JetBlue IPO Report, Case 28
Content
JetBlue Airways IPO Valuation
An Analysis of Valuation Processes
FINE 7600 VALUATION AND FINANCIAL ENTERPRISES October 24, 2012 Authored by: Xian “Sophie” Li, Yu “Charlotte” Pei, Tiancheng “Toby” Sun, Adrian Townsend, and Yu “Yvonne” Wang
JETBLUE AIRWAYS IPO VALUATION
An Analysis of Valuation Processes Contents
JETBLUE TAKES OFF! ................................................................................................ 1 CALCULATING AN APPROPRIATE PRICING POLICY RANGE ..................................................... 1 CORRECT VALUATION LEAVES MONEY ON THE TABLE ......................................................... 2 IS THE I.P.O WORTH THE EXPENSE? .............................................................................. 2 COMPARABLE COMPANIES ANALYSIS .............................................................................. 2 P/E MULTIPLE .................................................................................................2 TOTAL CAPITAL MULTIPLE ................................................................................... 3 EBIT MULTIPLE ................................................................................................ 4 DISCOUNTED CASH FLOW ANALYSIS .............................................................................. 4 ASSUMPTIONS...................................................................................................4 WEIGHTED AVERAGE COST OF CAPITAL ...................................................................5 DISCOUNTED CASH FLOW SHARE PRICE VALUATION .................................................... 6 JETBLUE AIRWAYS IPO VALUATION ............................................................................... 6 WORKS CITED ........................................................................................................ 8
JetBlue Airways IPO Valuation | 10/24/2012
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JetBlue Airways IPO Valuation
An Analysis of Valuation Processes JetBlue Takes Off!
JetBlue is an aggressive start-up, which began service in February 2000, and has grown steadily since its inception. Duplicating Southwest’s simplicity, high aircraft utilization and low fares, JetBlue offers comfortable, affordable and convenient point-to-point air travel with some unique amenities (for example, leather seats and live-feed TV monitors). It has relied primarily on word of mouth advertising to execute its strategy. In contrast with most upstart discount carriers, JetBlue operates a fleet of 31 brand new, highly fuel-efficient Airbus A320 aircraft and employs a non-unionized FAA certified workforce (pilots, technicians, dispatchers) The management team has an extensive leadership track record with successful carriers, such as Southwest Airlines. This report examines the April 2002, decision of JetBlue management to price the initial public offering of JetBlue, just months after the terrorist attacks of 2001. Although the timing “The market is never dead for a good company seemed risky, John Owen, with real revenues and real earnings” Executive vice president and chief financial officer of JetBlue Airways stated “the market is never dead for a good company with real revenues and real earnings”. JetBlue had managed to remain profitable and grow aggressively despite the challenges facing the airline industry.
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Over the last 50 years, I.P.O.’s in the United States have been underpriced by 16.8 percent on average. This translates to more than $125 billion that companies have left on the table in the last 20 years. I.P.O. underpricing is also a worldwide phenomenon. In China, the underpricing has been severe, averaging 137.4 percent from 1990 to 2010. This compares with 16.3 percent in Britain from 1959 to 2009. In most other countries, I.P.O. underpricing averages above 20 percent.” (Davidoff, 2011)
Calculating an Appropriate Pricing Policy Range
The lead underwriter for the JetBlue I.P.O. Morgan Stanley had initially calculated a price per share of $22 to $24. However, with sizeable excess demand for the 5.5 million shares being offered; they had adjusted the range upwards ($25 to $26). This report utilized four different share valuation methods: 1) Price/earnings multiple (comparison pricing); 2) Total capital multiple (comparison pricing); 3) EBIT multiple (comparison pricing); and 4) Discounted free cash flows (fundamentals pricing). We conclude that the JetBlue offering price should be $27 to $29.
We conclude that the JetBlue offering price should be $27 to $29
1
Correct Valuation Leaves Money on the Table
According to economist Kevin Rock (Rock, 1986), because informed investors do not exist in sufficient number, underwriters re-price I.P.O offerings to bring in uninformed investors and ensure that they maximize total bidding. This theory has empirical support in papers that have found that when investment banks can allocate shares in greater measure to informed investors, the underpricing is reduced since the compensation needed to draw uninformed investors is lower. (Davidoff, 2011). Underpricing has also been found to be lower when information about the issuer is more freely Underpricing gives uninformed available so that uninformed investors are at less of a disadvantage. investors normal return. Underpricing gives uninformed investors normal return. In countries where share allocation is transparent (Singapore and Finland), investors receive more shares of overpriced offerings making average profits zero. (Keloharju, 1993). JetBlue is only offering approximately ten percent of the firm’s outstanding shares; a successful I.P.O. will help to not only raise short-term capital, but also provide access to future capital. Increasing the share price aggressively will dampen demand and reduce the publicity buzz surrounding the event and the company. In line with the benefits of underpricing we agree with a more conservative pricing range as suggested by the Morgan Stanley underwriters.
