Introduction
JetBlue is a low-cost domestic airline launched in 1999 in the United States which follows a rather interesting combination of ‘low-cost and differentiation’ as its strategy. The core of JetBlue’s strategy was low-cost achieved through a smaller and more productive workforce; automated processes; better use of technology; use of brand new single model planes that reduced maintenance costs and training costs at the same time. It had been the only other airline apart from Southwest airlines, to have been profitable during the aftermath of the September 11, 2001 attacks on World Trade Centre, and at a time when the entire airline industry was experiencing losses. After a few years of strong growth and continuous success since its origination, JetBlue transformed its ownership to become a public listed company in 2002. The process of this transformation is a complex and expensive business however, one can expect high returns and rapid growth that follows.
This report describes the process of going public by first explaining the importance and application of firm valuation. The second part of the report introduces the advantages and disadvantages of the transformation. The third part of this report summarises main methods of firm valuation which follows by the illustration of a valuation for JetBlue. In addition, to the process of going public and firm valuation, SWOT Analysis as well as Porters Analysis for JetBlue is also considered as these are necessary in determining current position and future direction of the firm.
One of the most vital determinations that every private and public firm must consider is its value. The principle behind firm valuation is to express its price in monetary terms taken into account the firm’s assets, debt and equity. The value of the firm is not found in the financial statements because the value arises from expectations. These expectations lay in the future cash flows. Valuation of a firm is used for many applications. These are listed below:1.In company buying and selling operationsa.For the buyer, the valuation will tell him the highest price he should pay1.
b.For the seller, the valuation will tell him the lowest price at which he should be prepared to sell1.
2.Valuations of listed companiesa.The valuation is used to compare the value obtained with the share’s price on the stock market and to decide whether to sell, buy or hold the shares1.
b.The valuation of several companies is used to decide the securities that the portfolio should concentrate on: those that seem to it to be undervalued by the market.
3.Public offeringsa.The valuation is sued to justify the price at which the shares are offered to the public1.
4.Inheritances and willsa.The valuation is used to compare the shares’ value with that of the other assets.
5.Compensation schemes based on value creationa.The valuation of a company or business unit is fundamental for quantifying the value creation attributable to the executives being assessed1.
6.Identification of value driversa.The value of a company or business unit is fundamental for identifying and stratifying the main value drivers1.
7.Strategic decisionsa.The value of a company or business unit is a prior step in the decision to continue in the business, sell, merge, grow or buy other companies1.
8.Strategic Planninga.The valuation of a company or business unit is fundamental for deciding what products/business lines/countries/customers etc. To maintain grow or abandon1.
b.The valuation provides a means for measuring the impact of the company’s possible policies and strategies on value creation and destruction1.
Firm valuation is the most important process for any ownership transformation. After the value of the company is certain, JetBlue has to go through the Going Public process in order to become a public listed company. This is explained below.
The Going Public processThe going public or the Initial Public Offering (IPO) process is a stage when a company sells publicly traded equity for the first time. For a private firm to enter the IPO, it needs an established business plan to indicate to stakeholders of the goals in which the firm will be working towards. The company must consist of qualified management team and independent board of directors to ensure that the operations and shareholders’ funds are properly administered. In addition, audited financial statements with performance measures and projections are to be prepared prior to the process.
After satisfying the requirements, the process of going public follows through stages as follows:a)The “all hands” meeting is organised by key stakeholders which includes management, underwriters, accountants and legal members representing underwriters and the firm itself. The purpose of the meeting is to plan the IPO process and to agree on relevant terms.
b)After the all hands meeting, the company enters the “quiet period”. This is the time during which the Securities and Exchange Commission (SEC) restricts the company to increase any form of publicity to raise attention and awareness from the public in regards to the going public process of the firm. This includes the prohibition of advertising in business journals or newspapers, etc.
c)Interviews are carried out by the underwriters on the firm’s management, suppliers as well as customers. There is also a review of the firm’s financial statements. This is known as the “Due Diligence” procedure and is done in order to ensure that there is no possibility for misleading information. After this time if the underwriters agree to work with the firm, a company should receive “letter of intent” prepared by legal representative of the underwriters. The letter explains the rights and obligations of each party, security to be sold as well as informs the firm of the underwriters’ compensation. The letter is not legally binding until it is signed on the day the offering price is determined. Thus, any party is able to withdraw themselves during the time however, the firm should be aware that withdrawing may incur reimbursement fees payable to the underwriters to cover the expenses that occurred during document preparation process. This process should take approximately 15 to 44 days.
