JetBlue Airways IPO Valuation

An Analysis of Valuation Processes

FINE 7600 VALUATION AND FINANCIAL ENTERPRISES October 24, 2012 Authored by: Xian
Sophie Li, Yu Charlotte Pei, Tiancheng Toby Sun, Adrian Townsend, and Yu Yvonne Wang
JETBLUE AIRWAYS IPO VALUATION
An Analysis of Valuation Processes Contents
JETBLUE TAKES OFF! .............................................................
................................... 1 CALCULATING AN APPROPRIATE PRICING POLICY
RANGE ..................................................... 1 CORRECT VALUATION
LEAVES MONEY ON THE TABLE ......................................................
... 2 IS THE I.P.O WORTH THE EXPENSE? ..........................................
.................................... 2 COMPARABLE COMPANIES ANALYSIS ...........
................................................................... 2 P/E MULTIP
LE .............................................................................
....................2 TOTAL CAPITAL MULTIPLE ...................................
................................................ 3 EBIT MULTIPLE ...............
................................................................................
. 4 DISCOUNTED CASH FLOW ANALYSIS ..............................................
................................ 4 ASSUMPTIONS..................................
.................................................................4 WEIGHTED AVER
AGE COST OF CAPITAL ............................................................
.......5 DISCOUNTED CASH FLOW SHARE PRICE VALUATION ............................
........................ 6 JETBLUE AIRWAYS IPO VALUATION .......................
........................................................ 6 WORKS CITED .........
................................................................................
............... 8
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JetBlue Airways IPO Valuation
An Analysis of Valuation Processes JetBlue Takes Off!
JetBlue is an aggressive start-up, which began service in February 2000, and has
grown steadily since its inception. Duplicating Southwests simplicity, high airc
raft utilization and low fares, JetBlue offers comfortable, affordable and conve
nient point-to-point air travel with some unique amenities (for example, leather
seats and live-feed TV monitors). It has relied primarily on word of mouth adve
rtising to execute its strategy. In contrast with most upstart discount carriers
, JetBlue operates a fleet of 31 brand new, highly fuel-efficient Airbus A320 ai
rcraft and employs a non-unionized FAA certified workforce (pilots, technicians,
dispatchers) The management team has an extensive leadership track record with
successful carriers, such as Southwest Airlines. This report examines the April
2002, decision of JetBlue management to price the initial public offering of Jet
Blue, just months after the terrorist attacks of 2001. Although the timing The ma
rket is never dead for a good company seemed risky, John Owen, with real revenue
s and real earnings Executive vice president and chief financial officer of JetBl
ue Airways stated the market is never dead for a good company with real revenues
and real earnings. JetBlue had managed to remain profitable and grow aggressively
despite the challenges facing the airline industry.
JetBlue Airways IPO Valuation | 10/24/2012
Over the last 50 years, I.P.O.s in the United States have been underpriced by 16.
8 percent on average. This translates to more than $125 billion that companies h
ave left on the table in the last 20 years. I.P.O. underpricing is also a worldw
ide phenomenon. In China, the underpricing has been severe, averaging 137.4 perc
ent from 1990 to 2010. This compares with 16.3 percent in Britain from 1959 to 2
009. In most other countries, I.P.O. underpricing averages above 20 percent. (Dav
idoff, 2011)
Calculating an Appropriate Pricing Policy Range
The lead underwriter for the JetBlue I.P.O. Morgan Stanley had initially calcula
ted a price per share of $22 to $24. However, with sizeable excess demand for th
e 5.5 million shares being offered; they had adjusted the range upwards ($25 to
$26). This report utilized four different share valuation methods: 1) Price/earn
ings multiple (comparison pricing); 2) Total capital multiple (comparison pricin
g); 3) EBIT multiple (comparison pricing); and 4) Discounted free cash flows (fu
ndamentals pricing). We conclude that the JetBlue offering price should be $27 t
o $29.
We conclude that the JetBlue offering price should be $27 to $29
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Correct Valuation Leaves Money on the Table
According to economist Kevin Rock (Rock, 1986), because informed investors do no
t exist in sufficient number, underwriters re-price I.P.O offerings to bring in
uninformed investors and ensure that they maximize total bidding. This theory ha
s empirical support in papers that have found that when investment banks can all
ocate shares in greater measure to informed investors, the underpricing is reduc
ed since the compensation needed to draw uninformed investors is lower. (Davidof
f, 2011). Underpricing has also been found to be lower when information about th
e issuer is more freely Underpricing gives uninformed available so that uninform
ed investors are at less of a disadvantage. investors normal return. Underpricin
g gives uninformed investors normal return. In countries where share allocation
is transparent (Singapore and Finland), investors receive more shares of overpri
ced offerings making average profits zero. (Keloharju, 1993). JetBlue is only of
fering approximately ten percent of the firms outstanding shares; a successful I.
