Learning objectives 1. institutional aspects of equity issuance transaction 2. costs and benefits associated with public share offerings 3. develop a deeper appreciation for challenges of valuing unseasoned firms and enhance corporate valuation skills KEY QUESTIONS FOR CONISDERATION 1)What are the advantages and disadvantages of going public? 2)What different approaches can be used to value JetBlue’s shares? 3)At what price would you recommend that JetBlue offer their shares? Potential Questions to be addressed in report submission * What is an Initial Public Offering and why is it such a big deal? Is going public, particularly at the time they did, a good idea for JetBlue? * What do you believe JetBlue stock is really worth? * Does the financial forecast in case Exhibit 13 seem reasonable? * What are the key assumptions in the IPO valuation? * Is the length of the forecast period within the IPO valuation (exhibit 13) reasonable? * What discount rate is appropriate for the cash flow forecast? * How would you suggest estimating the terminal value? What assumptions have you made? How have your assumptions affected the estimated value of JetBlue shares? Introduction
After the terrorist attacks on September 11, 2001, it was upset deeply because of the safety for the airline industry in the United States. The passenger demand suddenly reduced and many flights cancelled afterwards, which led a lot of American airlines declared bankruptcy afterwards, including US Airways and United Airlines. It was a challenging time for airline industry, however, David Neeleman, the CEO and Founder of JetBlue Airways, discovered an opportunity for the company. Barely two years after its foundation, the company decided to raise additional capital through initial public offering (IPO).
This report is aimed to apply financial theories and concepts into analyse the real case study of JetBlue Airline. Firstly, the background of JetBlue will be introduced briefly. Also, the advantages and disadvantages of going public for JetBlue will be discussed in the following pages. In addition, the share valuation of JetBlue IPO will be estimated based on several assumptions. Last but not least, the recommendation will be provided in the last past of this report. Background JetBlue was founded by David Neeleman in 1999, which looked to fulfil the purpose of “humanity back to air travel”.
By following the low-cost model of Southwest Airlines, JetBlue pursued to offer passengers an enjoyable flying experience by providing in-flight entertainment, comfortable room and high-quality customer service. In addition, in order to organise a strong and experienced working team, Neeleman employed several skilled senior managers, comprising of David Barger who was a former vice president of Continental Airlines to be president and COO and John Owen who was executive vice president and former treasurer of Southwest Airlines to be CFO in JetBlue.
Moreover, as the founder of JetBlue, Neeleman have own extensive experience with airline start-ups from managing low-fare flights during university period. Based on the explicit marketing strategy of JetBlue, barely less than one year, the company increased the routes to other cities in America and it continued to grow rapidly to 17 destinations in early 2002.
And not only that, JetBlue adopted the active measures to increase expenditures for security by setting up equip cockpits with bulletproof doors and security cameras, which enhanced the confidence of US residences to take flights under the circumstance of few people was afraid of flying after September 11 hijackings. Advantages and disadvantages of going public Refer to Bodie, Kane and Marcus (2011), initial public offerings are stocks issued by a formerly privately owned company that is going public, which means that selling stock to the public for the first time.
According to Rothberg, the following table are shown some advantages and disadvantages of going public. Pros| Cons| Potentially large bonuses for business owners| High explicit cost – roughly 7% of the funds raised| Ability to raise additional capital rapidly in the future| Pressure to meet investor expectations| Attraction and retention for the valuable talents| Less control on make business decisions – decisions should be based on the interest of shareholders and investors other than owners themselves| Easy to sell ownership shares when owners exit business or retire| Reporting disclosure on regular basis| Access to capital markets| |
In relation to this case, JetBlue aimed to raise additional capital through an IPO in order to support company’s growth and offset portfolio losses by investors. Moreover, according to John Owen, JetBlue had prepared the initial registration statement with security and exchange commission (SEC) for the IPO on September 11, 2001. However, based on the September 11 attacks, they delayed IPO before it came into force. In fact, not only the terrorist attacks on September 11, 2001, but several events happened negatively affected the global economy during the period of going public for JetBlue.
