JetBlue Airways IPO Valuation

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JetBlue Airways: IPO Valuation

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JetBlue Airways: IPO Valuation
Prepared for:
M. Sadiqul Islam
Professor
Department of Finance
Faculty of Business Studies
University of Dhaka
Prepared by:
Group No:
Section: A
BBA 23rd Batch
Serial Name ID Marks
1 Minhajur Rahman Joy 23-106
2 Md. Foyez Alam 23-155
3 H. M. Rahat Fida 23-187
4 Md. Riaj Morshed 23-197
Date of Submission: Aug 16, 2020

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Letter of Transmittal
Aug 16, 2020
M. Sadiqul Islam
Professor
Department of Finance,
Faculty of Business Studies
University of Dhaka.
Subject: Submission of the semester term paper.
Dear Sir:
It is our pleasure to submit the term paper of our 7 th semester course Investment Banking &
Lease Financing (F-403). It has been a privilege for us to have this opportunity to apply our
academic knowledge in real life situations through this case study.
We tried our level best to put sincere effort for the preparation of this term paper. As
undergraduate students, it is usual that inadequacy or error may arise and it may lack
professionalism in some cases. For any unintentional inadequacy in the term paper, your
sympathetic consideration would be highly appreciated. In addition, we will enthusiastically
welcome any clarification and suggestion about any view and conception disseminated in the
report.
We, therefore, pray that you would be kind enough to accept our report for evaluation and
oblige thereby.
Sincerely,
………………………………
Minhajur Rahman Joy
On behalf of Group no.
Section: A
Department of Finance
University of Dhaka

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Table of Contents
Executive Summary ................................................................................................................. 5
Chapter 01: Introduction ........................................................................................................ 6
1.1 Scope of the study: ............................................................................................................... 6
1.2 Methodology of the study: ................................................................................................... 6
Primary Data: ......................................................................................................................... 6
Secondary Data: ..................................................................................................................... 6
Chapter 02: Analysis of Economy .......................................................................................... 7
Chapter 03: Industry Analysis ................................................................................................ 8
Porters Five Forces............................................................................................................... 8
PESTEL Analysis ................................................................................................................... 9
Chapter 04: Company Analysis ............................................................................................ 10
SWOT Analysis .................................................................................................................. 10
Ratio Analysis ..................................................................................................................... 10
Profitability Ratio ............................................................................................................. 10
Liquidity Ratio .................................................................................................................. 10
Risk Analysis ....................................................................................................................... 10
Probability of Financial Distress ...................................................................................... 10
DuPont Analysis ................................................................................................................. 11
Decompose ROE ................................................................................................................. 11
Chapter 05: Problem Statement ........................................................................................... 12
Chapter 07: Analysis of Each Alternatives .......................................................................... 14
Alternative Evaluation: Over Pricing....................................................................................... 14
Alternative Evaluation: Under Pricing..................................................................................... 14
Chapter 08: Valuation ........................................................................................................... 15
Discounted Cash Flow Approach ............................................................................................ 15
Multiple Valuation ................................................................................................................... 16
Chapter 09: Recommendation .............................................................................................. 18

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Executive Summary
JetBlue Airways set an extraordinary example the US airline industry by keeping a steady
growth since its first founding in February 1999. It managed to stay profitable even after the
infamous September 11, 2001 event by its affordable point to point comfortable air travel. And
to maintain the growing trend of the management decided to raise capital by offering stocks to
the public.
Though the initial pricing for each stock was ranging from $22 to $ 24. The massive demand
for 5.5 million stock being offered encouraged them to raise the price range to $25 to $26.
But valuating their company and evaluating other alternatives suggest that the pricing for the
stocks is still underpriced. And the suggested price for each stock is around $26 to $29.
Otherwise, they are leaving behind a lot of potential capital to be raised.