P.O. will help to not only raise short-term capital, but also provide access to
future capital. Increasing the share price aggressively will dampen demand and r
educe the publicity buzz surrounding the event and the company. In line with the
benefits of underpricing we agree with a more conservative pricing range as sug
gested by the Morgan Stanley underwriters.
Is the I.P.O Worth the Expense?
A good valuation of the I.P.O. share offering will leave money on the table. In
addition to that loss, JetBlue will have to pay legal, accounting, and underwrit
ing fees associated with public offerings. Is it worth it? From an operation per
spective, the I.P.O. supplies capital to JetBlue which the firm can use to incre
ase competitiveness and support aggressive growth. From a financing perspective,
JetBlue investors will gain access to a more liquid equity market which will re
duce JetBlues cost of capital from the much higher cost of private equity. Additi
onally, the new equity will lower the debt to equity ratio. With a lower debt to
equity ratio, JetBlue will then have increased access to the debt market with m
ore favorable terms. The ability to access more debt can then be used to again d
ecrease the cost of capital by altering the capital structure of JetBlue to take
advantage of the tax advantages provided by debt financing. The tax shield of t
he debt financing will increase the enterprise value of the company.
Comparable Companies Analysis
P/E Multiple Using the leading P/E multiple method of valuation is standard prac
tice in the airline industry (Yale School of Management, 2002). However, in our
analysis (figure 1) the comparison sample size had to be reduced to include only
low-cost airlines with positive earnings which limited the scope of the relativ
e values. Due to the small sample size, the average P/E ratio was skewed high to
wards Frontiers outlying performance. Therefore we determined that the median P/E
ratio of comparable companies provided a more accurate figure. With predicted e
arnings per share in 2002 of $1.20, JetBlues price per share would be $34.12.
JetBlue Airways IPO Valuation | 10/24/2012
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However, using trailing indicators we calculated the current share price to be s
ubstantially lower at $28.84. The wide variance is due to: 1) Increased price ea
rnings ratios in 2002 for low-cost carriers; and 2) Increased earnings per share
for JetBlue. The range is made wider when using the average P/E multiple from t
he sample group: $28.46 to $37.28.
Price / Earnings Multiple
Trailing Price/ Share $6.60 $17.00 $32.05 $18.48 $15.85 Earnings/ Share 0.26 2.0
3 0.73 0.67 0.81 0.90 0.73 1.14 PE Multiple 25.29 8.37 44.02 27.59 19.57 24.97 2
5.29 $25.30 (mult. med.) 1.20 $28.43 (mult. med.) Leading Earnings/ Share 0.33 0
.37 0.94 0.65 0.59 0.58 0.59 PE Multiple 20.00 45.95 34.10 28.43 26.86 31.07 28.
43
Airlines positive earnings AirTran Frontier Ryanair Southwest WestJet Average Me
dian JetBlue
Tr ailing
$28.84 $34.12
JetBlue Leading
(Trailing EPS supplied Exhibit 3; Leading EPS adjusted for increased earnings an
d newly issued shares)
F IGURE 1
Total Capital Multiple The total capital multiple company comparison (figure 2)
utilized published figures from all low-cost carrier airlines; the sample size f
or this comparison was the largest of the comparable companies analysis methods.
While the total capital multiple uses trailing indicators, the multiple is the l
east subject to accounting practice variances; debt and equity accounting have f
ewer GAAP methods of calculation.
Total Capital Multiple Trailing
Price/ Share AirTran Alaska Air America West ATA Frontier Ryanair Southwest West
Jet Average Median JetBlue Tr ailing $6.60 $29.10 $3.50 $14.95 $17.00 $32.05 $18
.48 $15.85 Book Equity/ Share 0.49 32.12 12.47 10.79 5.36 5.54 5.26 2.82 Book De
bt/ Share 3.96 33.80 10.20 32.90 0.01 3.33 1.79 0.97 Total Capital Multiple 2.37
0.95 0.60 1.10 3.17 3.99 2.88 4.44 2.44 2.62 $2.62 (mult. med.)
JetBlue Airways IPO Valuation | 10/24/2012
$27.50
5.16
8.59
F IGURE 2
Again, the median figure was most representative of the sample (as it disregarde
d unusual outlying high and low performers), and provided a valuation of $27.50
for JetBlue. This valuation is slightly below the range of the leading and trail
ing values generated by the P/E multiple ($28 to $34). The valuation estimate dr
ops to $24.93 per share when using the average total capital multiple from the s
ample group. However, the
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median figure is still conservative as it is below the 2.88 multiple of Southwes
t. Southwest provides the closest proxy to JetBlue, because JetBlue duplicated S
outhwests operational practices in the unclaimed New York hub market. EBIT Multip
le The EBIT multiples (figure 3) provide a useful comparison with low-cost airli
ne carriers with different capital structures. However, the EBIT multiple had th
e widest range between trailing and leading estimates; and the widest range betw
een the EBIT multiple average and median. For these calculations, the average of
the sample represented JetBlue most closely.
