JETBLUE AIRWAYS IPO VALUATION ² A CASE STUDY

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23 July 2011

CONTENTS

1. Introduction 2. Company and Industry Background 3. Going Public 4. The IPO Process 5. JetBlue Valuation 6. Recommendation 7. What happened

INTRODUCTION
Following the terrorist attacks of 9/11, the airline industry was in the doldrums. Many of the largest carriers in the nation had filed for bankruptcy protection and were asking the federal government for help so they could survive. Few people at this time considered the airline industry to be an extremely profitable venture, but where others saw despair, David Neeleman, CEO and founder of JetBlue Airways, saw opportunity. In 2002, after 2 years of profitable operations and 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.

In the following presentation.INTRODUCTION This case study outlines the IPO underwriting process and uses JetBlue as an example to describe the steps throughout the way. we will discuss the followings : The Company and Industry Background  Pros and Cons of going public  IPO process  JetBlue Valuation  Recommendation .

. concentrating on customer service and low fares. David Neeleman was experienced in the operations of airlines and start up airlines.  Later he joined Canadian low fare airline West Jet. The airline was to provide new levels of service in the airline travel industry.  He started Morris Air which became a pioneer in ticketless travel which was later acquired by Southwest Airlines. with 87 new start up airlines failing over the twenty year period.  He also developed the e-ticket system Open Skies which was purchased by Hewlett-Packard in 1999. The starting of new airlines had proven to be a very difficult task over the past twenty years.THE COMPANY & INDUSTRY BACKGROUND JetBlue airways are a low cost airline established in July 1999 by David Neeleman.

. To ensure this goal and the company¶s future Neeleman assembled an impressive management team and group of investors.THE COMPANY & INDUSTRY BACKGROUND Neeleman plan was to commit to innovation in people. John Owen who was executive vice-president and treasurer of Southwest Airlines agreed to become JetBlue¶s CFO. JetBlue¶s COO was to be David Barger exvice president of Continental Airlines. policies and technology to keep the companies planes full and thus the company profitable. Chase Capital Partners and Quantum Industrial Partners. Neeleman received $130million form venture capital firms such as Western Presidio Capital.

. The company had grown quickly and aggressively by sticking to its strategic plan of offering high quality service to passengers travelling to high metropolitan areas which had high average fares and highly travelled markets that were underserved. The New airline in April of 2002 had decided that the need for raising equity via the issuing of an IPO was required to enable the company continue to expand.THE COMPANY & INDUSTRY BACKGROUND Seven months after start up JetBlue had grown rapidly : JetBlue had a small fleet of Airbus A320 planes servicing two routes.  By mid 2000 the company had added 6 other routes  By early 2002 the company had grown to having 24 planes in operation servicing 17 routes and running 108 flights per day.

Frontier and Alaska Air. Other low-fare airlines in operation are AirTran. 25% and 11% respectively. WestJet and easyjet had gone public with trailing EBIT multiples of 8. The most recent IPOs were non-U. America West.4X respectively and firstday returns of 62%.5X.S airlines Industry. 11. . Ryanair.THE COMPANY & INDUSTRY BACKGROUND The Low-Fare Airlines Southwest Airlines is the pioneer and the dominant player in U.S carriers. ATA.6X and 13.S airlines combines. Southwest Airlines is financially successful ± Its market capitalization was larger than all other U.

GOING PUBLIC Advantages Of Going Public One of the main advantages of going public is the additional capital the company obtains. going public puts a greater discipline on managers. geographical expansion or other strategic ventures. Currency of the future where the stock of a public company can be used as a currency of finance future acquisitions ± a consideration that can be important if your long-term strategy includes plans for diversification. . It is a means of attracting and retaining quality personnel. Going public can ³raise the profile´ of a company. From a shareholder perspective.

Time Demands. There can be a loss of privacy and autonomy from going public. Increased recurring costs.GOING PUBLIC Disadvantages Of Going Public There are high costs involved with going public. There is a high failure rate of new entrants into the airline market. . The company must also pay a return to satisfy shareholders.

THE IPO PROCESS The Process In Summary Select investment banker File registration document (S-1) with SEC Choose price range for preliminary (or red herring ) prospectus Go on roadshow Set final offer price in final prospectus .

. Common underwriting issue ± the ³firm commitment´ underwriting. 2.THE IPO PROCESS 1. Also depends on whether issuer would like to see its securities held more by individuals or by institutional investor. Once the decision to go public is made the first step is to select an investment bank. Relies on investment banker¶s general reputation & expertise.

The lead manager also responsible assembling group of underwriters. The lead manager almost always appears on the left of the cover of the prospectus. Public offerings can be managed by one underwriter (sole managed) or by multiple managers. 4. . The lead underwriter.THE IPO PROCESS 3. the co-manager and the syndicate members receive compensation from the company. The lead underwriters receives 20% fee.

. There is no guarantee of the final offering price. Lead underwriter¶s agenda is to draft a letter of intent. Gross spread or underwriting discount. 4.THE IPO PROCESS 5. Letter of intents contains clause requiring the company to reimburse the underwriter for any out-ofpocket expenses incurred. The letter of intent remains in force until Underwriting Agreement is executed at pricing.