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Chapter 01: Introduction
This report illustrates the valuation of the IPO of the JetBlue Airways and how it affected the
rest of the US economy. They focused more on the customer experience at a more affordable
cost than others. JetBlue Airways kept their costs low by using only one type of aircraft and
efficient training process. Taking cost cutting measures and online based customer services
helped them to stay profitable in the most challenging times.
1.1 Scope of the study:
JetBlue Airways kept on being profitable even though the rest of the US Airlines were facing
loses due to mishaps during 2001. So, the IPO valuation of JetBlue Airways is a very intriguing
study to learn how the company went about to manage such a feat.
1.2 Methodology of the study:
The report uses data collected from public sources and other related studies done on such
industry. For industry and company analysis the Porter’s Five Forces and Pestel analysis has
been implemented. And alternative courses of action have been evaluated and compared to the
actual decision JetBlue Airways decided to adapt.
Primary Data:
No primary data were used in this study.
Secondary Data:
Data from JetBlue Airway’s prospectus and their financial statements has been referenced as
secondary data for this study.

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Chapter 02: Analysis of Economy
Highlights:
 Stalled US economy for nearly two years in 2002
 Lowest interest rate in a generation
 The yield of current long-term US Treasuries is 5%
 The yield of current short-term US Treasuries is 2%
 Market risk premium is 5%
 Market experts forecast steady 4% inflation for next 10 years.
This are some of the information available in the case to give us an indication about the
condition of the economy in the near future.
US economy was already stalling up to two years by April of 2002, leading Federal Reserve
to take Expansionary policy to help boost the economy. Meaning, it lowered the interest rate.
Lowest interest in its generation. Current long-term bond yield was 5%, short term bond yield
was 2% and risk premium was 5%.
The goal was to encourage investment in the economy. A lower interest rate meant people
were more likely to have a growth in disposable income and invest more. Also, a rise in
investment lowers unemployment. Lowering of the unemployment rate made the market
experts to forecast a steady 4% inflation for the next 10 years.
Expansionary policies often tend to increase the price of the Bond as the relation between
interest rate and bond is inverse in relation. So, at that point in the economy people were
more likely to shift their investments to Stock market which helped JetBlue Airways in their
capital raising.

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Chapter 03: Industry Analysis
Porters Five Forces
Force Value Justification
Power of Suppliers Low As the low-fare business models are getting
the momentum and a flurry of new airlines
with such models are entering the market,
the suppliers have a little influence over the
pricing
Power of Buyers High As there are now so many options available
to customers, thus they have higher
bargaining power than that of suppliers
Threat of Substitute Moderate Buses, trains and ships etc. are always there
as the substitute of airlines. However when
it comes to travelling from one continent to
another, airlines is the only way. Thus the
threat level is moderate.
Competitive Rivalry High The competition level in this industry is
extremely high as the players like Southwest
Airlines are dominating the market with
their low-fare business model.
Barrier to entry Low There are no legal barrier for a new
company to enter the market. Thus the
number of new companies investing in the
airlines industry is growing everyday

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PESTEL Analysis
Economic
Low fare business model started to disrupt the
industry since 2002
Social
Low level of motivation to travel via airlines
after the 9/11 attack
Environmental
No data was available in the case regarding
the environmental impact of the industry
Political
The government is showing dedicated support to
the airlines industry after 9/11 attack
Technological
Increasing use of technologies such as laptop
computers, bulletproof Kevlar doors and security
cameras
Legal
The SEC required firms selling equity in public
markets solicit the commission’s approval

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Chapter 04: Company Analysis
SWOT Analysis
Internal External
Strengths Weaknesses Opportunities Threats
(1) Impressive new
management team
(2) Growing group
of investors
(3) Strong support
from the venture
capital community
(1)
Long term debt
exposing to
financial risk
(1) Becoming the
market leader
(2) To dominate the
low-fare airlines
segment
(1) Intense rivalry
among the players
(2) Security concern
over terrorist attacks
Ratio Analysis
Profitability Ratio
2001 2000
Operating Profit Margin 8.4% -20.3%
Net Profit Margin 12.0% -20.4%
Liquidity Ratio
2001 2000
Current Ratio 74.3% 65.8%
Quick Ratio 71.2% 61.6%
Risk Analysis
Probability of Financial Distress
Z score
Total Assets 673,773
NWC 34,000
Retained Earnings -
EBIT 41,915
Equity 3,889
Liabilities 705,940
Sales 320,414

