Jetblue Ipo

Introduction

The case is about IPO valuation of JetBlue airline company which established in 1999 and in 2002 JetBlue planned to capture capital from public to support future growth. It aimed to issue 5.5 million shares for the IPO. With expected huge demand, the management team would increase the offering price range from ($22 to $24) to ($25 to $26).

About IPO

Initial public offering (IPO) is the first time for private company to go public and raise capital from stock market. It is very crucial to companies as it expands their resource of funding and it is risky investment. The cost is huge and it brings uncertainty to the company’s future value. On the other hand, if IPO does not go well, the company will end up to bankruptcy such as the failure of Vonage IPO in 2006.

Everything has pro and cons so does IPO. It is obvious that the most distinct advantage is to raise capital for companies which could use in support future growth, funding capital expenditure, research and development and pay off current debt etc. Moreover, it is not just for short term, it targets in long term capital raising. At the same time, the funding from stock market could reduce the cost of capital as high return expected from venture capital investors. As company going public, it generates a great opportunity to build up brand name and increase publicity therefore to bring more potential customers and increase market share and improve competitive. Though there are a few disadvantages. IPO could be treated as an investment which cost is large such as lawyer, accounting and underwriter fee etc. As going to public, it will require more transparency on financial and operating sectors. The company needs to release financial data to public and comply with government and state law. There will be potential cost on the auditing and financial statement made up. As the shares trading in the market, company will face idiosyncratic risks and price will be fluctuate by market condition as well. Another concern is the pressure from shareholders as they would ask for maximum value of their share thus it may push the management to focus on short term profit rather than long term goal.

The IPO plan was set as April 2002, right after terrorist attacks of 911. There was a strong hit to U.S economic and airline industry. It is clearly from exhibit 12 in the case that the share price for airlines plummeted because of the unexpected event by nearly down 60%. However, in the worst period for airline industry, JetBlue remained profitable and was growing aggressively. As it shown in exhibit 1 in the case, the results of operations were positive. The revenue was consistently increasing. JetBlue was building up their name in the airline industry as the sales from its own website rising steadily. Also, the cost of fuel was decreasing as it implied the expense was decreasing while profit was increasing. It is good time to recovery from 911 and build up investor confidence with strong financial data. Meanwhile, JetBlue has good business characteristic. First of all, the expense of JetBlue is relatively low as high fuel-efficiency and one model of aircraft to minimize the maintenance complexity. Second, the most experience management team have included CEO, COO and CFO all have experience in airline industry. Third, leveraging advanced technology equip cockpits with bulletproof Kevlar doors and security cameras helps to potential customer to recover from 911. Fourth, the operating strategy was fixing the current issue and weakness in airline industry which JetBlue offered passenger not only great customers experience but unique flying experience and its target market was underserved. The last is strong corporate governance with passionately communication to employees and focus on building up employee morale thus create a strong brand name. All the reasons above add value to JetBlue stock.

Valuation JetBlue share price

There are different approaches to value JetBlue shares such as fundamental discount cash flow method (DCF) and using relative comparator multiple valuation techniques such as using price-earnings ratio, EBITDA multiple, price book value ratios and total capital multiple etc.

The key assumptions in the IPO valuation are the forecasting future projection of the company, the proper discount rate for the cash flow calculation. The exhibit 13 has provide the financial forecast which was quite reasonable with a few concerns. As it is airline company and the revenue is based on the number of aircraft the company owns and how much service it could provide. The expected inflation rate could be treated as a growth rate. Even in 2002 it has expected 16% inflation rate as the highest among all. Compared with other airline company in exhibit 8, in the beginning of airline business started up, there were dramatically revenue increasing. It could reflect the aggressive growth or business strategy with low price to attract potential customers as increasing sales. Also, the forecast period is the next 10 years. From the historical growth rate of Southwest, the growth pattern is not statable and it was fluctuated up and down by industry specific factors and economic cycles. Meanwhile, the most valuable assets of airline companies are aircrafts which are long-term investments and need longer period for depreciation.

Capital expenditure and working capital will increase associated with increasing number of aircrafts. The flat tax rate is 40% but the marginal tax for different company could be different such as Southwest has 38.5% expected tax rate and JetBlue has expected 34% tax rate in the future. The concern is the expected inflation rate or growth rate in practice will not be consistent as it showed in the exhibit. But it was trying to illustrate a reasonable forecast and easy calculation for valuation.

Because Southwest airline company has similar structure and operating strategy. The CEO used to be one of the top management team members. So WACC will use Southwest information as a proxy to unlevered the beta to achieve JetBlue levered beta as table one showed below.

As there is limit information on debt to equity (D/E) ratio, therefore it will use book capitalization value and book debt value to estimate the D/E ratio. Tax rate will be stick with the forecast table. The case has provided market risk premium and risk-free rate. Therefore, the cost of equity is 11.901%. While, as bond yield to maturity could be treated as cost of debt. The cost of debt will be the proxy as the average YTM of current debt