Registration statement consists of two parts:  the prospectus  the information that need to be furnished to public . The Securities Act of 1933 Before registration statements is ready. usually takes several weeks & many meetings of the working group (company management. counsel& auditors. underwriters & also underwriters¶ counsel & accountants).THE IPO PROCESS 6. The registration also is circumscribed by Section 5 of the Act.

THE IPO PROCESS 7. . The purpose of registration and disclosure requirements is to ensure the public adequate and reliable information regarding securities offered for sale. may sue these signatories. Any purchaser of the securities who is damaged as a result of misstatement or omission of material fact. ³due diligence´ requirement Securities Act requires that the registration statement signed by directors and principal officers of the issuer.

Once the registration statement is filed. . The SEC Examines registration statements ³price amendment´.THE IPO PROCESS 8. it is transformed into the preliminary prospectus or ³Red Herring´. SEC responds to the initial filing within 20 days. The Red Herring is amended & transformed into prospectus.

the marketing of the offering begins. Once the registration statement is approved. 10. The underwriter receives indications of interest from investor. Retail investors submit ³market order´ Retail orders are receive earlier than institutional order Institutions submit order with commitment to purchase more shares .THE IPO PROCESS 9. The company & underwriter promote the IPO through the road show.

The firm and the lead underwriter meet to discuss two final details.THE IPO PROCESS 11. but may be preferable for company if it guarantees the issues succeeds. . The underwriter files with the SEC acceleration request 12.company is not getting full value for its shares. Registration & marketing process can take several months. The offer price The exact number of share to be sold Order Book IPOs tend to be ³under-priced´ Under-pricing ³leaves money on the table´.

The underwriter & the issuer execute the Underwriting Agreement. Once approved. But the IPO is still far from being completed. and underwriter files a ³price amendment´ on the morning of the chosen effective date. After market stabilization Provision of analyst recommendations Making a market in the stock . the final prospectus is printed. the distribution of stock begins 14.THE IPO PROCESS 13.

The final stage of the IPO begins 25 calendar days after IPO when the so-called ³quiet period´ ends. ³Quiet Period´ mandates by SEC Only underwriters (and other syndicate members) can comment on the valuation & provide earning estimates of the new company.THE IPO PROCESS 15. Thus. underwriter¶s role evolves in this after-market period into an advisory and evaluatory function. .

. stabilize and support the issue. Throughout the process. the company relies on the underwriter¶s expertise to market. The underwriter relies on the information & integrity of the company. the underwriter and the syndicate members. The completion of the process provides new capital for the firm.THE IPO PROCESS 16. The initial public offering process thus involves a complex combination of task by the company. distribute. price. and a new investment opportunity for the public.

Price set to place the firm¶s P/E and M/B ratios in line with publicly traded firms in the same industry having similar risk and growth prospects. and specify a range (such as $10 to $12) in the preliminary prospectus. the investment banker would determine a ballpark price.THE IPO PRICING PROCESS In general the process as per the followings: Since the firm is going public. . there is no established price. Banker and company project the company¶s future earnings and free cash flows The banker would examine market data on similar companies. On the basis of all relevant factors.

THE IPO PRICING PROCESS There are several methods that can be used to calculate the IPO pricing: Dividend Growth Model ± however as per declaration by Jetblue in its prospectus that they intended to retain any future earnings for expansion and investment for company growth (refer Exhibit 1) Benchmarking with competitors or those in similar industries e.g. using Southwest Airlines Discounted cashflow model .

price-to-cashflow. . Deloof. Based on study done on 49 IPOs conducted in Brussels between 1993 and 2001. and it relies heavily on sentiment-driven market values Discounted cashflow is favoured as reflects the dynamic nature of the business and is independent of market noise.THE IPO PRICING PROCESS The IPO valuation puzzle. Out of 49 of the IPOs studied. De Maeseneire & nghelbrecht found that underwriters in the study never employed just one valuation method. the underwriters used  discounted free cashflow (DFCF) in all 49 IPOs  dividend discount model (DDM) in 24 IPOs  added price-to-earnings. or other multiples valuation methods in 40 IPOs Some consider valuation based on a multiple to be flawed as does not take into account future cashflow and other metrics.

3) / (5.000 shares (Exhibit 1) 4) Common stock estimated to be outstanding immediately after this offering was 40.578. using Southwest Airlines: Price / Earning Ratio (P/E) 1) P/E ratio of Southwest Airlines was 49.000+40.THE IPO VALUATION Benchmarking with competitors or those in similar industries e.829 shares (Exhibit 1) Thus Offering Price = (21.000*49.578.g.829) $23.567 thousands ( Exhibit 3) 3) Common stock offered was 5.567.07 .500.500.3(Exhibit 5) 2) Net income applicable to common stockholders was $21.

