
most certainly lead to lower passengers for the airlines, including JetBlue.

The Airlines Industry, according to the porters five forces analysis clearly shows that
the industry in general is not a highly profitable one. Moreover, the external economic,
political factors also affected the profitability of the airlines industry.

Nevertheless, despite daunting economic and industrial situations, JetBlue airlines

has been performing well since its inception and may well continue to do so, if it
handles the situations properly and raises the capital effectively from the capital
market.
 STP analysis

Below is given the Market segment, target market and Positioning analysis of JetBlue Airways:

STP

Segment Middle class/Price sensitive upper middle class

Target Group Customers looking for low cost and high quality

Positioning Low cost carrier

 SWOT Analysis

SWOT Analysis is a useful technique for understanding the qualitative aspects of a

company including its Strengths and Weaknesses, and the Opportunities open to it
and the Threats it faces.

Below we have conducted the SWOT analysis for JetBlue Airlines as follows:

Strengths Weakness
Strong Brand Image Over-dependence on
Highest Customer domestic routes
Satisfaction High cost due to providing
Modern Aircraft Fleet unique services
Strong Financial To position themselves as a
Performance despite low fare airline, JetBlue
9/11 might fail to attract luxury
passengers

Opportunities
Expanding Fleet has
facilitated flights on more
routes
Low fare airlines have also
appeared in market outside
US
Failure of Competitors in
satisfying Customers
Threats
Overall Economic Slump
Emergence of new low fare
airlines such as AirTran,
ATA, etc. saturating market
Declining Airline Industry
due to 9/11 attacks
Rising Fuel prices and other
subsidiary products
 Ratio Analysis

Ratio analysis is one of the most commonly used substantive techniques to evaluate
the financial performance of an organization. It looks into the quantitative aspects
such as liquidity, profitability, efficiency and solvency of an organization. Below we
have calculated the various ratios of JetBlue Airways

Liquidity Ratio

JetBlue Airways Liquidity Ratio 2000 2001

Current Ratio 0.66 0.74

Quick Ratio 0.62 0.71

Interpretation: The liquidity ratios above clearly signify a threat for the company as
they are well below the benchmarks. Nevertheless, JetBlues liquidity position has
improved slightly from 2000 to 2001.The primary reason behind their poor liquidity
position is their rapid rate of route expansion which has greatly increased their Air
traffic liabilities as well as their accounts payables from 2000 to 2001.

Profitability Ratio

Profitability ratios are used to assess a business's ability to generate earnings as

compared to its expenses and other relevant costs incurred during a specific period.

JetBlue Airways Profitability Ratio 2000 2001

Operating Margin -20.25% 8.37%

Net Income Margin -20.39% 12.03%

EPS -27 9.88

Return on Asset -6.20% 5.72%

Interpretation: The profitability position of JetBlue showed stark improvement from
2000 to 2001. As a newly established company, all of their ratios were negative in
2000, since they earned very little revenue back then while incurring major startup
costs. However, their profitability performance for 2001, especially their EPS is simply
extraordinary. This bodes really well for their future.

Efficiency Ratio

Efficiency ratios also called activity ratios measure how well companies utilize their
assets to generate income. Efficiency ratios are used to measure the relative efficiency
of a firm based on its use of its assets, leverage or other such balance sheet items.
These ratios are important in determining whether a company's management is doing
a good enough job of generating revenues, cash, etc. from its resources.

JetBlue Airways Efficiency Ratio

2000 2001

Total Asset Turnover 0.30 0.48

Inventory Turnover 92.34 191.69

Receivables Turnover 4.84 15.11

Interpretation: The efficiency ratios of JetBlue have increased from 2000 to 2001.
This is consistent with their financial performance.

Solvency ratio

A leverage ratios meant to evaluate a companys debt levels. The most common
leverage ratios are the debt-to-equity ratio, Equity to Asset ratio and Debt to Asset
ratio.