d)The next step is the filing or registration process which involves the preparation of the prospectus which constitutes part one of the registration statement. By completion of the process, the firm should be able to provide copies of the underwriting contract, company charter, by-laws as well as the sampling of the security. All of these represent part two of the registration statement.
e)The registration statement is filed with SEC for a review process as required per the Securities Act of 1933. Under the Act, the characteristic of the traded securities need full and fair disclosure. Once filed with SEC, the statement requires 20 days after the filing date to become effective. Any misleading information uncovered in the statement during this time, a “letter of comment” will be issued. The firm then amend the statement as per required and once this is returned to SEC, the 20 day waiting period begins again. The filing with SEC usually occurs after 45 days of the IPO process.
f)During firm’s registration process, the underwriter is also preparing “syndicates” which lists various investment banks who are willing to buy some of the offerings at certain price. Usually this price is the offer price less any underwriting discount. However, once again this is not legally binding until the offering which is approximately 48 hours before the trading begins. Members of the syndicates are also required to pay compensation to the underwriters as per agreed in the contract.
g)The underwriters usually engage in “book-building activities” during the review process of the registration statement. The activities involve a survey of potential investors in order to estimate demand and offer the new issues. It is during this period when the company is able to advertise its offerings and answer any questions from potential stakeholders. This is the period when a “road show” is organised by the underwriters to promote to potential investors of the offer. “A Preliminary Prospectus” also known as “red herring” is given to potential investors, discussing investment plans and providing information on management procedures and financial analysis of the firm. This whole period takes 45 to 75 days after filing of registration statement with SEC.
h)The last stage of the IPO process occurs once the registration statement becomes effective when the firm receives “letters of comment” from SEC. The company and the underwriters agree on the final offering price and underwriters’ discount. Both parties then sign the underwriting agreement which is to be filed with the SEC with the amendment to the registration if that is required. Once filed, it usually takes a few hours for the sale to be ready to the public. This stage occurs on the 75th day of the IPO process and takes up to the 99th day for SEC to give final approval of registration statement. It is after this day when stocks are issued and the trading begins.
i)Once the trading begins, it usually takes approximately 8 days until a settlement date when the underwriters allocate proceeds to the firm.
It is obvious that the going public process requires time and money however, considering long term benefits from being a public company, the process is worth engaging in.
Question 2As JetBlue wants to maintain its profitability and its aggressive growth in market share, its management decided to issue shares to raise additional capital. Listed below are advantages and disadvantages of a company going publicAdvantagesNew Financing for the Company: The most significant advantage of an IPO is it gives JetBlue a large financial infusion in the form of cash3. Going public also creates a type of currency in the form of its stock that the business can use to make acquisitions.
Ratio improvement: Going public increase the equity asset weight in JetBlue’s capital structure. It improves JetBlue’s debt-to-equity ratio. This would potentially increase JetBlue’s ability to obtain a more favourable loan terms from lenders4.
Liquidity for Investors: Once JetBlue goes public, its stock can be easily bought and sold on the public market. The liquidity of the stock makes it attractive to investors. With more confidence in investing in JetBlue, they are willing to pay a premium for this liquidity. For the company, stock liquidity means that stock can be used to compensate employees4, attract new partners.
Exit for investors and employees’: An IPO provides an “exit” for existing investors6. An IPO creates a public market for company stock which, after a waiting period, allows venture capital investors the opportunity to sell their shares and cash out their investment. Likewise, for the company’s founders and employees of the company who received stock options, an IPO presents the opportunity to some or all of the shares and make a profit on their years of hard work for the company.
Flexible compensation package for employees: After IPO, JetBlue would be able to include stock options in its compensation package for its key personnel and other staff. This helps to retain JetBlue’s management e.g. David Barger (COO) and John Owen (CFO) and other employees.