THE IPO VALUATION Discounted Cash Flow Method The Corporate Value Model (By Discounted Cash Flow Method) FCF = NOPAT+ Depreciation .59 .g ) = Vcompany at t=n V = FCF1 / (1+WACC)1 + FCF2 / (1+WACC)2 + «.CAPEX NWC Terminal Value = FCF Steady State / (WACC ..+FCFn / (1+WACC)n +Terminal Value V=D+E Note : See WACC and Table 1 Offering Price = $25.

700 Preferred stock dividends was $16.441.THE IPO VALUATION Corporate MV asset weights Bond rating Pretax cost of debt Tax rate After-tax cost of debt 7.970 thousands ( Exhibit 3) 210.41% Kd =Yield to maturity of Southwest Airlines debenture (Exhibit 6) 34% 4.89% Kd (1t) 169.06% Kp = Dp / Pp Dp Pp Cost of preferred stock .000 Convertible redeemable preferred stock ( Exhibit 2) 8.

049 (App.00% 5.078. Exhibit 2) Preferred 210.S.441 stock= (Book value.1% 9.00% 10.829*$26) WACC = Kd (1-t) * W d + Kp*W p + Ke* We WACC = Kd (1-t) * D/(D+P+E) + Kp*P/(D+P+E) + Ke* E/(D+P+E) 17.50% Refer Beta of Southwest Airlines was (Exhibit 5) Current long-term U. Market stock= =46. Exhibit 2) Common 1.21% .198.6% 12.THE IPO VALUATION Summary of WACC Calculation for JetBlue Airways Equity beta Rf RM RM-Rf Cost of common stock Weight of debt Weight of preferred stock Weight of common stock WACC 1.10 5. Long term debt.373 (Book value.3% 70. Treasuries traded at a yield of 5% Rm = Rf + Rp Market risk premium is 5% Ke = Rf + b*(Rm-Rf) Debt = 301.00% 10.

5 5% 9.9 4% 15.8 $33.9 4% 15.7 $29.0 4% 15.420 .144 1.694 2.485 1.4% $0.2% $0.2% $0.229 2.1 4% 15.6 $24.4 $320 283 10 27 9 18 10 234 34 (206) $17.2 4% 15.192 975 36 181 62 120 36 345 126 33 (222) $20.3 9.2% $0.2% $0.921 (11) 2.0% 9.4 $600 502 18 80 27 53 18 290 63 30 (250) $18.5 $22.2% $0.7 $31.5 $23.3 5% 9.4 $2.2% $0.4 $2.2% $0.7 $28.016 75 375 127 247 75 299 261 34 (11) $23.THE IPO PRICING PROCESS JETBLUE AIRWAYS IPO VALUATION JetBlue Financial Forecast Assumption / Estimation Operating margin 15.1 5% 9.802 1.4 4% 15.202 83 410 139 270 83 157 285 24 172 $24.3% $0.6 16% 13.9 5% 9.380 90 443 151 292 90 132 308 23 227 6001 6.4 5% 9.2% Steady-state growth Discount rate (WACC) Tax Rate Inflation Rate (prices and costs) 7.5 5% 9.4 $2.262 $3.220 2.645 (98) 1.373 (124) 1.4 $884 723 26 134 46 89 26 328 94 30 (243) $19.5 $21.466 2.21% 34% 4% Steady State Growth 2011 $ figures in millions Number of aircraft $ Revenue/plane Expected inflation Operating margin $ Depreciation/plane $ CapEx/New planes Expected inflation NWC Turnover Financial forecast Revenue Cash expenses Depreciation EBIT Tax 34% NOPAT Depreciation Capital expenditure Net working capital Increase in NWC Free cash flow Terminal value Free cash flow+Terminal value NPPE Actual Estimate Estimate Estimate Estimate Estimate Estimate Estimate Estimate Estimate 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 21 34 48 62 74 86 98 108 113 117 $15.107 (148) 1.474 54 274 93 181 54 326 191 34 (124) $21.4 $1.912 2.215 45 226 77 149 45 310 157 31 (148) $21.6 $27.9 5% 9.4 $2.145 172 2.2% $0.8 4% 15.6 5% 9.116 313 (158) 330 22 133 (206) 224 (250) 496 (243) 798 (222) 1.3 8.4 $1.0 5% 9.753 65 326 111 215 65 342 227 36 (98) $22.8 4% 15.4 $1.6 $25.

5788 46.179 5.THE IPO VALUATION From the previous table: Enterprise Value PV(FCF) Debt = Preferred stock= Common stock= Common stock offered= Common stock outstanding= Comon stock= Offering price= $1.5 40.691 301 210 $1.0788 $25.59 .

THE IPO VALUATION Recommendation: - Thus it is recommended that the IPO pricing to be set at around $25 per share .

Note that original owners generally sell only a small part of their stock. they benefit.THE IPO PRICING CONFLICT There is an inherent conflict of interest. . Firm would like price to be high. because the banker has an incentive to set a low price:  to make brokerage customers happy.  to make it easy to sell the issue. Later offerings easier if first goes well. so if price increases.

CORPORATE VALUATION .

HIGHEST FIRST-DAY IPO RETURNS FOR 2002 .

5-YEAR STOCK CHART FOR JBLU .

JETBLUE AIRWAYS CORP¶S PRICE (14/07/11) .

The End .

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