JetBlue Airways Leverage Ratio 2000 2001

Debt- Equity Ratio -7.35 -21.95

Equity Ratio -0.16 -0.05

Debt-Assets Ratio 1.16 1.05

Interpretation: The solvency ratios of JetBlue are negative, however they are not a
major reason to be worried about since the negative ratio was caused by the exorbitant
level of debt financing used to finance the rapid growth and expansion of JetBlue. A
positive aspect, however, is the fact that the debt to assets ratio of JetBlue has
improved from 2000 to 2001. All in all, the negative solvency situation does give a
cause for financing through equity for JetBlue

DuPont Ratio

DuPont analysis is a method of examining ROE by breaking it down into three

components as follows:

Profit Margin

Total Asset Turnover

Financial Leverage

DuPont Ratio= Profit margin * Total Asset Turnover * Financial Leverage

The DuPont Ratio of JetBlue is as follows:

DuPont Analysis 2000 2001

Net Income Margin -20.39% 12.03%

Financial Leverage -6.35 -20.95

Total Asset Turnover 0.30 0.63

DuPont Ratio 39.39% -158.64%

Interpretation: The DuPont ratio of JetBlue analysis doesnt really indicate anything
since the company is only a start up and the two years of figures used in the ratio are
inconclusive
 Summary of Ratio Analysis

The summary of the various quantitative aspects of JetBlue as per their Ratio
Analysis is as follows:

RATIO Remarks
Liquidity Poor
Profitability Good
Efficiency Good
Solvency Poor
DuPont Inconclusive

Risk Analysis

Risk can be defined as the deviation of the actual outcome from the expected outcome.
It is a product of various components as follows:

Business Risk
Financial Risk

Business Risk: This refers to the possibility that a company will have lower than
anticipated profits, or that it will experience a loss rather than a profit. JetBlues
business risk is influenced by numerous factors, including their sales volume, per-unit
price, input costs, competition, and overall economic climate and government
regulations.

We have taken the following figures from the unaudited operational result in Exhibit 1
as the indicators of business risk of Jet blue airlines.
 Business Risk Indicators 31-Dec- 31-Mar- 30-Jun- 30-Sep- 31-Dec-
00 01 01 01 01
Yield Per Passenger Mile 10.11 10.32 9.94 9.29 8.76

Operating Revenue Per 7.85 8.56 8.16 7.3 6.97

available seat mile
Operating Expense Per 8.03 7.55 7.01 6.93 6.68
available seat mile
Average Fuel Cost per 103.38 86.03 83.24 79.53 60.94
Gallon

The graphical representations of the above indicators have been given below with their
respective interpretations.

Figure 1.1 and 1.3 represent the cost curves of JetBlue Airlines which have been
decreasing over the 5 quarters. This is a very positive thing and can be attributed to
the economies of scale and good management of JetBlue Airways. The decreasing
average costs signify a low level of business risk.

Figure 1.2 and 1.4 represent the revenue curves of JetBlue airlines. The yield
increased in the first quarter but has steadily declined ever since. However, the rate
of decline in the post 9/11 era has been a very high one and this signifies greater
business risk for JetBlue Airways.

Overall, we can conclude that the business risk inherent to JetBlue airways was a
minimal one but the risk has increased after the 9/11 terrorist attacks.

Financial Risk: Every firm is exposed to some sort of financial risk because every
growing firm needs debt financing besides equity financing. This debt financing
exposes a firm to financial risk which is the risk that the firm will fail to meet its fixed
obligation like interest payment. Financial risk analysis has three components-

Debt-equity ratio.
Degree of financial leverage
 JetBlue Airways 2000 2001
-21.95
Debt- Equity Ratio -7.35

Financial Leverage -6.35 -20.95

The debt to equity ratio of JetBlue airlines has been a very poor one and it has
deteriorated from year 2000 to year 2001. This is due to the high level of debt financing
used by them. There total liability has more than doubled from $ 398,281,000 to
$705,940,000.
 CHAPTER 7
Problem Statement

Ever since is inception, JetBlue airways has operated profitably. Even in the aftermath
of the 9/11 terrorist attacks, the company grew aggressively. To support their growth
trajectory and offset portfolio losses by their Venture capital Investors, management
was ready to raise additional capital through a public equity offering.

However, the management of JetBlue and its underwriters were in a dilemma

regarding the issue price of shares in the IPO. This, in fact, is the fundamental problem
posed in the JETBLUE IPO VALUATION CASE STUDY. The management of
JetBlue were very much concerned with getting the issue price right, as anything
otherwise, might jeopardize the issue.

Thus, the main problems of the case study, to which solutions are needed to be
ascertained are as follows:

1. What is the Intrinsic Value of the JetBlue Airways Stocks?

The solution to this problem is critical since it is the intrinsic value of the stocks
that serves as the primary guide while determining issue price.

2. Should the company overvalue its shares during IPO?

Doing so might project a sense of confidence to potential investors and help

exploit the high demand of investors, thereby raising large amounts of funds

3. Should the company undervalue its shares during IPO?

 Doing so might help in creating a high level of investor demand and help ensure
access to future capital raisings?

4. At what price should the IPO be conducted?

This, in fact, is the fundamental problem of this case study.