Market Recognition: The IPO provides high profile market visibility. The company can gain publicity and an image of stability by trading publicly3.
Future Capital raising ability: Being a public listed company would enable JetBlue to raise money for growth plan in the future and at better rates than private companies of similar sizee4.
Better situated for making acquisitions: An IPO provides a public valuation of a business. This means that it will be easier for the company to enter into mergers and acquisitions6, because it can offer stock rather than cash.
However, there are also some disadvantages on the process of being a public company.
•Costs and Complexity: Going public is expensive and payable regardless of the outcome of the process. The typical expenses include legal and accounting fees, commissions for investment bankers, filing and registration with Division of Corporate Finance, printing costs for the “Preliminary Prospectus” and underwriter’s expense allowance for the “road show”. During the process, JetBlue’s day-to-day business operations will likely be disrupted.
•Increased disclosure: JetBlue will be required by stock exchanges, securities commissions and regulators to disclose information on a regular basis so that investors and potential investors can buy sell or hold decisions6. This has the potential of leaking out JetBlue’s core competence to JetBlue’s competitors.
•Restrictions and requirements: Public companies must comply with reporting requirements as soon as the registration statement becomes effective3. This is expensive and will result in an increased risk of exposure to civil liability for JetBlue, its executives and directors for false conducts or misleading statements.
•Short-Term Focus: There is pressure to increase earnings after going public. JetBlue’s managers might feel compelled to increase current earnings and follow strategies that support the share price in the short term, rather than over a long time horizon to meet shareholders’ expectation.
•Cash Overload: The increasing share price may compromise the success of the IPO. If the IPO is successful, there will be a large cash amount in the short-run for JetBlue. From management’s view, a successful offering entails not only raising the short-term capital requirements, but also maintaining access to future capital raisings.
•Fear of Takeover: By diluting the holdings of the company’s original owners, going public also gives management less control and flexibility over day-to-day operations. In addition, SEC regulations restrict the ability of a public company’s management to trade their stock and to discuss company business with outsiders.
Question 3There are many methods that can be used to evaluate the value of the Jet Blue Shares:Difference in Valuation Methods (Refer to appendix 1.3 for details)As a theoretical matter, value should be independent of the valuation model used. This is generally not the case. The reason is that the inputs that each method requires may not be consistent across valuation approaches, and hence a different answer emerges depending on which method is being used7.
Alternatively, it is also recognized that multiple valuations arising out of using different valuation approaches contain relevant and important information related to the underlying value of the firm7.
Research indicates that there are two most commonly used valuation approaches—discounted free cash flow and the method of multiples.
Method of Discounted Cash FlowThe goal of the method is to estimate cash flows, not profits. Capital cash flow, measures value of whole firm – free cash flows do not include tax benefits of debt since that is in discount rate8. In discounted cash flow valuation, the value of an asset is the present value of the expected cash flows on the asset. This is based on the premise that every asset has an intrinsic value that can be estimated, based upon its characteristics in terms of cash flows, growth and risk8.
The key assumptions are:1.Growth in earnings should translate into growth in cash flow2.All cash flow will eventually be given back to shareholdersThe starting data required for this technique is:1.Free Cash Flow (FCF) of the firm2.Cost of debt of firm3.Cost of equity of firm4.Tax Slab structure5.Total Debt and Total equityCalculating Free Cash Flows: The beginning point for calculating free cash flows is EBIT (Earnings before interest and taxes).
The purpose of measures to adjust the accounting figures is to transform accounting recognition of receipts and expenses into cash flow definitions.
Adjustments include:1.Subtracting capital expenditure2.Adding depreciation3.Subtracting change in net working capital4.Subtracting change in net assetsCalculate the terminal or the horizon value. Since a company is assumed to have infinite life: Estimate FCF on a yearly basis for about 5 -10 years.
After that, calculate a “Terminal Value”, which is the ongoing value of the firm.
Estimate a long-term growth and use the constant growth perpetuity model.
i.e. FCFF/(WACC-growth rate)Cost of debt can be approximated by the yield to maturity of the debt. If it is not directly available, check the bond rating of the company and find the YTM of similar rated bonds.
Cost of equity: Two methods can be used for calculating the cost of equity.
1.CAPM: Find be and calculate required re.
