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Case #28

JetBlue Airways IPO

Synopsis and Objectives

This case examines the April 2002, decision of JetBlue management to price the
initial public offering of JetBlue stock during one of the worst periods in airline history.
The case outlines JetBlue’s innovative strategy and the associated strong financial
performance over its initial two years. The task is to value the stock and take a position
on whether the current $25–$26 per share filing range is appropriate. The case is
designed to showcase corporate valuation using discounted cash flow and peer-company
market multiples.

The case provides opportunities for:

• 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.

Suggested Questions

1. What are the advantages and disadvantages of going public?


2. What different approaches can be used to value JetBlue’s shares?
3. At what price would you recommend that JetBlue offer their shares?
JETBLUE AIRWAYS IPO VALUATION

Evidence on IPO Underpricing

Winner’s Curse. Uninformed investors’ demand rationed for good firms and not for
poor firms due to informed investors’ participation in only good IPOs. Underpricing
gives uninformed investors normal return.1

Evidence: In countries where share allocation is transparent (e.g., Singapore and Finland)
investors receive more shares of overpriced offerings such that average profits are zero.2

Monopsony. Small number of underwriters following any particular industry allow for
potential monopsony profits.3

Evidence: In support, the severe average underpricing of 1980 was concentrated wholly
among a few regional underwriters within the petroleum industry.4 Against support,
underwriters that take themselves public tend to underprice themselves.5

Lawsuit Avoidance. To avoid litigation for misrepresenting stock to shareholders,


firms/underwriters discount initial price.

Evidence: In support, offerings before the Securities Act of 1933 (which holds companies
responsible for misrepresentation) tend to be less underpriced than offerings after 1933.6
However, firms that are sued following their IPO tend to be just as underpriced as firms
that are not sued.7

Reputation. Firms better able to access capital markets in future if “leave a good taste”
in investors’ mouth.8

1
Kevin Rock, “Why New Issues Are Underpriced,” Journal of Financial Economics, 15 (1986), 187-
212.
2
Francis Koh and Terry Walter, “A Direct Test of Rock's Model of the Pricing of Unseasoned Issues,”
Journal of Financial Economics, 23 (1989), 251-272; and Matti Keloharju, “The Winner's Curse, Legal
Liability, and the Long-Run Price Performance of Initial Public Offerings in Finland,” Journal of Financial
Economics, 34 (1993), 251-277.
3
David Baron, “A Model of the Demand for Investment Banking Advice and Distribution Services for
New Issues,” Journal of Finance, 37 (1982), 955-976.
4
Jay Ritter, “The Hot Issue Market of 1980,” Journal of Business, 57 (1984), 215-240.
5
Chris Muscarella and Michael Vetsuypens, “A Simple Test of Barons's Model of IPO Underpricing,”
Journal of Financial Economics, 24 (1989), 125-135.
6
Seha Tinic, “Anatomy of Initial Public Offerings of Common Stock,” Journal of Finance, 43 (1988),
789-822.
7
Philip Drake and Michael Vetsuypens, “IPO Underpricing and Insurance Against Legal Liability,”
Financial Management, 22 (1993), 64-73.
8
Franklin Allen and Gerald Faulhaber, “Signaling by Underpricing in the IPO Market,” Journal of
Financial Economics, 23 (1989), 303-323; Thomas Chemmanur, “The Pricing of IPOs: A Dynamic Model
With Information Production,” Journal of Finance, 48 (1993), 285-304; Mark Grinblatt and Chuan-Yang
Hwang, “Signaling and the Pricing of New Issues, Journal of Finance, 44 (1989), 393-420; and Ivo Welch,
Seasoned Offerings, Imitation Costs and the Underwriting of IPOs,” Journal of Finance 44 (1989), 421-
Evidence: Little empirical support has been found for a relationship between
underpricing and subsequent offerings.9

Censored distribution. Underwriters correctly price on average, but stock stabilization


efforts remove the left-hand side of non-stabilized first-day distribution of returns—
leading to average positive performance.

Evidence: A disproportionate number of IPOs have first-day returns of zero. IPOs with
first-day returns of zero tend to experience negative returns over first month, suggesting
they are temporarily held above their true value.10

Bandwagon. If investors pay attention to IPO demand of other investors, bandwagon


effects can create excessive demand for some offerings.11

449.
9
Narasimhan Jegadeesh, Mark Weinstein, and Ivo Welch, “An Empirical Investigation of IPO Returns
and Subsequent Equity Offerings,” Journal of Financial Economics, 34 (1990), 153-176; and Roni
Michaely and Wayne Shaw, “The Pricing of Initial Public Offerings: Tests of Adverse Selection and
Signaling Theories,” Review of Financial Studies, 7 (1994), 279-313.
10
Judith Ruud, “Underwriter Price Support and the IPO Underpricing Puzzle,” Journal of Financial
Economics, 34 (1993), 135-151.
11
Ivo Welch, “Sequential Sales, Learning, and Cascades,” Journal of Finance, 47 (1992), 695-732.