Jetblue Presentation

Group Presentation By :

23 July 2011

JETBLUE AIRWAYS IPO VALUATION – A CASE STUDY

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.

INTRODUCTION

This case study outlines the IPO underwriting process and uses JetBlue as an example to describe the steps throughout the way.

In the following presentation, we will discuss the followings :-

The Company and Industry Background

Pros and Cons of going public

IPO process

JetBlue Valuation

Recommendation

THE COMPANY & INDUSTRY BACKGROUND

JetBlue airways are a low cost airline established in July 1999 by David Neeleman.

David Neeleman was experienced in the operations of airlines and start up airlines. He started Morris Air which became a pioneer in ticketless

travel which was later acquired by Southwest Airlines. Later he joined Canadian low fare airline West Jet. He also developed the e-ticket system Open Skies which was

purchased by Hewlett-Packard in 1999.

The airline was to provide new levels of service in the airline travel industry, concentrating on customer service and low fares.

The starting of new airlines had proven to be a very difficult task over the past twenty years, with 87 new start up airlines failing over the twenty year period.


Neeleman plan was to commit to innovation in people,

policies and technology to keep the companies planes full and thus the company profitable.

To ensure this goal and the company’s future Neeleman assembled an impressive management team and group of investors. JetBlue’s COO was to be David Barger ex-vice president of Continental Airlines. John Owen who was executive vice-president and treasurer of Southwest Airlines agreed to become JetBlue’s CFO.

Neeleman received $130million form venture capital firms such as Western Presidio Capital, Chase Capital Partners and Quantum Industrial Partners.


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.

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 Low-Fare Airlines

Southwest Airlines is the pioneer and the dominant player in U.S airlines Industry.

Southwest Airlines is financially successful – Its market capitalization was larger than all other U.S airlines combines.

Other low-fare airlines in operation are AirTran, America West, ATA, Frontier and Alaska Air.

The most recent IPOs were non-U.S carriers. Ryanair, WestJet and easyjet had gone public with trailing EBIT multiples of 8.5X, 11.6X and 13.4X respectively and first-day returns of 62%, 25% and 11% respectively.

GOING PUBLIC

Advantages Of Going Public One of the main advantages of going public is the

additional capital the company obtains. Going public can “raise the profile” of a company. It is a means of attracting and retaining quality

personnel. From a shareholder perspective, going public puts a

greater discipline on managers. 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, geographical expansion or other strategic ventures.

GOING PUBLIC

Disadvantages Of Going Public

There are high costs involved with going public. Increased recurring costs. Time Demands. The company must also pay a return to satisfy

shareholders. There can be a loss of privacy and autonomy from

going public. There is a high failure rate of new entrants into the

airline market.

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

THE IPO PROCESS

1. 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. Also depends on whether issuer would like to see its

securities held more by individuals or by institutional investor.

2. Common underwriting issue – the “firm commitment” underwriting.

THE IPO PROCESS

3. Public offerings can be managed by one underwriter

(sole managed) or by multiple managers. The lead manager almost always appears on the left

of the cover of the prospectus. The lead manager also responsible assembling

group of underwriters.

4. The lead underwriter, the co-manager and the syndicate members receive compensation from the company. The lead underwriters receives 20% fee.

THE IPO PROCESS

5. Lead underwriter’s agenda is to draft a letter of intent.

Letter of intents contains clause requiring the company to reimburse the underwriter for any out-of-pocket expenses incurred.

Gross spread or underwriting discount.

4. There is no guarantee of the final offering price. The letter of intent remains in force until

Underwriting Agreement is executed at pricing.

THE IPO PROCESS

6. 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 registration also is circumscribed by Section 5 of the Act.

Registration statement consists of two parts: the prospectus the information that need to be furnished to

public

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. “due diligence” requirement Securities Act requires that the registration statement

signed by directors and principal officers of the issuer.

Any purchaser of the securities who is damaged as a result of misstatement or omission of material fact, may sue these signatories.

THE IPO PROCESS

8. Once the registration statement is filed, it is transformed into the preliminary prospectus or “Red Herring”.SEC responds to the initial filing within 20 days.The Red Herring is amended & transformed into

prospectus.The SEC Examines registration statements“price amendment”.