Is the I.P.O Worth the Expense?
A good valuation of the I.P.O. share offering will leave money on the table. In addition to that loss, JetBlue will have to pay legal, accounting, and underwriting fees associated with public offerings. Is it worth it? From an operation perspective, the I.P.O. supplies capital to JetBlue which the firm can use to increase competitiveness and support aggressive growth. From a financing perspective, JetBlue investors will gain access to a more liquid equity market which will reduce JetBlue’s cost of capital from the much higher cost of private equity. Additionally, the new equity will lower the debt to equity ratio. With a lower debt to equity ratio, JetBlue will then have increased access to the debt market with more favorable terms. The ability to access more debt can then be used to again decrease the cost of capital by altering the capital structure of JetBlue to take advantage of the tax advantages provided by debt financing. The tax shield of the debt financing will increase the enterprise value of the company.
Comparable Companies Analysis
P/E Multiple Using the leading P/E multiple method of valuation is standard practice in the airline industry (Yale School of Management, 2002). However, in our analysis (figure 1) the comparison sample size had to be reduced to include only low-cost airlines with positive earnings which limited the scope of the relative values. Due to the small sample size, the average P/E ratio was skewed high towards Frontier’s outlying performance. Therefore we determined that the median P/E ratio of comparable companies provided a more accurate figure. With predicted earnings per share in 2002 of $1.20, JetBlue’s price per share would be $34.12.
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However, using trailing indicators we calculated the current share price to be substantially lower at $28.84. The wide variance is due to: 1) Increased price earnings ratios in 2002 for low-cost carriers; and 2) Increased earnings per share for JetBlue. The range is made wider when using the average P/E multiple from the sample group: $28.46 to $37.28.
Price / Earnings Multiple
Trailing Price/ Share $6.60 $17.00 $32.05 $18.48 $15.85 Earnings/ Share 0.26 2.03 0.73 0.67 0.81 0.90 0.73 1.14 PE Multiple 25.29 8.37 44.02 27.59 19.57 24.97 25.29 $25.30 (mult. med.) 1.20 $28.43 (mult. med.) Leading Earnings/ Share 0.33 0.37 0.94 0.65 0.59 0.58 0.59 PE Multiple 20.00 45.95 34.10 28.43 26.86 31.07 28.43
Airlines positive earnings AirTran Frontier Ryanair Southwest WestJet Average Median JetBlue
Tr ailing
$28.84 $34.12
JetBlue Leading
(Trailing EPS supplied Exhibit 3; Leading EPS adjusted for increased earnings and newly issued shares)
F IGURE 1
Total Capital Multiple The total capital multiple company comparison (figure 2) utilized published figures from all low-cost carrier airlines; the sample size for this comparison was the largest of the comparable companies’ analysis methods. While the total capital multiple uses trailing indicators, the multiple is the least subject to accounting practice variances; debt and equity accounting have fewer GAAP methods of calculation.
Total Capital Multiple Trailing
Price/ Share AirTran Alaska Air America West ATA Frontier Ryanair Southwest WestJet Average Median JetBlue Tr ailing $6.60 $29.10 $3.50 $14.95 $17.00 $32.05 $18.48 $15.85 Book Equity/ Share 0.49 32.12 12.47 10.79 5.36 5.54 5.26 2.82 Book Debt/ Share 3.96 33.80 10.20 32.90 0.01 3.33 1.79 0.97 Total Capital Multiple 2.37 0.95 0.60 1.10 3.17 3.99 2.88 4.44 2.44 2.62 $2.62 (mult. med.)
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$27.50
5.16
8.59
F IGURE 2
Again, the median figure was most representative of the sample (as it disregarded unusual outlying high and low performers), and provided a valuation of $27.50 for JetBlue. This valuation is slightly below the range of the leading and trailing values generated by the P/E multiple ($28 to $34). The valuation estimate drops to $24.93 per share when using the average total capital multiple from the sample group. However, the
3
median figure is still conservative as it is below the 2.88 multiple of Southwest. Southwest provides the closest proxy to JetBlue, because JetBlue duplicated Southwest’s operational practices in the unclaimed New York hub market. EBIT Multiple The EBIT multiples (figure 3) provide a useful comparison with low-cost airline carriers with different capital structures. However, the EBIT multiple had the widest range between trailing and leading estimates; and the widest range between the EBIT multiple average and median. For these calculations, the average of the sample represented JetBlue most closely.