5. Are there any alternative courses of action that JetBlue can take besides
IPO?

CHAPTER 8
Valuation
Valuation is the process of determining the current worth of an asset or company.
There are many techniques that can be used to determine value, some are subjective
and others are objective.

Stock valuation of JetBlue Airways can be done in various financial approaches like-

Dividend Discount Model

Free cash-flow to equity method (FCFE)
Free Cash-flow to Firm method (FCFF)
Market Multiples

However, in this case we cannot use DDM approach because JetBlue is deciding to
go public by selling IPO shares and has not declared any dividend. We have used
FCFF and market multiples methods in valuation process. We made our assumption
based on the financial forecast of JetBlue management.
 Market Multiple Technique: P/E Ratio

To get a proper range for JetBlues offering price we will look at market multiples for
the Low-Cost Airline Industry and come up with a number that makes sense, once we
compare those other financials to JetBlues. Below is a chart describing some of
JetBlues competitors and the multiples that they carried at the end of 2001. Weve
calculated what their price should be based upon these multiples and can now apply
the same technique for JetBlue.

Price/Shar Earnings/Shar PE EBIT

e e Multiple EBIT/Share Multiple

AirTran $6.60 0.3 22.00 0.8 8.25

Frontier $17.00 2 8.50 3 5.67

Ryanair $32.10 0.7 45.86 0.9 35.67

Southwest $18.50 0.7 26.43 1.1 16.82

WestJet $15.90 0.8 19.88 1.3 12.23

Avg EBIT
Avg PE = $24.53 Mult. $15.73

JetBlue

Diluted EPS 1.14

Pro forma EPS 1.3

Stock Price (Diluted EPS) $27.97

Stock Price (Pro forma EPS) $31.89

EBIT/share (2001) 0.72057279

Stock Price (EBIT) $13.53

Based upon the information above we can figure out what the average PE Multiple is for the
five companies similar to JetBlue, which comes out to be 24.53. According to Exhibit 3 in the
case write-up, JetBlue has a Diluted EPS of $1.14. Multiplying those two together would give
us a Price/Share of $27.97. If we were to go off of the Pro Forma EPS ($1.30/share) the equity
price would be even higher at $31.89. By averaging them, we get the intrinsic value as follows:

Stock Price (Diluted EPS) $28.48

Stock Price (Pro forma EPS) $32.47
Stock Price (EBIT) $13.53

Equity Value / share 23.75

Avg value $24.56

CHAPTER 9
Alternative Courses of Action

According to its prospectus, JetBlue Airways is going public to raise funds to finance
their working capital and capital expenditure needs, especially to finance the
expansion of its aircraft fleet.

However, In addition to going public, there are some other ways through which JetBlue
Airways can support its rapid growth. Two such alternatives are as follows:

1. Issuing Bonds

Instead of raising the entire amount by issuing common stock, JetBlue can raise a
sizeable portion of it through issuing bond and debentures.
According to Exhibit 6, the YTM of a 25 year bond of Southwest airlines is 8.68 %. If
we assume this figure to represent the general return that the bond purchasers seek
in the market and compare it with the return that equity investors of JetBlue seek, as
represented by their cost of equity of 10.52 %, we can conclude that Bond issue might
be a more cost effective source of financing for JetBlue Airways than issuing equity.

The advantages & Disadvantages of Issuing bonds is as follows:

Advantages Disadvantages
Bond indentures might restrict the
Less floatation costs involved
activity of the firm
More cost effective financing than
May not raise as much funds as IPO
issuing shares
Less complicated process of issuance Increases the financial risk of the firm
Allows diversification of the overall
capital structure

2. Leasing
The largest component of expenditure for JetBlue airways is its capital expenditure.
This is understandable since jetBlue is growing very rapidly and is thus purchasing a
lot of new aircrafts which are very expensive.

One way in which the company can finance this expenditures is through leasing the
aircrafts instead of purchasing them. A lease is a contractual arrangement calling for
the lessee (user) to pay the lessor (owner) for use of an asset. Aircraft lease is a very
common phenomenon and the industry has two main leasing types: wet-leasing, which
is normally used for short-term leasing, and dry-leasing which is more normal for
longer-term leases.
The advantages and disadvantages of this course of action for JetBlue is as follows:

Advantages
Less Initial cash outlay required
Facilitates use of the aircraft without the
financial burden of buying them
Frees up capital for use elsewhere
May result in temporary increase in
capacity during rush season such as
Eid , Christmas etc.
Disadvantages
JetBlue wont have the ownership of the
assets
Might increase the business risks of the
company
Leased aircraft are often second hand
 CHAPTER 10
Recommendation & Justification
In light of the findings of this report, we have the following recommendations for
JetBlue Airways:

1. JetBlue Airways should go Public immediately in order to increase the

portion of equity in their overall capital structure. The Price should of stock
should be between $24 and $26. This is necessary to reduce their exposure
to financial risks, which currently is very high as represented through their
leverage ratios

2. JetBlue Airways should sell their common stocks at a premium during the
IPO. This will allow them to raise large amount of capital by taking
advantage of the high investor demand, as implied in Exhibit 10.