THE IPO PROCESS

9. Once the registration statement is approved, the

marketing of the offering begins. The company & underwriter promote the IPO

through the road show.

10. The underwriter receives indications of interest from investor. Retail investors submit “market order” Retail orders are receive earlier than institutional

order Institutions submit order with commitment to

purchase more shares

THE IPO PROCESS

11. Registration & marketing process can take several

months. The underwriter files with the SEC acceleration

request

12. The firm and the lead underwriter meet to discuss two final details. The offer price The exact number of share to be sold Order Book IPOs tend to be “under-priced” Under-pricing “leaves money on the table”- company

is not getting full value for its shares, but may be preferable for company if it guarantees the issues succeeds.

THE IPO PROCESS

13. The underwriter & the issuer execute the Underwriting Agreement, the final prospectus is printed, and underwriter files a “price amendment” on the morning of the chosen effective date. Once approved, the distribution of stock begins

14. But the IPO is still far from being completed. After market stabilization Provision of analyst recommendations Making a market in the stock

THE IPO PROCESS

15. The final stage of the IPO begins 25 calendar days after

IPO when the so-called “quiet period” ends. “Quiet Period” mandates by SEC Only underwriters (and other syndicate members)

can comment on the valuation & provide earning estimates of the new company.

Thus, underwriter’s role evolves in this after-market period into an advisory and evaluatory function.

THE IPO PROCESS

16. The initial public offering process thus involves a

complex combination of task by the company, the underwriter and the syndicate members. Throughout the process, the company relies on the

underwriter’s expertise to market, price, distribute, stabilize and support the issue.

The underwriter relies on the information & integrity of the company.

The completion of the process provides new capital for the firm, and a new investment opportunity for the public.

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.

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.

On the basis of all relevant factors, the investment banker would determine a ballpark price, and specify a range (such as $10 to $12) in the preliminary prospectus.


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


The IPO valuation puzzle. Based on study done on 49 IPOs conducted in Brussels

between 1993 and 2001, Deloof, De Maeseneire & nghelbrecht found that underwriters in the study never employed just one valuation method.

Out of 49 of the IPOs studied, the underwriters used discounted free cashflow (DFCF) in all 49 IPOs dividend discount model (DDM) in 24 IPOs added price-to-earnings, price-to-cashflow, 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, 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 VALUATION

Price / Earning Ratio (P/E)

1) P/E ratio of Southwest Airlines was 49.3(Exhibit 5)

2) Net income applicable to common stockholders was $21,567 thousands ( Exhibit 3)

3) Common stock offered was 5,500,000 shares (Exhibit 1)

4) Common stock estimated to be outstanding immediately after this offering was 40,578,829 shares (Exhibit 1)

Thus Offering Price =

(21,567,000*49.3) / (5,500,000+40,578,829)

$23.07

Benchmarking with competitors or those in similar industries e.g. using Southwest Airlines: -

THE IPO VALUATION

Discounted Cash Flow Method

The Corporate Value Model (By Discounted Cash Flow Method)

FCF = NOPAT+ Depreciation - CAPEX - NWC

Terminal Value = FCF Steady State / (WACC - g ) = Vcompany at t=n

V = FCF1 / (1+WACC)1 + FCF2 / (1+WACC)2 + …..+FCFn / (1+WACC)n +Terminal Value

V = D + E

Note : See WACC and Table 1

Offering Price = $25.59

THE IPO VALUATION

CorporateMV asset weightsBond ratingPretax cost of debt 7.41% Kd =Yield to maturity of Southwest

Airlines debenture (Exhibit 6)Tax rate 34%After-tax cost of debt 4.89% Kd (1-

t)

Dp 169,700 Preferred stock dividends was $16,970 thousands ( Exhibit 3)

Pp 210,441,000 Convertible redeemable preferred stock ( Exhibit 2)

Cost of preferred stock

8.06% Kp = Dp / Pp

THE IPO VALUATION

Equity beta 1.10 Refer Beta of Southwest Airlines was (Exhibit 5)