EBIT Multiple
Trailing Airlines positive earnings AirTran Frontier Ryanair Southwest WestJet Average Median JetBlue Tr ailing JetBlue Leading Price/ Share $6.60 $17.00 $32.05 $18.48 $15.85 Book Debt/ Share 3.96 0.01 3.33 1.79 0.97 EBIT/ Share 0.81 2.99 0.92 1.09 1.32 1.43 1.09 1.42 EBIT multiple 13.04 5.69 38.45 18.60 12.74 17.70 13.04 $17.70 (mult. ave.) 1.97
$19.12 (mult. ave.)
Leading EBIT/ Share 0.76 0.64 1.17 1.42 1.59 1.12 1.17 EBIT multiple 13.89 26.58 30.26 14.27 10.58 19.12 14.27
$16.48 $29.08
8.59
(Trailing EBIT 18% greater than net income, Exhibit 3; Leading EBIT $80M / 40.6M shares, Exhibit 13)
F IGURE 3
Similar to the P/E multiple, the large gap between the trailing and leading estimate is mainly due to JetBlue’s large jump in EBIT for 2002 (over 100 percent). JetBlue’s increase in EBIT is magnified by the sample’s increase in the EBIT multiple. The trailing multiple valuation provides a conservative $16.48 per share ($9.87 per share when using sample median multiple). However, the leading valuation is in line with the other multiples at $29.08 per share ($19.54 per share when using the median multiple).
Discounted Cash Flow Analysis
Assumptions We have used the following assumptions supplied by the JetBlue management forecast and the case-writer analysis provided in Exhibit 13 (Bruner, Eades, & Schill, 2010): 1. The Revenue per aircraft will commence at $17 million per aircraft and increase by 4 percent per year (inflation) going forward from 2003-2009 since the airline is at the height of the industry in terms of load factors. This estimate will drive the revenue growth rates in the DCF model. 2. Operating expenses are projected as a percentage of revenues. 3. Capital expenditures estimates are based on information presented in JetBlue’s I.P.O. prospectus and adjusted upwards for inflation of 5 percent per year. 4. The debt-to-equity ratio is estimated using the Total Capital Multiple estimate (figure 2).
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5. The risk-free rate and market premium are as of April 2002 6. Corporate income tax rate remains flat at the 2002 level of 34 percent. 7. A terminal growth rate of 4.5 percent, which is a reasonable estimate of GDP growth, based on official estimates. (Bureau of Labor Statistics projection for GDP by 2005 plus inflation) 8. The levered beta for the Airline Industry is 1.08 (Yale School of Management, 2002); however we chose the higher levered beta of Southwest (1.10) as the best representation of low-cost carriers’ levered beta (figure 4).
Southwest Capital Structure
Market Value Equity Market Value Debt Enterprise Value Southwest D/E Ratio SW Levered Beta SW Unlevered Beta Southwest Tax Rate JetBlue Tax Rate Jet Blue D/E Ratio JetBlue Levered Beta 16,071,992 (776.8M shares * $20.69, ex hibit 5) 1,842,000 (Exhibit 5) 17,913,992 0.11
JetBlue Beta
1.10 (Ex hibit 5) 1.02 31% (Ex hibit 5) 34% (Ex hibit 13) 0.31 Estimate using median total capital multiple (ex hibit 7) 1.23
F IGURE 4
Weighted Average Cost of Capital Using the market value capital structure estimate from the total capital multiple (figure 2), we calculated the weighted average cost of capital for JetBlue to be 9.22 percent (figure 5).