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Factor
A 0.050462099 6.56
B 0 3.26
C 0.062209379 1.05
D 0.005508967 6.72
Z Score 0.43337147
Interpretations
Z > 2.90 Safe Zone
1.23 < Z < 2.99 Gray Zone
Z < 1.23 Distress Zone
DuPont Analysis
2001 2000
Net Income 38,537 (21,330)
Sales 320,414 104,618
Profit Margin 0.12027252 -0.20388461
2001 2000
Sales 320,414 104,618
Assets 673,773 344,128
Asset Turnover 0.475551855 0.304008973
2001 2000
Assets 673,773 344,128
Equity (32,167) (54,153)
Leverage -20.9460938 -6.35473566
Decompose ROE
2001 2000
Profit Margin 0.1203 -0.2039
Asset Turnover 0.4756 0.3040
Leverage -20.9461 -6.3547
ROE -119.8% 39.4%

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Chapter 05: Problem Statement
The core issue of this case can be summarized in the following statement:
Finding the ideal offer price that ensures the firm can avail the optimum benefit from
this opportunity without jeopardizing the success of a fully sold out IPO launch.
Our comprehensive analysis of the JetBlue Airways IPO Valuation case has provided us a
number of issues based on the current scenario which we believe to have a large impact on the
outcome of this offering. Our findings have been discussed below with proper reasoning:
(1) The aftermaths of September 11: The terrorist attack on World Trade Centre has
obviously slowed down the growth of airlines industry. People are showing lack of
motivation on travelling via airlines which is leading towards the small companies
being bankrupt. Also it has shown the industry how important it is to invest in
technologies to ensure the safety of passengers.
(2) The low-fare business model: The low-fare business models started to disrupt the
industry in 2002. One of the dominant player with such business model is Southwest
Airlines. In fact, Southwest’s market capitalization was larger than all other airlines
companies of U.S. combined.
(3) New players entering the market: Following the success of Southwest Airlines a
flurry of new players with low-fare business models are entering the market. AirTran,
America West, ATA and Frontier etc. are the player that are following the model of
Southwest.

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Chapter 06: Alternate Courses of Action
There are 2 possible courses of action in the context of this case. The firm can either choose to
stay conservative in their approach by offering shares at a price that has overwhelming demand
or they can choose a slightly riskier approach to find out how much they can increase the price
without causing an issue failure. Additionally, we shall also try to determine the effects of
raising the whole amount as a debt which at a glance does not seem like a viable option as the
company already has high long term obligations.
In the following chapters we will try to find that ideal price through different qualitative &
quantitative approach. For the valuation purpose we will utilize Discounted Cash Flow (DCF)
approach as well as several multiple valuation methods to verify the results.
But before we move on to the viability test of these alternatives, we need to understand some
of the key factors that has to be considered while fixing the offer price:
Demand: First and & foremost the IPO price has to be matched with the market demands. As
the simple economic theory of supply & demand dictates, any good or service(s) tend to have
increased demand as the price declines. So, market demand at various price points has to be
tested.
Probability of Success: Issue failures are much more unlikely when IPO is priced right. This
builds market credibility & investor’s confidence which leads to easier fund raising in the near
future if required.
Comparable Firms: The price should also reflect the peer company’s valuation which
operates in the same industry and more importantly follows similar business models. Because
when an investor decides s/he would invest in a specific industry of specific country, s/he would
choose the alternative stock which is more undervalued.
Growth Prospects: Let’s assume two companies in a similar industry are going for IPO, one
has been in operation for 20+ years successfully while the other has been running for last 2-3
years. Obviously, the growth prospects are much higher in the 2 nd company in this example.
So, growth prospects has to be accounted for while pricing as the rational investor will look for
additional returns for companies that are relatively newer.