For example, the contagion of bird flu was quite severe during taking flights, which definitely influenced the demand of flights. The increasing oil price also raised the basic cost in any transportation industry. Another negative condition could be the economic downturn, including crash of the dot-com bubble and financial crisis in Asia. From this point of view, it seemed not to be an appropriate time to going public. However, faced with the weak financial markets, JetBlue measured the targeted strategies and made success in profitable operations.
And IPO market is never dead for good company with real revenues and real earnings just like JetBlue. It then turned out that it was a suitable time for JetBlue to IPO during the economic downturn though. JetBlue’s shares valuation There are various methods to value shares for a company, including free cash flow to equity (FCFE) method discounted by WACC, free cash flow to firm (FCFF) method discounted by cost of equity, dividend discount model and relative valuation techniques. Since JetBlue had not paid out any dividends on common stock, dividend discount model cannot be used to estimate company share value.
In addition, FCFF method do not consider the effect of interest payment, however, as mentioned in the case, the Federal Reserve had attempted to stimulate economic activity by reducing interest rates. Therefore, from my point of view, it was more appropriate to value JetBlue share by FCFE method to consider the consequences of interest rate. The assumptions are made for evaluate JetBlue share value as follows. The long-run growth rate was expected to be 7% annually. And the company would have survived and would be a typical firm with an estimated cost of equity of 15% in 2010.
Last but not least, the appropriate discount rate was assumed to be 30%. Additionally, there was a quite weird number disappeared in the Exhibit 13, which was the expected inflation rate was 4 times in 2002 than other years. After changing it back to the normal, the share value then could be calculated to be around $24. 60 per share. (Appendix 1) Recommendation Based on the assumptions, the calculated consequence is identical to the initial offering prices which ranged from initial price to implemented offering price ($24 to $25).
Faced with sizable excess demand to potential investors, JetBlue took the appropriate measure to increase share value in order to avoid “money leave on the table”. In the long run, I believe that JetBlue will still grow at a stable stage as the innovative spirit and seasonable measures to the different types of events. Therefore, JetBlue’s stock was worth for the potential and incoming investors. We prepared to retristrict initial registration with SEC for the IPO on September 11, 2001. Based on the event of that morning, we didnot .
We waited until stock market settled down. We returned the profitability in November and December. We started to issue IPO gain in Christmas time. Obviously, we modified the document a bit. High growth, low cost profitable airline has rebounded substantially in the market place. It was a very good stands to do the IPO for JetBlue. Even though it was 2002, the IPO market was pretty much dead, the IPO market is never dead for good company with real revenues and real earnings. So we were confident even a small amount of – John Owen registration statement with underwriters
FCFF we do not consider the effect of interest payment 1) In FCFF, we use EBIT (1-t) whereas in FCFE, we use Net Income; this is because while using EBIT (1-t) in FCFF we do not consider the effect of interest payment as mentioned above. 2) IN FCFE, we use Change in Non- Cash Working Capital*(1-D) – Capital expenditure*(1-D) whereas in FCFF we use Change in Non-Cash Working Capital – Capital Expenditure; this is because we just want to concentrate on cash flow due to equity only. Reference Bodie Z. , Kane, A. , & Marcus, A. J. (2011).
Investments (9th ed. ). New York: McGraw-Hill Rothberg F. The Pros and Cons of Going Public. Retrieved from http://www. cfoedge. com/resources/articles/cfo-edge-the-pros-and-cons-of-going-public. pdf Appendix (Appendix 1: Share valuation of JetBlue Airways) ——————————————– [ 1 ]. Bodie Z. , Kane, A. , & Marcus, A. J. (2011). Investments (9th ed. ). New York: McGraw-Hill [ 2 ]. Rothberg F. The Pros and Cons of Going Public. Retrieved from http://www. cfoedge. com/resources/articles/cfo-edge-the-pros-and-cons-of-going-public. pdf