Rf 5.00% Current long-term U.S. Treasuries traded at a yield of 5%

RM 10.00% Rm = Rf + Rp

RM-Rf 5.00% Market risk premium is 5%

Cost of common stock

10.50% Ke = Rf + b*(Rm-Rf)

Weight of debt 17.6% Debt = 301,373 (Book value, Long term debt, Exhibit 2)

Weight of preferred stock

12.3% Preferred stock=

210,441 (Book value, Exhibit 2)

Weight of common stock

70.1% Common stock=

1,198,049 (App. Market =46,078,829*$26)

WACC 9.21% WACC = Kd (1-t) * Wd + Kp*Wp + Ke* We

WACC = Kd (1-t) * D/(D+P+E) + Kp*P/(D+P+E) + Ke* E/(D+P+E)

Summary of WACC Calculation for JetBlue Airways


JETBLUE AIRWAYS IPO VALUATIONJetBlue Financial ForecastAssumption / Estimation Steady-state growth 7.0%Operating margin 15.2% Discount rate (WACC) 9.21% Tax Rate 34%

Inflation Rate (prices and costs) 4%

Steady State

Growth$ figures in millions Actual Estimate Estimate Estimate Estimate Estimate Estimate Estimate Estimate Estimate2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Number of aircraft 21 34 48 62 74 86 98 108 113 117

$ Revenue/plane $15.3 $17.6 $18.4 $19.2 $20.1 $21.0 $21.9 $22.8 $23.8 $24.9 Expected inflation 16% 4% 4% 4% 4% 4% 4% 4% 4%Operating margin 8.4% 13.3% 15.2% 15.2% 15.2% 15.2% 15.2% 15.2% 15.2% 15.2%

$ Depreciation/plane $0.5 $0.5 $0.5 $0.6 $0.6 $0.6 $0.7 $0.7 $0.7 $0.8$ CapEx/New planes $21.3 $22.3 $23.5 $24.6 $25.9 $27.1 $28.5 $29.9 $31.4 $33.0 Expected inflation 5% 5% 5% 5% 5% 5% 5% 5% 5%NWC Turnover 9.4 9.4 9.4 9.4 9.4 9.4 9.4 9.4 9.4 9.4 Financial forecastRevenue $320 $600 $884 $1,192 $1,485 $1,802 $2,144 $2,466 $2,694 $2,912 $3,116 Cash expenses 283 502 723 975 1,215 1,474 1,753 2,016 2,202 2,380 Depreciation 10 18 26 36 45 54 65 75 83 90 EBIT 27 80 134 181 226 274 326 375 410 443 Tax 34% 9 27 46 62 77 93 111 127 139 151 NOPAT 18 53 89 120 149 181 215 247 270 292 313Depreciation 10 18 26 36 45 54 65 75 83 90

(158)Capital expenditure 234 290 328 345 310 326 342 299 157 132 Net working capital 34 63 94 126 157 191 227 261 285 308 330 Increase in NWC 30 30 33 31 34 36 34 24 23 22 Free cash flow (206) (250) (243) (222) (148) (124) (98) (11) 172 227 133 Terminal value 6001Free cash flow+Terminal value (206) (250) (243) (222) (148) (124) (98) (11) 172 6,229 NPPE 224 496 798 1,107 1,373 1,645 1,921 2,145 2,220 2,262 2,420

THE IPO VALUATION

From the previous table: -

Enterprise Value PV(FCF) $1,691 Debt = 301Preferred stock= 210Common stock= $1,179 Common stock offered= 5.5Common stock outstanding= 40.5788Comon stock= 46.0788Offering price= $25.59

THE IPO VALUATION

Recommendation: -

Thus it is recommended that the IPO pricing to be set at around $25 per share

THE IPO PRICING CONFLICT

There is an inherent conflict of interest, because the banker has an incentive to set a low price:

to make brokerage customers happy. to make it easy to sell the issue.

Firm would like price to be high.

Note that original owners generally sell only a small part of their stock, so if price increases, they benefit.

Later offerings easier if first goes well.

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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Jetblue Presentation