JetBlue - Cost of Capital
K d =Yield to maturity of Southwest Airlines 5 y r debenture
Pretax cost of debt Tax rate After-tax cost of debt Dividends of Preferred Stock Convertible Preferred Stock Cost of preferred stock Equity beta Rf RM-Rf Cost of common stock Debt-to-Cap Preferred-to-Cap Common-to-Cap WACC
7.91% (Ex hibit 6) + 0.5% premium for new company w/ 10y r debt 34% 5.22% K d (1-t) 16,970 ( Ex hibit 3) 210,441 ( Ex hibit 2) 8.06% K p = Dp / P p 1.23 5.00% April 2002 long-term U.S. Treasuries 5.00% Market risk premium giv en at 5% 11.15% K e = Rf + b*(Rm-Rf) 23.80% Estimate using median total capital multiple (ex hibit 7) 16.62% Estimate using median total capital multiple (ex hibit 7) 59.58% Estimate using median total capital multiple (ex hibit 7) 9.22% WACC = K d (1-t) * Wd + K p *Wp + K e * We
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F IGURE 5
5
Discounted Cash Flow Share Price Valuation The resulting share price from the discounted cash flow analysis (figures 6 and 7) is $29.89. This figure is within the P/E multiple valuation range (the industry’s standard practice for valuation) of $28 to $34. The discounted cash flow analysis price per share is slightly higher than the total capital and EBIT multiples. We subjected the DCF price per share to a sensitivity analysis (figure 8) to calculate the effect of a change in growth and a change in the weighted average cost of capital. An adjustment of 0.5 percent to either the WACC or the terminal growth rate resulted in changes to the share price estimate of 20 to 30 percent. The effect of the WACC rate on JetBlue’s share price highlights the value of the I.P.O. to JetBlue. The I.P.O. will reduce the cost of equity (by introducing liquidity to private equity holders); additionally the improved debt-to-equity ratio will provide JetBlue with increased access to the debt markets. With a carefully calculated capital adjustment, JetBlue can further decrease its weighted cost of capital by using the tax shield benefits of capital debt and the lower cost of debt.
Year NOPAT Growth (NOPAT) Depreciation Capital expenditure Net working capital ∆ Net working capital Free Cash Flows Discounted FCF
F IGURE 6
2002E
52.64 196% 17.71 290.37 63.47 29.56 (249.58) (228.51)
2003E
88.67 68% 26.25 328.34 93.54 30.08 (243.50) (204.11)
2004E
119.57 35% 35.60 344.76 126.14 32.60 (222.19) (170.52)
2005E
148.99 25% 44.62 310.29 157.18 31.04 (147.71) (103.79)
2006E
180.77 21% 54.45 325.80 190.71 33.53 (124.10) (79.84)
2007E
215.06 19% 65.15 342.09 226.88 36.17 (98.05) (57.75)
2008E
247.44 15% 75.38 299.33 261.03 34.15 (10.66) (5.75)
2009E
270.28 9% 82.82 157.15 285.13 24.10 171.85 84.84
2010E
292.16 8% 90.04 132.00 308.22 23.08 227.11 102.66
Terminal
5024.17 2270.95
Share Price
F IGURE 8
$
Terminal Growth Rate 4.0% 4.5% 5.0% 31.88 39.06 48.17 24.29 29.89 36.81 18.13 22.58 27.98 F IGURE 7
JetBlue Airways IPO Valuation
From the analysis of the company comparison multiples and the discounted cash flows, we conclude that the JetBlue Airways I.P.O. should have a share price within the range of $27 to $29. This range is below the price per share of all leading multiples estimates and is below the DCF estimate. The range captures the more conservative trailing estimate of the Total Capital multiple estimate. To accommodate the benefits of
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WACC
Terminal Growth WACC NPV Less: Preferred Shares Less: Long Term Debt Add: Cash Equity Value $ Shares (millions)
4.50% 9.22% 1,608 (210) (301) Sensitivity Analysis 117 Price/Share 1,213 8.72% 40.60 9.22% 29.89 9.72%
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underpricing (access to future capital; generating goodwill and publicity; enticing uninformed investors), we therefore suggest the conservative range of $27 to $29. The current suggested price of $25 to $26 unnecessarily leaves too much money on the table.
