JetBlue Case Study Analysis

JetBlue Airways Corporation Overview
JetBlue Airways Corporation is an American low-fare airline, which headquartered in the Long Island City near the New York City. Its main base is John F. Kennedy International Airport. Basically, the airline mainly serves destinations in the United States, as well as many Latin American countries. As of October 2013, JetBlue serves 84 destinations in multiple countries.
Low-fare airline is an airline that generally with a lower operating cost structure. In many people’s view, low-are airline also with has low ticket prices and limited services. However, JetBlue is a low-fare airline corporation with a goal of fixing everything that “sucked” about airline travel. Its passengers could get unique flying experience by providing new aircraft, simple and low fare, leather seats, free LiveTV at every seat, preassigned seating, reliable performance, and high-quality customer service.
JetBlue Airways Corporation
David Neeleman, the starter of JetBlue, had raised funds of $130 million for this brilliant company at the beginning. Even JetBlue has strong support from venture-capital community, it also had the intent to go public in April 2002. At that time, the whole industry was still in recession due to 9/11 attack.
A company sells stock shares to the general public for the first time via security exchange, it is Initial public offering (IPO). Before IPO, there is no general shareholders in the company. After IPO, the company goes to public with general shareholders and it is subject to regulations by the Securities and Exchange Commission.
Going public can bring some advantages to JetBlue. 1> Going public can generate capital for the JetBlue. Besides the support from venture-capital, stock could be another source of capital for JetBlue. This diversified the capital structure of the company. When debt-to-equity ratio optimized, the credit rank of the company will be improved. This will benefit the company for future lending from other lenders. 2> By doing IPO, JetBlue itself can get control to a certain extent. Venture capital company always requires decision-making power. But if going public, JetBlue may avoid from reporting their decision. 3> Increase public awareness of JetBlue. Generally, listed companies are well-known. This is a chance to promote itself. This chance could not only attract customers, but also attract better qualified person to contribute to the company.
Anyway, going public also can lead some disadvantages. 1> It could be costly and time consuming. JetBlue uses more than three months to go public. The process of IPO is an expensive sunk cost, if the offering does not pass, company will loss the money. What’s more, there will be some fees relate to public company regulations. 2> Heavily regulation may impact on its operation. Being a listed company required to report itself in transparency. Prospectus may disclose some information that the company would not reveal; decision-making process may not be flexible as before. 3> Decision-making focus on short-term and becoming short-sighted. Shareholders interested in company’s current earning and invest in short-term, favorable current earning can get more invest. In order to appeal to such investment, listed company needs to make some decision to benefit short-term performance.
JetBlue Airways Corporation IPO Valuation
The biggest issue which impact on JetBlue’ IPO in April 2002 is 9/11 attack. At this time, airline industry was during the worst periods. Mainly based on John F. Kennedy International Airport, which near the attacked place New York City, makes investors anxious about this investment. Nevertheless, there are some facts that encourages JetBlue going public. Recently, there is no US low-fare carriers doing IPO. If JetBlue go public now, it can get more attention. Morgan Stanley found the demand of JetBlue stock exceeded supply. Analysts and reporters have positive view of this IPO, they believe it is possible to raise the price due to this strong demand.
For deciding whether JetBlue should IPO or not, we should value the company in 2002. To do IPO valuation, there are some different approaches, like discounted cash flow and relative valuation techniques. ❖ Discounted Cash Flow
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The weight of debt and equity come from Table 1 in appendix. Convertible redeemable preferred stock was included in liability, but it will become to equity later. That’s why it included in total equity.
WACC is for forecasting. So tax rate should be 34%, because it was used in JetBlue Financial Forecast (Exhibit 13).
The return of debt is 8%. It is an average debt of Southwest, JetBlue’s leading competitor. Refer to the cost of debt in Table 2.
Cost of equity is 10.5%. This is calculated from capital asset pricing model (Re=rf+β*MRP). Beta is 1.1, which is the beta of Southwest airline (Exhibit 5) . Risk free rate (5%) and market risk premium (5%) are given in the case. Calculation refers to Table 3.
Assume a constant growth, thel growth rate is 4%, so the NPV of the DCF is $1232 million. Calculation process refers to Table 4.
According to NPV of DCF is $1232, the price per share should be $24.64. ❖ Relative Valuation Techniques ➢ Price Earnings Ratio
P/E ratio measures how much investors willing to pay for $1 of current earnings. Earning power is a vital driver of investment value.The price-to-earnings (P/E) ratio could be used to evaluate the price of the common stock, and estimate the earnings of the firms.
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JetBlue’s P/E ratio is between 19 to 23 based on the stock price range from $22 to $26. As assumed before, the convertible redeemable preferred stock will transfer to equity, hence, the denominator is the diluted EPS of $1.14.
Compare to the airline industry (Exhibit 7), it is in the range. The leading competitor, Southwest, which has a P/E ratio of 18.5. JetBlue is very similar to it. ➢ EBIT Per Share
Common stock offered of JetBlue is $5.5 million shares, and the number of pre-money shares outstanding is $35.1 million. Hence, the total number of common stock outstanding shares is $40.6 million.
EBIT of 2002 is $80 million, so the EBIT per share should be $80/$40.6=$1.97. Compare EBIT per share of JetBlue with industry, it is outstanding. Southwest has $0.7/share, Ryanair has $0.9/share and WestJet has $0.6/share. ➢ Price to Sale Ratio
Price-to-sales ratio compares a company’s stock price to its sales (revenues). The ratio indicate the value placed on each dollar of a company’s sales or revenues. A low ratio may indicate price is undervalued, while a above average ratio suggest price is overvalued.
The price of JetBlue is ranged from $22 to $26. So the price to sale ratio is from $2.79 to $3.3. Calculation process refers to Table 5.
Conclusion
On valuation basis, JetBlue should price its share at $25. DCF valuation priced JetBlue at $24.64, approximation to $25.
JetBlue cares about that if the share is overpriced. If it is overpriced, the secondary offering would be ruined and investors get burned. However, the DCF shows the stock is worth in this price. What’s more, relative valuation techniques proved that JetBlue is ranked in its industry. Low-fare airline is in highly demand in market, so priced to $25 is appropriate.

Appendix

Table 1 The Weight of Debt and Equity
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Table 2 Cost of Debt
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Table 3 Cost of Equity
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Table 4 Cash flow and NPV
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Take the data from 2010 for example:
Change in NWC=NWCt-NWCt-1
23=308-285
Free Cash Flow= EBIT*(1-t)+Depreciation-Capital Expenditure-Change in NWC
Free Cash Flow2010= 443*(1-34%)+90-132-23
Value of Cashflow=Free Cash Flow/(1+discounted rate)t
120=227/(1+7.3%)9
NPV of FCF= [pic]value of cashflow from t=1 to t=9
-674=-231-213-180-111-88-64-6+98+120
Perpetual Growth Rate=4%
Terminal Value= Value of Cashflow in t=9/(Discounted Rate-Growth Rate)
3603=120/(7.3%-4%)
Present Value of Termianl Value=Terminal Value/(1+Discounted Rate)t
1906=3603/(1+7.3%)9
NPV=NPV of FCF+Present Value of Termianl Value
1232=-674+1906

Table 5 Price to Sale Ratio
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Market Value=Share Price*Number of Common Stock Outstanding
When price=$22
Market Value=$22*40,600,000=$893,200,000
Price to sale ratio=$893,200,000/320,000,000=2.79
When price=$26
Market Value=$26*40,600,000=$1,055,600,000
Price to sale ratio=$1,055,600,000/320,000,000=3.30

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