Jetblue Airways Ipo Valuation - 01

The case JetBlue Airways IPO Valuation outlines JetBlues innovative

strategy and the associated strong financial performance over the initial two
years, in order to determine the price of initial public offering of its stock on
April 2002.
To the whole industry of Airlines, the terrorist attacks of September 2001
caused a challenge, especially to large numbers of low-fare U.S. airlines.
However, JetBlue remained profitable and grew aggressively. From 2002,
the low-fare business model gained momentum in the U.S. airline industry.
The dominant player among low-fare airlines, Southwest Airlines, has been
going so successfully with its stable growth rate of revenue (Exhibit 8) and
increasing operating margin forecasts (Exhibit 5). As a relatively new
company, JetBlue had made significant progress in establishing a strong
brand by seeking to be identified as a safe, reliable, low-fare airline. In
addition, a solid Neelemans management team, with David Barger and
John Owen joining, was formed to enhance the success of going public.
Therefore, to support JetBlues growth trajectory, going public and raising
financing for the company is appropriate at this moment.
Going public has both advantages and disadvantages.
Advantages
The main purpose of going public is to increase capital for the issuer. A
public offering would place a value on the company's stock and insiders
who retain stock may be able to sell their shares or use them as collateral.
Going public also creates a type of currency in the form of its stock that the
business can use to make acquisitions. In addition, the company will likely
have access to capital markets for future financing needs.
In this case of JetBlue Airways, the company can offset portfolio losses by
its venture-capital investors by going public, meanwhile, create exit
opportunity for venture capitalists and early-stage investors. On the other
hand, shareholders increase liquidity for holdin gs through going public.

In addition, going public to JetBlue will generally result in the ability to

better promote the company. JetBlue would gain publicity, recognition and
an image of stability by trading publicly. Along with prestige and the ability
to better promote the company, going public may allow the company to
attract better personnel. To JetBlues customer-service strategy, the
employees stock options can be more valuable as generous
compensation, which would build stronger employee morale.
Disadvantages
First of all, going public is an expensive and timely, and if the offering does
not go through, the company will lose that money for nothing. Typical
expenses associated with a public offering include legal and accounting
fees, filing fees and underwriter's expense allowance. Going public to
JetBlue can also be an extremely difficult process, especially if the board of
management is not familiar with the registration process. The company will
need to put all its business affairs in order and the day-to-day business
operations will likely be disrupted.
Another disadvantage of going public is that public companies operate
under close scrutiny. The prospectus reveals substantial information about
the company including transactions with management, executive
compensation and prior violations of securities laws. This may be
information the company would rather not reveal. In addition, public
companies must comply with reporting requirements under the Exchange
Act of 1934 as soon as the registration statement becomes effective.
Complying with these reporting requirements can be expensive and timely.
In addition, there is also an increased risk of exposure to civil liability for
public companies, executives and directors for false or misleading
statements in the registration statement.
Valuation Methods for JetBlues equity
There are a lot of approaches can be used to determine the value of a
company and its equity. Three of them are commonly used. The first one is
Free Cash Flow to Equity Method (FCFE), which is a measure of how
much cash can be paid to the equity shareholders of the company after all
expenses, reinvestment and debt repayment. The second one is Free Cash
Flow to Firm Method (FCFF), which is a measurement of a companys

profitability after all expenses and reinvestments. It is one of the many

benchmarks used to compare and analyse financial health. The third one is
Relative Valuation Techniques, whose main target elements include price
earnings ration, EBITDA multiple, price cash flow ratios, price book value
ratios and price sales ratio.
Determine the price of IPO
As shown Exhibit 2 Balance Sheet of JetBlue, the total debt was $152
million and $319 million in 2000 and 2001 respectively. The debt-to-equity
ratio was -9.9 (319million/-32million) in 2001, and the ratio in 2000 was only
-2.8 (152 million/-54million), which indicates the leverage changes
significantly. In this case however, the balance sheet only shows the twoyear information. In accordance with the issuance of IPO, the leverage ratio
can be estimated as relatively stable. Therefore, FCFE would be preferable
to value the JetBlue compared to FCFF.
According to Exhibit 8 Historical Annual Growth Rates for 5 Low-Fare
Airlines, the average $Revenue Growth rate of the five companies is 44%
from 1999 to 2000, and 13.8% from 2000 to 2001. Therefore, the
$Revenue Growth Rate of JetBlue from 2001 to 2002 should not be very
different with the rate of previous two growth rates, which indicates that the
growth rate (about 200%) shown in Exhibit 13 seems to be inaccurate. The
further forecasts for nine-year period, which is based on the estimated
value of 2002, would not be appropriate and reliable information to value
the firm and its stock value.
Compared to the 10-year forecasts for JetBlue shown in Exhibit 8, the
benchmark of the airline industry shown in Exhibit 8 would be more
accurate, reliable and reasonable. It can be seen from the Exhibit 8 that the
five low-fare airline firms experienced highly fluctuant revenue growth
except Southwest. As John Owen was the former treasurer of Southwest
Airline and became to be JetBlues CFO, JetBlue can be estimated to have
the similar corporate strategy as well as growth trajectory with the
Southwest.
In this case, as the mentioned, Southwest was the dominant player in the
industry, it supposed that the expected growth rate for JetBlue would be
lower than Southwest. According to the data shown in Exhibit 8, Southwest