EBIT Multiple
Trailing Airlines positive earnings AirTran Frontier Ryanair Southwest WestJet A
verage Median JetBlue Tr ailing JetBlue Leading Price/ Share $6.60 $17.00 $32.05
$18.48 $15.85 Book Debt/ Share 3.96 0.01 3.33 1.79 0.97 EBIT/ Share 0.81 2.99 0
.92 1.09 1.32 1.43 1.09 1.42 EBIT multiple 13.04 5.69 38.45 18.60 12.74 17.70 13
.04 $17.70 (mult. ave.) 1.97
$19.12 (mult. ave.)
Leading EBIT/ Share 0.76 0.64 1.17 1.42 1.59 1.12 1.17 EBIT multiple 13.89 26.58
30.26 14.27 10.58 19.12 14.27
$16.48 $29.08
8.59
(Trailing EBIT 18% greater than net income, Exhibit 3; Leading EBIT $80M / 40.6M
shares, Exhibit 13)
F IGURE 3
Similar to the P/E multiple, the large gap between the trailing and leading esti
mate is mainly due to JetBlues large jump in EBIT for 2002 (over 100 percent). Je
tBlues increase in EBIT is magnified by the samples increase in the EBIT multiple.
The trailing multiple valuation provides a conservative $16.48 per share ($9.87
per share when using sample median multiple). However, the leading valuation is
in line with the other multiples at $29.08 per share ($19.54 per share when usi
ng the median multiple).
Discounted Cash Flow Analysis
Assumptions We have used the following assumptions supplied by the JetBlue manag
ement forecast and the case-writer analysis provided in Exhibit 13 (Bruner, Eade
s, & Schill, 2010): 1. The Revenue per aircraft will commence at $17 million per
aircraft and increase by 4 percent per year (inflation) going forward from 2003
-2009 since the airline is at the height of the industry in terms of load factor
s. This estimate will drive the revenue growth rates in the DCF model. 2. Operat
ing expenses are projected as a percentage of revenues. 3. Capital expenditures
estimates are based on information presented in JetBlues I.P.O. prospectus and ad
justed upwards for inflation of 5 percent per year. 4. The debt-to-equity ratio
is estimated using the Total Capital Multiple estimate (figure 2).
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5. The risk-free rate and market premium are as of April 2002 6. Corporate incom
e tax rate remains flat at the 2002 level of 34 percent. 7. A terminal growth ra
te of 4.5 percent, which is a reasonable estimate of GDP growth, based on offici
al estimates. (Bureau of Labor Statistics projection for GDP by 2005 plus inflat
ion) 8. The levered beta for the Airline Industry is 1.08 (Yale School of Manage
ment, 2002); however we chose the higher levered beta of Southwest (1.10) as the
best representation of low-cost carriers levered beta (figure 4).
Southwest Capital Structure
Market Value Equity Market Value Debt Enterprise Value Southwest D/E Ratio SW Le
vered Beta SW Unlevered Beta Southwest Tax Rate JetBlue Tax Rate Jet Blue D/E Ra
tio JetBlue Levered Beta 16,071,992 (776.8M shares * $20.69, ex hibit 5) 1,842,0
00 (Exhibit 5) 17,913,992 0.11
JetBlue Beta
1.10 (Ex hibit 5) 1.02 31% (Ex hibit 5) 34% (Ex hibit 13) 0.31 Estimate using me
dian total capital multiple (ex hibit 7) 1.23
F IGURE 4
Weighted Average Cost of Capital Using the market value capital structure estima
te from the total capital multiple (figure 2), we calculated the weighted averag
e cost of capital for JetBlue to be 9.22 percent (figure 5).