3. JetBlue Airways, instead of raising all its capital through common stock, may
rather pursue other alternatives such as Bonds issue or leasing. Doing so
might prove to be more cost effective for them.

4. JetBlue Airways, should invest heavily on building their Brand Value in an

attempt to overthrow its competitors. It should especially focus on the high
tech security measures taken on their aircrafts to address attacks similar to
the 9/11 attack.

5. JetBlue Airways, should try to decrease its dependence on the domestic

market by expanding its destinations and launching flight to new
international routes. This has to be done, because their overreliance on the4
US domestic Airlines market makes them very vulnerable and susceptible
to any adverse economic or industrial factor, relevant to the US.
 Appendix
Appendix

Financial Forecast
Of JetBlue
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Revenue 320 600 884 1192 1485 1802 2114 2466 2694 2912
Cash Expenses 283 502 723 975 1215 1474 1753 2016 2202 2380
Depreciation 10 18 26 36 45 54 65 75 83 90
EBIT 27 80 135 181 225 274 296 375 409 442
Taxes 9 27 46 62 77 93 101 128 139 150
NOPAT 18 53 89 119 148 181 195 247 270 292
Capital
Expenditure 234 290 328 345 310 326 342 299 157 132
Net Working
capital 34 63 94 126 157 191 227 261 285 308

JetBlue Airways
Forecasting
Variables 2002 2003 2004 2005 2006 2007 2008 2009 2010
Revenue
growth factor 87.50% 47.33% 34.84% 24.58% 21.35% 17.31% 16.65% 9.25% 8.09%
Total operating
expenses (excluding
depreciation) 83.67% 81.79% 81.80% 81.82% 81.80% 82.92% 81.75% 81.74% 81.73%
Depreciation
to sales 3.13% 3.00% 2.94% 3.02% 3.03% 3.00% 3.07% 3.04% 3.08%
Capital expenditure - - - -
growth rate 23.93% 13.10% 5.18% 10.14% 5.16% 4.91% 12.57% 47.49% 15.92%
Change in net working
capital to sales ratio 4.83% 3.51% 2.68% 2.09% 1.89% 1.70% 1.38% 0.89% 0.79%

Income tax
rate 34.00%
Constant
growth
rate(assumed) 2.00%
Discount rate 9.43%
 2002 2003 2004 2005 2006 2007 2008 2009 2010
Valuation Model
Outputs:
Net operating profit
margin 9% 10% 10% 10% 10% 9% 10% 10% 10%
$ $ $ $ $ $ $ $ $
Free cash flow ($ mil) (0.19) (0.18) (0.16) (0.08) (0.06) (0.05) 0.06 0.22 0.27
$
Terminal value ($ mil) 2.95
$ $ $ $ $ $ $ $ $
(0.19) (0.18) (0.16) (0.08) (0.06) (0.05) 0.06 0.22 3.23

PV of Company $
Operations ($ mil) 1.01
Market Value of $
Company Assets ($ mil) 1.12

Total Present Value of

Company Operations $1,006,281
Plus Cash and cash
equivalents 117,522
Total Enterprise Value $1,123,803
Less Long - term debt 290665
Equity Value $833,138
Number of shares
outstanding 35079
Equity Value / share $23.75
EBIT/Share(2001) 0.7642

No. of common stock after IPO offering 40578829

Common stock offered 5500000
Common stock outstanding before IPO 35078829
Common stock outstanding before IPO (in
thousands) 35079

Risk - free rate 5.00%

Risk premium 5.00%
Beta 1.1

tax rate 34%

 2000 2001

Debt 137110 290665

Interest expenses 7395 14132
Effective interest
rate 5.39% 4.86%
Average interest
rate 5.13%

Cost of Debt 10.52%

After Tax Cost of
Debt 6.94%

Cost of
capital weight WACC
Equity 10.50% 0.7 7.4%
Debt 6.94% 0.3 2.1%
9.43%