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Chapter 07: Analysis of Each Alternatives
Alternative Evaluation: Over Pricing
IPO overpricing means setting the opening offer price of the IPO higher than the fair value
price. Following are the advantages and disadvantages of the over pricing of the IPO offer
price
Advantages:
 Opportunity to collect additional capital
 Reflects strong and sound financial position of the company
 Shows confidence of the company to the market
Disadvantages:
 Unsustainable demand leading towards unsuccessful IPO
 Risk of having huge number of shares remaining unsubscribed
 Raising the expectations of the investors and failure to fulfil them
 Failure to collect the required amount of capital
 Risk of jeopardizing access to future capital needs
 Investors are more likely to suffer negative return
Alternative Evaluation: Under Pricing
An IPO is said to be underpriced when the first day closing price is higher than the offer
price. The main underlying reason for this phenomenon is information asymmetry among
different parties. Usually most of the companies follow the route of underpricing to attract
more investors & to send a positive signal to the market. But significant underpricing would
mean that company has raised significantly lower amount than they should have done & the
issue manager has done a poor job.
Advantages:
 Higher probability of successful IPO
 Less risk of undersubscription of IPO shares
 Attracting uninformed investors at lower cost
 Maintaining access to future capital needs
 More opportunity to ensure positive return for investors and other stakeholders
Disadvantages:
 Higher opportunity cost in the form of lower amount of capital collected
 Showing less confidence to the market
 Investors perceived scepticism of the company

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Chapter 08: Valuation
Discounted Cash Flow Approach
We have used the following assumption to estimate the expected future cash flows for the
next 15 years:
Assumptions:
1. Sales have been forecasted to grow at a CAGR of 13.78%, adjusting for inflation rate
of 4% for the first 10 years & 3.5% for the next 5 years.
2. Operating expense was assumed to be 84.8%, in line with the JetBlue financial forecast
(Ex. 13).
3. Capital expenditures estimates are based on the data provided by the case writer where
it assumes 5% upward inflation on capital equipment.
4. Corporate income tax rate will remain fixed at current level of 34%.
5. A terminal growth rate of 2.5 percent, which is a reasonable estimate as it is
consistent with the expected long run GDP growth rate of USA.
Weighted Average Cost of Capital
Value Source
Pre-tax cost of debt
SWA 5 Year Debenture
YTM
7.41% Exhibit 6
Premium for a new company 1%
Tax Rate 34%
After-tax cost of debt 5.55%
Dividends of Preferred Stock 16,970 Exhibit 3
Convertible Preferred Stock 210,441 Exhibit 2
Cost of preferred stock 8.06%
Equity Beta 1.23 Appendix 1
Risk Free rate 5% April 2002
long-term U.S.
Treasuries
Risk Premium 5%
Cost of common stock 11.15%
Weight of Debt 23.80% Estimate using
median total
capital multiple
(exhibit 7)
Weight of Preferred Stock 16.62%
Weight of Common stock 59.58%
WACC 9.30%

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From the discounted cash flow valuation, the resulting share price is $31.74. The P/E multiple
valuation range (the industry’s standard practice for valuation) is $28 to $34 and the calculated
share price. However, the resulting share price from the discounted cash flow analysis is little
bit higher than that of total capital and EBIT multiples. Additionally, the sensitivity analysis is
conducted on the resulting share price from DCF analysis to measure the impact of change in
growth rate and WACC rate. The changes to the share price is estimated to be 20 to 30 percent
for an adjustment of 0.5 percent to either the WACC or the terminal growth rate. The output
value has been tested with Monte Carlo Simulation test, which yielded a coeff. of variance of
0.49. (Appendix 03)
Values in $ Million
Year 1 2 3 4 5 ….. 14 15 Terminal
Value
NOPAT 60.16 88.67 119.57 148.99 176.57 ….. 394.45 417.47
Depreciation 17.71 26.25 35.60 44.62 54.45 ….. 143.39 155.72
Capital Expenditure (290.37) (328.34) (344.76) (310.29) (271.50) ….. (126.36) (132.67)
NWC Investments (25.68) (103.98) (57.56) (54.13) (45.57) ….. 0.52 1.12
Free CF (238.18) (317.41) (247.15) (170.80) (86.06) ….. 412.01 441.63 6,656.89
Present Value (217.91) (265.69) (189.27) (119.68) (55.17) ….. 118.64 116.35 1,753.75
Discount Factor 0.91 0.84 0.77 0.70 0.64 ….. 0.29 0.26 0.26
Net Present Value 1,682.84
Less: Pref. Shares (210)
Less: Long Term Debt (301)
Add: Cash & Equivalent 117
Equity value 1,288.84
Outstanding No. of Shares 40.60
Share Price 31.74
Multiple Valuation
1. P/E Multiple
Low-fare and high performing airlines such as AirTran, Frontier, Ryanair, Southwest and
WestJet are selected as samples in the analysis. Here, the selected sample size is small and the
frontier’s performance is outlying. Therefore, the median number of the PE Multiple sample to
represent JetBlue’s trailing and leading PE multiple is selected.
Trailing Leading
P/E EPS P/E Multiple EPS P/E Multiple
AirTran 6.60 0.26 25.29 0.33 20
Frontier 17 2.03 8.37 0.37 45.95
Ryanair 32.05 0.73 44.02 0.94 34.1
Southwest 18.48 0.67 27.59 0.65 28.43
WestJet 15.85 0.81 19.57 0.59 26.86
Average 0.90 24.97 0.58 31.07
Median 0.73 25.29 0.59 28.43
JetBlue (trailing) 28.83 1.14 25.29
JetBlue (leading) 36.96 1.30 28.43
Sensitivity Analysis
Terminal Growth Rates
Disc. Rate 2.00% 2.50% 3.00%
8.80% 35.46 39.35 43.92
9.30% 28.59 31.74 35.4
9.80% 22.74 25.32 28.28