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Works Cited
Bruner, R., Eades, K., & Schill, M. (2010). Case 28 JetBlue Airways IPO Valuation. In R. Bruner, K. Eades, & M. Schill, Case Studies in Finance (pp. 381-399). McGraw-Hill. Davidoff, S. M. (2011, May). Why I.P.O.'s Get Underpriced. Retrieved from New York Times: http://dealbook.nytimes.com/2011/05/27/why-i-p-o-s-get-underpriced/ Keloharju, M. (1993). THe Winner's Curse. Journal of Financial Economics, 254-277. Rock, K. F. (1986). Why New Issues are Underpriced. Journal of Financial Economics, 187-212. Yale School of Management. (2002, October 9). JetBlue. Retrieved from http://analystreports.som.yale.edu/reports/JetBlue.pdf
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An Analysis of Valuation Processes
FINE 7600 VALUATION AND FINANCIAL ENTERPRISES October 24, 2012 Authored by: Xian “Sophie” Li, Yu “Charlotte” Pei, Tiancheng “Toby” Sun, Adrian Townsend, and Yu “Yvonne” Wang
JETBLUE AIRWAYS IPO VALUATION
An Analysis of Valuation Processes Contents
JETBLUE TAKES OFF! ................................................................................................ 1 CALCULATING AN APPROPRIATE PRICING POLICY RANGE ..................................................... 1 CORRECT VALUATION LEAVES MONEY ON THE TABLE ......................................................... 2 IS THE I.P.O WORTH THE EXPENSE? .............................................................................. 2 COMPARABLE COMPANIES ANALYSIS .............................................................................. 2 P/E MULTIPLE .................................................................................................2 TOTAL CAPITAL MULTIPLE ................................................................................... 3 EBIT MULTIPLE ................................................................................................ 4 DISCOUNTED CASH FLOW ANALYSIS .............................................................................. 4 ASSUMPTIONS...................................................................................................4 WEIGHTED AVERAGE COST OF CAPITAL ...................................................................5 DISCOUNTED CASH FLOW SHARE PRICE VALUATION .................................................... 6 JETBLUE AIRWAYS IPO VALUATION ............................................................................... 6 WORKS CITED ........................................................................................................ 8
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JetBlue Airways IPO Valuation
An Analysis of Valuation Processes JetBlue Takes Off!
JetBlue is an aggressive start-up, which began service in February 2000, and has grown steadily since its inception. Duplicating Southwest’s simplicity, high aircraft utilization and low fares, JetBlue offers comfortable, affordable and convenient point-to-point air travel with some unique amenities (for example, leather seats and live-feed TV monitors). It has relied primarily on word of mouth advertising to execute its strategy. In contrast with most upstart discount carriers, JetBlue operates a fleet of 31 brand new, highly fuel-efficient Airbus A320 aircraft and employs a non-unionized FAA certified workforce (pilots, technicians, dispatchers) The management team has an extensive leadership track record with successful carriers, such as Southwest Airlines. This report examines the April 2002, decision of JetBlue management to price the initial public offering of JetBlue, just months after the terrorist attacks of 2001. Although the timing “The market is never dead for a good company seemed risky, John Owen, with real revenues and real earnings” Executive vice president and chief financial officer of JetBlue Airways stated “the market is never dead for a good company with real revenues and real earnings”. JetBlue had managed to remain profitable and grow aggressively despite the challenges facing the airline industry.
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Over the last 50 years, I.P.O.’s in the United States have been underpriced by 16.8 percent on average. This translates to more than $125 billion that companies have left on the table in the last 20 years. I.P.O. underpricing is also a worldwide phenomenon. In China, the underpricing has been severe, averaging 137.4 percent from 1990 to 2010. This compares with 16.3 percent in Britain from 1959 to 2009. In most other countries, I.P.O. underpricing averages above 20 percent.” (Davidoff, 2011)
Calculating an Appropriate Pricing Policy Range
The lead underwriter for the JetBlue I.P.O. Morgan Stanley had initially calculated a price per share of $22 to $24. However, with sizeable excess demand for the 5.5 million shares being offered; they had adjusted the range upwards ($25 to $26). This report utilized four different share valuation methods: 1) Price/earnings multiple (comparison pricing); 2) Total capital multiple (comparison pricing); 3) EBIT multiple (comparison pricing); and 4) Discounted free cash flows (fundamentals pricing). We conclude that the JetBlue offering price should be $27 to $29.
We conclude that the JetBlue offering price should be $27 to $29
1
Correct Valuation Leaves Money on the Table
According to economist Kevin Rock (Rock, 1986), because informed investors do not exist in sufficient number, underwriters re-price I.P.O offerings to bring in uninformed investors and ensure that they maximize total bidding. This theory has empirical support in papers that have found that when investment banks can allocate shares in greater measure to informed investors, the underpricing is reduced since the compensation needed to draw uninformed investors is lower. (Davidoff, 2011). Underpricing has also been found to be lower when information about the issuer is more freely Underpricing gives uninformed available so that uninformed investors are at less of a disadvantage. investors normal return. Underpricing gives uninformed investors normal return. In countries where share allocation is transparent (Singapore and Finland), investors receive more shares of overpriced offerings making average profits zero. (Keloharju, 1993). JetBlue is only offering approximately ten percent of the firm’s outstanding shares; a successful I.P.O. will help to not only raise short-term capital, but also provide access to future capital. Increasing the share price aggressively will dampen demand and reduce the publicity buzz surrounding the event and the company. In line with the benefits of underpricing we agree with a more conservative pricing range as suggested by the Morgan Stanley underwriters.