JetBlue - Cost of Capital
K d =Yield to maturity of Southwest Airlines 5 y r debenture
Pretax cost of debt Tax rate After-tax cost of debt Dividends of Preferred Stock
Convertible Preferred Stock Cost of preferred stock Equity beta Rf RM-Rf Cost o
f common stock Debt-to-Cap Preferred-to-Cap Common-to-Cap WACC
7.91% (Ex hibit 6) + 0.5% premium for new company w/ 10y r debt 34% 5.22% K d (1
-t) 16,970 ( Ex hibit 3) 210,441 ( Ex hibit 2) 8.06% K p = Dp / P p 1.23 5.00% A
pril 2002 long-term U.S. Treasuries 5.00% Market risk premium giv en at 5% 11.15
% K e = Rf + b*(Rm-Rf) 23.80% Estimate using median total capital multiple (ex h
ibit 7) 16.62% Estimate using median total capital multiple (ex hibit 7) 59.58%
Estimate using median total capital multiple (ex hibit 7) 9.22% WACC = K d (1-t)
* Wd + K p *Wp + K e * We
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F IGURE 5
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Discounted Cash Flow Share Price Valuation The resulting share price from the di
scounted cash flow analysis (figures 6 and 7) is $29.89. This figure is within t
he P/E multiple valuation range (the industrys standard practice for valuation) o
f $28 to $34. The discounted cash flow analysis price per share is slightly high
er than the total capital and EBIT multiples. We subjected the DCF price per sha
re to a sensitivity analysis (figure 8) to calculate the effect of a change in g
rowth and a change in the weighted average cost of capital. An adjustment of 0.5
percent to either the WACC or the terminal growth rate resulted in changes to t
he share price estimate of 20 to 30 percent. The effect of the WACC rate on JetB
lues share price highlights the value of the I.P.O. to JetBlue. The I.P.O. will r
educe the cost of equity (by introducing liquidity to private equity holders); a
dditionally the improved debt-to-equity ratio will provide JetBlue with increase
d access to the debt markets. With a carefully calculated capital adjustment, Je
tBlue can further decrease its weighted cost of capital by using the tax shield
benefits of capital debt and the lower cost of debt.
Year NOPAT Growth (NOPAT) Depreciation Capital expenditure Net working capital N
et working capital Free Cash Flows Discounted FCF
F IGURE 6
2002E
52.64 196% 17.71 290.37 63.47 29.56 (249.58) (228.51)
2003E
88.67 68% 26.25 328.34 93.54 30.08 (243.50) (204.11)
2004E
119.57 35% 35.60 344.76 126.14 32.60 (222.19) (170.52)
2005E
148.99 25% 44.62 310.29 157.18 31.04 (147.71) (103.79)
2006E
180.77 21% 54.45 325.80 190.71 33.53 (124.10) (79.84)
2007E
215.06 19% 65.15 342.09 226.88 36.17 (98.05) (57.75)
2008E
247.44 15% 75.38 299.33 261.03 34.15 (10.66) (5.75)
2009E
270.28 9% 82.82 157.15 285.13 24.10 171.85 84.84
2010E
292.16 8% 90.04 132.00 308.22 23.08 227.11 102.66
Terminal
5024.17 2270.95
Share Price
F IGURE 8
$
Terminal Growth Rate 4.0% 4.5% 5.0% 31.88 39.06 48.17 24.29 29.89 36.81 18.13 22
.58 27.98 F IGURE 7
JetBlue Airways IPO Valuation
From the analysis of the company comparison multiples and the discounted cash fl
ows, we conclude that the JetBlue Airways I.P.O. should have a share price withi
n the range of $27 to $29. This range is below the price per share of all leadin
g multiples estimates and is below the DCF estimate. The range captures the more
conservative trailing estimate of the Total Capital multiple estimate. To accom
modate the benefits of
JetBlue Airways IPO Valuation | 10/24/2012
WACC
Terminal Growth WACC NPV Less: Preferred Shares Less: Long Term Debt Add: Cash E
quity Value $ Shares (millions)
4.50% 9.22% 1,608 (210) (301) Sensitivity Analysis 117 Price/Share 1,213 8.72% 4
0.60 9.22% 29.89 9.72%
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underpricing (access to future capital; generating goodwill and publicity; entic
ing uninformed investors), we therefore suggest the conservative range of $27 to
$29. The current suggested price of $25 to $26 unnecessarily leaves too much mo
ney on the table.
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Works Cited
Bruner, R., Eades, K., & Schill, M. (2010). Case 28 JetBlue Airways IPO Valuatio
n. In R. Bruner, K. Eades, & M. Schill, Case Studies in Finance (pp. 381-399). M
cGraw-Hill. Davidoff, S. M. (2011, May). Why I.P.O. s Get Underpriced. Retrieved
from New York Times: http://dealbook.nytimes.com/2011/05/27/why-i-p-o-s-get-und
erpriced/ Keloharju, M. (1993). THe Winner s Curse. Journal of Financial Economi
cs, 254-277. Rock, K. F. (1986). Why New Issues are Underpriced. Journal of Fina
ncial Economics, 187-212. Yale School of Management. (2002, October 9). JetBlue.
Retrieved from http://analystreports.som.yale.edu/reports/JetBlue.pdf
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