had an average revenue growth rate of 15.67% from 1990 to 2001. In

addition, based on Exhibit 11, the air-transport would have a steady trend
after year 2003. Thus, the growth rate after take into consideration of
inflation was expected to be 14%, 19%, 18%, 20% and 19% from 2002 to
2006. Under the assumption that the capital structure, tax rate and inflation
rate were constant, the number of aircraft grew with growth rate. The
operating margin forecasts are estimated from Exhibit 5. The adjusted
financial forecast statement for JetBlue is:
$ Figures in millions | 2001 | 2002E | 2003E | 2004E | 2005E | 2006E |
Number of aircraft | 21 | 24 | 28 | 34 | 40 | 48 |
$ Revenue/plane | $15.3 | $17.4 | $20.7 | $24.4 | $29.3 | $34.9 |
Expected inflation r | | 5% | 5% | 5% | 5% | 5% |
Operating margin | 20% | 20% | 20% | 20% | 20% | 20% |
$ Depreciation/plane | $0.5 | $0.5 | $0.5 | $0.6 | $0.6 | $0.6 |
$CapEx/New planes | $16.4 | $17.2 | $18.0 | $18.9 | $19.9 | $20.9 |
Expected inflation | | 5% | 5% | 5% | 5% | 5% |
NWC Turnover | (6.5) | (6.5) | (6.5) | (6.5) | (6.5) | (6.5) |
Revenue | $320 | $365 | $435 | $513 | $615 | $732 |
Cash expenses | 246283 | 280 | 332 | 391 | 468 | 556 |
Depreciation | 10 | 12 | 16 | 19 | 24 | 30 |
EBIT | 64 27 | 73 | 87 | 103 | 123 | 146 |
Tax (34%) | 22 9 | 25 | 30 | 35 | 42 | 50 |
NOPAT | 42 | 48 | 57 | 68 | 81 | 97 |
Capital expenditure | 180 | 51 | 82 | 97 | 134 | 160 |
Net working capital | (49) | (56) | (66) | (78) | (94) | (112) |

The discount rate for FCFE is the cost of equity which can be calculated by
CAPM. The beta is 1.3 which is higher the Southwest as JetBlue was a
new company and higher risk was exposed. It is 11.5% (calculated by
Ke=Rf+beta*risk premium= 5%+1.3*5%). We assume that the principal
repayment was 10 million each year due to the successful issuance of IPO
and the proceeds from debt issue was 80 million due to the expansion of
the firm. Also, the long term debt in 2002 was assumed to be 100 million
depending on past years performance. The FCFE for JetBlue is calculated
as the figure below,
$ million | 2002 | 2003 | 2004 | 2005 | 2006 |
Net income | 48 | 57 | 68 | 81 | 97 |
plus depreciation | 12 | 16 | 19 | 24 | 30 |
minus capital expenditure | 51 | 82 | 97 | 134 | 160 |
minus change in working capital | (7) | (10) | (12) | (16) | (18) |
minus principal repayment | 18 | 18 | 18 | 18 | 18 |
plus proceeds from new debt issues | 80 | 80 | 80 | 80 | 80 |
FCFE | 79 | 63 | 64 | 50 | 46 |
PV of FCFE as at Apr 30, 2002 (11.5%) | 73 | 52 | 48 | 34 | 28 |
Market value of firm | 235 | | | | |
Less long term debt | 100 | | | | |
Per share value (5.5 million shares) $ dollar | 24.5 | | | | |
The share price calculated by the FCFE method is $24.5. It is close to the
initial offering range.
The P/E ratio of the industry or comparable firms times the earnings of the
firm being valued is another method to calculate the value of the firm. The
P/E ratio is calculated from the average PE multiple of American low-fare
airline company which consists of AirTran, Alaska Air, America West, ATA,

Frontier and Southwest. The average P/E ratio was 5.9, thus, the value of
the firm was $159.3 million (calculated by 5.9*27) and the share price was
$29 (calculated by 159.3/5.5).
2001 | PE Multiple |
AirTran | 25.3 |
Alaska Air | -19.3 |
America West | -0.8 |
ATA | -5.7 |
Frontier | 8.4 |
Southwest | 27.6 |
average | 5.9 |
To sum up, the share price calculated by the FCFE method is less reliable
compare to the relative valuation method. The information used to compute
the FCFE was estimated with uncertainty, instead, the P/E multiple and
earnings of JetBlue was the real number and might be more persuasive
and close to the true value of the firm. Thus, the initial offering price should
be close to $29 which was higher than the price suggested by analysts. It
seems reasonable because of the popularity and the valuation of the
JetBlue.