Is the I.P.O Worth the Expense?
A good valuation of the I.P.O. share offering will leave money on the table. In addition to that loss, JetBlue will have to pay legal, accounting, and underwriting fees associated with public offerings. Is it worth it? From an operation perspective, the I.P.O. supplies capital to JetBlue which the firm can use to increase competitiveness and support aggressive growth. From a financing perspective, JetBlue investors will gain access to a more liquid equity market which will reduce JetBlue’s cost of capital from the much higher cost of private equity. Additionally, the new equity will lower the debt to equity ratio. With a lower debt to equity ratio, JetBlue will then have increased access to the debt market with more favorable terms. The ability to access more debt can then be used to again decrease the cost of capital by altering the capital structure of JetBlue to take advantage of the tax advantages provided by debt financing. The tax shield of the debt financing will increase the enterprise value of the company.
Comparable Companies Analysis
P/E Multiple Using the leading P/E multiple method of valuation is standard practice in the airline industry (Yale School of Management, 2002). However, in our analysis (figure 1) the comparison sample size had to be reduced to include only low-cost airlines with positive earnings which limited the scope of the relative values. Due to the small sample size, the average P/E ratio was skewed high towards Frontier’s outlying performance. Therefore we determined that the median P/E ratio of comparable companies provided a more accurate figure. With predicted earnings per share in 2002 of $1.20, JetBlue’s price per share would be $34.12.
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However, using trailing indicators we calculated the current share price to be substantially lower at $28.84. The wide variance is due to: 1) Increased price earnings ratios in 2002 for low-cost carriers; and 2) Increased earnings per share for JetBlue. The range is made wider when using the average P/E multiple from the sample group: $28.46 to $37.28.
Price / Earnings Multiple
Trailing Price/ Share $6.60 $17.00 $32.05 $18.48 $15.85 Earnings/ Share 0.26 2.03 0.73 0.67 0.81 0.90 0.73 1.14 PE Multiple 25.29 8.37 44.02 27.59 19.57 24.97 25.29 $25.30 (mult. med.) 1.20 $28.43 (mult. med.) Leading Earnings/ Share 0.33 0.37 0.94 0.65 0.59 0.58 0.59 PE Multiple 20.00 45.95 34.10 28.43 26.86 31.07 28.43
Airlines positive earnings AirTran Frontier Ryanair Southwest WestJet Average Median JetBlue
Tr ailing
$28.84 $34.12
JetBlue Leading
(Trailing EPS supplied Exhibit 3; Leading EPS adjusted for increased earnings and newly issued shares)
F IGURE 1
Total Capital Multiple The total capital multiple company comparison (figure 2) utilized published figures from all low-cost carrier airlines; the sample size for this comparison was the largest of the comparable companies’ analysis methods. While the total capital multiple uses trailing indicators, the multiple is the least subject to accounting practice variances; debt and equity accounting have fewer GAAP methods of calculation.
Total Capital Multiple Trailing
Price/ Share AirTran Alaska Air America West ATA Frontier Ryanair Southwest WestJet Average Median JetBlue Tr ailing $6.60 $29.10 $3.50 $14.95 $17.00 $32.05 $18.48 $15.85 Book Equity/ Share 0.49 32.12 12.47 10.79 5.36 5.54 5.26 2.82 Book Debt/ Share 3.96 33.80 10.20 32.90 0.01 3.33 1.79 0.97 Total Capital Multiple 2.37 0.95 0.60 1.10 3.17 3.99 2.88 4.44 2.44 2.62 $2.62 (mult. med.)
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$27.50
5.16
8.59
F IGURE 2
Again, the median figure was most representative of the sample (as it disregarded unusual outlying high and low performers), and provided a valuation of $27.50 for JetBlue. This valuation is slightly below the range of the leading and trailing values generated by the P/E multiple ($28 to $34). The valuation estimate drops to $24.93 per share when using the average total capital multiple from the sample group. However, the
3
median figure is still conservative as it is below the 2.88 multiple of Southwest. Southwest provides the closest proxy to JetBlue, because JetBlue duplicated Southwest’s operational practices in the unclaimed New York hub market. EBIT Multiple The EBIT multiples (figure 3) provide a useful comparison with low-cost airline carriers with different capital structures. However, the EBIT multiple had the widest range between trailing and leading estimates; and the widest range between the EBIT multiple average and median. For these calculations, the average of the sample represented JetBlue most closely.