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When it comes to trailing, the earnings/share is 1.14(Diluted Earnings Per Common Share in
Exhibit 3). And, for Leading, the earnings/share is 1.30(Pro forma basic Earnings Per Common
Share in Exhibit 3). The Price/Share is calculated using the formula Price/Share=
Earnings/Share * PE Multiple. More specific details are shown in Appendix 1.
2. EBIT Multiple
We also chose AirTran, Frontier, Ryanair, Southwest and WestJet here as our sample as they
follow similar business model and calculated the avg. & median number of the sample EBIT
Multiple to identify JetBlue’s trailing and leading EBIT multiple.
Trailing Leading
Price/Share BV of
Debt/Share
EBIT/Share EBIT
Multiple
EBIT/Share EBIT
Multiple
AirTran 6.60 3.96 0.81 13.04 0.76 13.89
Frontier 17 0.01 2.99 5.69 0.64 26.58
Ryanair 32.05 3.33 0.92 38.45 1.17 30.26
Southwest 18.48 1.79 1.09 18.6 1.42 14.27
WestJet 15.85 0.97 1.32 12.74 1.59 10.58
Average 1.43 17.70 1.12 19.12
Median 1.09 13.04 1.17 14.27
JetBlue (trailing) 14.21 1.09 13.04
JetBlue (leading) 28.11 1.97 14.27
The Price/Share is calculated using the formula Price/Share= EBIT/Share * EBIT Multiple.
Price/Share for Leading EBIT multiple was calculated in the following way
= 80/ (35.1+5.5) =1.97.
Before the year of 2002, there is no stocks for JetBlue, so we choose median of sample to
identify the price/Share for trailing EBIT multiple.
We got the price/Share is 14.21 for trailing and 28.12 for leading. As we have chosen the
median number of sample as EBIT/Share for trailing, it is less reasonable than that of leading.

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Chapter 09: Recommendation
Based on the study conducted, the JetBlue Airways IPO price should be around $26 to $29 as
pricing lower than that is unprofitable for the company considering the growth prospect.
There are different school of thoughts regarding the ideal pricing of the IPO. But empirical
evidence shows that traditionally issue managers tend to prefer slight underpricing over issue
failures because of over pricing. Slight underpricing also enables ideal first day trading
condition which indicates the success of an issue.
In this case, our valuation results using different methodologies gave us intrinsic share price
values ranging from $14 to $36 with a skewness to the upper limit. So, we conclude that even
if the firm chooses $26 to $29 price range, it leaves room for ideal trading condition.

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Appendix 01
Appendix 02

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Appendix 03
Forecast: Share Price
Statistic Forecast values
Trials 50,000
Base Case 31.7
Mean 60.04
Median 59.33
Mode '---
Standard Deviation 29.51
Variance 870.82
Skewness 0.1578
Kurtosis 3.17
Coeff. of Variation 0.4915
Minimum -77.29
Maximum 208.99
Mean Std. Error 0.13