EBIT Multiple
Trailing Airlines positive earnings AirTran Frontier Ryanair Southwest WestJet Average Median JetBlue Tr ailing JetBlue Leading Price/ Share $6.60 $17.00 $32.05 $18.48 $15.85 Book Debt/ Share 3.96 0.01 3.33 1.79 0.97 EBIT/ Share 0.81 2.99 0.92 1.09 1.32 1.43 1.09 1.42 EBIT multiple 13.04 5.69 38.45 18.60 12.74 17.70 13.04 $17.70 (mult. ave.) 1.97
$19.12 (mult. ave.)
Leading EBIT/ Share 0.76 0.64 1.17 1.42 1.59 1.12 1.17 EBIT multiple 13.89 26.58 30.26 14.27 10.58 19.12 14.27
$16.48 $29.08
8.59
(Trailing EBIT 18% greater than net income, Exhibit 3; Leading EBIT $80M / 40.6M shares, Exhibit 13)
F IGURE 3
Similar to the P/E multiple, the large gap between the trailing and leading estimate is mainly due to JetBlue’s large jump in EBIT for 2002 (over 100 percent). JetBlue’s increase in EBIT is magnified by the sample’s increase in the EBIT multiple. The trailing multiple valuation provides a conservative $16.48 per share ($9.87 per share when using sample median multiple). However, the leading valuation is in line with the other multiples at $29.08 per share ($19.54 per share when using the median multiple).
Discounted Cash Flow Analysis
Assumptions We have used the following assumptions supplied by the JetBlue management forecast and the case-writer analysis provided in Exhibit 13 (Bruner, Eades, & Schill, 2010): 1. The Revenue per aircraft will commence at $17 million per aircraft and increase by 4 percent per year (inflation) going forward from 2003-2009 since the airline is at the height of the industry in terms of load factors. This estimate will drive the revenue growth rates in the DCF model. 2. Operating expenses are projected as a percentage of revenues. 3. Capital expenditures estimates are based on information presented in JetBlue’s I.P.O. prospectus and adjusted upwards for inflation of 5 percent per year. 4. The debt-to-equity ratio is estimated using the Total Capital Multiple estimate (figure 2).
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5. The risk-free rate and market premium are as of April 2002 6. Corporate income tax rate remains flat at the 2002 level of 34 percent. 7. A terminal growth rate of 4.5 percent, which is a reasonable estimate of GDP growth, based on official estimates. (Bureau of Labor Statistics projection for GDP by 2005 plus inflation) 8. The levered beta for the Airline Industry is 1.08 (Yale School of Management, 2002); however we chose the higher levered beta of Southwest (1.10) as the best representation of low-cost carriers’ levered beta (figure 4).
Southwest Capital Structure
Market Value Equity Market Value Debt Enterprise Value Southwest D/E Ratio SW Levered Beta SW Unlevered Beta Southwest Tax Rate JetBlue Tax Rate Jet Blue D/E Ratio JetBlue Levered Beta 16,071,992 (776.8M shares * $20.69, ex hibit 5) 1,842,000 (Exhibit 5) 17,913,992 0.11
JetBlue Beta
1.10 (Ex hibit 5) 1.02 31% (Ex hibit 5) 34% (Ex hibit 13) 0.31 Estimate using median total capital multiple (ex hibit 7) 1.23
F IGURE 4
Weighted Average Cost of Capital Using the market value capital structure estimate from the total capital multiple (figure 2), we calculated the weighted average cost of capital for JetBlue to be 9.22 percent (figure 5).
JetBlue - Cost of Capital
K d =Yield to maturity of Southwest Airlines 5 y r debenture
Pretax cost of debt Tax rate After-tax cost of debt Dividends of Preferred Stock Convertible Preferred Stock Cost of preferred stock Equity beta Rf RM-Rf Cost of common stock Debt-to-Cap Preferred-to-Cap Common-to-Cap WACC
7.91% (Ex hibit 6) + 0.5% premium for new company w/ 10y r debt 34% 5.22% K d (1-t) 16,970 ( Ex hibit 3) 210,441 ( Ex hibit 2) 8.06% K p = Dp / P p 1.23 5.00% April 2002 long-term U.S. Treasuries 5.00% Market risk premium giv en at 5% 11.15% K e = Rf + b*(Rm-Rf) 23.80% Estimate using median total capital multiple (ex hibit 7) 16.62% Estimate using median total capital multiple (ex hibit 7) 59.58% Estimate using median total capital multiple (ex hibit 7) 9.22% WACC = K d (1-t) * Wd + K p *Wp + K e * We
JetBlue Airways IPO Valuation | 10/24/2012
F IGURE 5
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Discounted Cash Flow Share Price Valuation The resulting share price from the discounted cash flow analysis (figures 6 and 7) is $29.89. This figure is within the P/E multiple valuation range (the industry’s standard practice for valuation) of $28 to $34. The discounted cash flow analysis price per share is slightly higher than the total capital and EBIT multiples. We subjected the DCF price per share to a sensitivity analysis (figure 8) to calculate the effect of a change in growth and a change in the weighted average cost of capital. An adjustment of 0.5 percent to either the WACC or the terminal growth rate resulted in changes to the share price estimate of 20 to 30 percent. The effect of the WACC rate on JetBlue’s share price highlights the value of the I.P.O. to JetBlue. The I.P.O. will reduce the cost of equity (by introducing liquidity to private equity holders); additionally the improved debt-to-equity ratio will provide JetBlue with increased access to the debt markets. With a carefully calculated capital adjustment, JetBlue can further decrease its weighted cost of capital by using the tax shield benefits of capital debt and the lower cost of debt.
Year NOPAT Growth (NOPAT) Depreciation Capital expenditure Net working capital ∆ Net working capital Free Cash Flows Discounted FCF
F IGURE 6
2002E
52.64 196% 17.71 290.37 63.47 29.56 (249.58) (228.51)
2003E
88.67 68% 26.25 328.34 93.54 30.08 (243.50) (204.11)
2004E
119.57 35% 35.60 344.76 126.14 32.60 (222.19) (170.52)
2005E
148.99 25% 44.62 310.29 157.18 31.04 (147.71) (103.79)
2006E
180.77 21% 54.45 325.80 190.71 33.53 (124.10) (79.84)
2007E
215.06 19% 65.15 342.09 226.88 36.17 (98.05) (57.75)
2008E
247.44 15% 75.38 299.33 261.03 34.15 (10.66) (5.75)
2009E
270.28 9% 82.82 157.15 285.13 24.10 171.85 84.84
2010E
292.16 8% 90.04 132.00 308.22 23.08 227.11 102.66
Terminal
5024.17 2270.95
Share Price
F IGURE 8
$
Terminal Growth Rate 4.0% 4.5% 5.0% 31.88 39.06 48.17 24.29 29.89 36.81 18.13 22.58 27.98 F IGURE 7
JetBlue Airways IPO Valuation
From the analysis of the company comparison multiples and the discounted cash flows, we conclude that the JetBlue Airways I.P.O. should have a share price within the range of $27 to $29. This range is below the price per share of all leading multiples estimates and is below the DCF estimate. The range captures the more conservative trailing estimate of the Total Capital multiple estimate. To accommodate the benefits of
JetBlue Airways IPO Valuation | 10/24/2012
WACC
Terminal Growth WACC NPV Less: Preferred Shares Less: Long Term Debt Add: Cash Equity Value $ Shares (millions)
4.50% 9.22% 1,608 (210) (301) Sensitivity Analysis 117 Price/Share 1,213 8.72% 40.60 9.22% 29.89 9.72%
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underpricing (access to future capital; generating goodwill and publicity; enticing uninformed investors), we therefore suggest the conservative range of $27 to $29. The current suggested price of $25 to $26 unnecessarily leaves too much money on the table.
JetBlue Airways IPO Valuation | 10/24/2012
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Works Cited
Bruner, R., Eades, K., & Schill, M. (2010). Case 28 JetBlue Airways IPO Valuation. In R. Bruner, K. Eades, & M. Schill, Case Studies in Finance (pp. 381-399). McGraw-Hill. Davidoff, S. M. (2011, May). Why I.P.O.'s Get Underpriced. Retrieved from New York Times: http://dealbook.nytimes.com/2011/05/27/why-i-p-o-s-get-underpriced/ Keloharju, M. (1993). THe Winner's Curse. Journal of Financial Economics, 254-277. Rock, K. F. (1986). Why New Issues are Underpriced. Journal of Financial Economics, 187-212. Yale School of Management. (2002, October 9). JetBlue. Retrieved from http://analystreports.som.yale.edu/reports/JetBlue.pdf
JetBlue Airways IPO Valuation | 10/24/2012
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