Expected Return = Risk free Rate + [ (Equity Beta) * (Risk Premium) ]2.Gordon-growth model and find expected re. Under the assumption that market is efficient, this is the required re.
Return on equity=Dividend/Share PriceWeighted Average Cost of Capital (WACC) is the appropriate discount rate. The formula for WACC isThe total value of a firm, VF, equals the present value of the free cash flow that the firm is expected to provide investors, FCFF, discounted by the firm’s weighted average cost of capital, WACC.
Subtract the value of debt (VD) from the value of the firm (VF). This gives the value of the equity (VE) only as it is assumed that the value of the firm = debt + equity.
The value of shares (VS) is value of equity divided by the number of outstanding shares (N).
Method of MultiplesThis method focuses on comparing the subject company’s risk profile and growth prospects to selected reasonably similar, “guideline” companies.
The valuation multiples are derived from Guideline Company operating data and share prices and the valuation multiples are evaluated and adjusted based on relative strengths and weaknesses.
Selected multiples are then applied to the operating data of the subject company to derive implied ranges of value.
Steps1.The comparables are selected based on:a)Business descriptionb)Geographic location and markets servedc)Sources of revenue and profitabilityd)Size (revenues or membership)e)Stage of development (life cycle)2.Identify comparable assets.
3.Market values need to be obtained for these assets.
4.The market values obtained are converted into standardized values, since the absolute prices cannot be compared. This process of standardizing creates price multiples. The values can be standardized using a common variable such as earning, cash flows, book value or revenues.
5.Compare the standardized value or multiple for the asset being analysed to the standardized values for comparable asset, controlling for any differences between the firms that might affect the multiple, to judge whether the asset is under or over valuedNote: The key company specific factors that drive valuation are: Growth, Risk, Capital Expenditure and Takeover Issues. (Refer to appendix 1.1 for details)Ratios Used in the Case Study (Refer to appendix 1.2 for details of the multiples)Book to Market MultipleThe ratio can be calculated based on the current market price.
Book to market ratio = Market Value of Share Book Value of ShareThe market to book ratio suggests that for every $1 of book value, the market is willing to pay $x10.
Price Earnings Multiple12A price earning multiple (PE multiple) is used mostly to estimate the performance of companies whose shares are traded in public and therefore reflect market expectation to a credible extent. In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. The P/E is sometimes referred to as the “multiple”, because it shows how much investors are willing to pay per dollar of earnings.
EBIT MultipleThe ratio is given as follows:EBIT Multiple = Enterprise Value EBITThis ratio is not a good way to compare the total enterprise values of companies with dissimilar capital structures. EV/EBIT is not much used in practice. This ratio is often used in industries where capital expenditures are typically for maintenance purposes and are close to depreciation and amortization expenses14. A low ratio indicates that a company might be undervalued.
EBITDA Multiple (Most Popular)A ratio used to determine the value of a company. The enterprise multiple looks at a firm as a potential acquirer would, because it takes debt into account – an item which other multiples like the P/E ratio do not include. Enterprise multiple is calculated as:The enterprise value is = market value of equity + market value of debt –cash holdingsA low ratio indicates that a company might be undervalued. This ratio is less susceptible to manipulation by changes in capital structure. Since enterprise value includes both debt and equity, and EBITA is the profit available to investors, a change in capital structure will have no systematic effect. Only when such a change lowers the cost of capital will changes lead to a higher multiple.
Note for all MultiplesThe negative valuation multiples, which usually arise from losses, are not meaningful and should be ignored13.
Comparing discounted free cash flow and the method of multiples7,15In this case, both methods are subjected to various assumptions due to incomplete information. Market approach is fairly simple to understand. The income approach requires a mathematical model with many assumptions unlike the multiples method. In multiple method, it is difficult to find a good guideline company that is similar to the firm that is being valued.
For detailed discussion of the comparison, refer to Appendix 1.4.
Question 4Since, the discounted free cash flow and the method of multiples are commonly used; we will use these two methods to value Jet Blue’s shares.
Valuing JetBlue shares9 (Refer to the excel file)Discounted Cash Flow MethodThis valuation method based on free cash flow is considered a strong tool because it concentrates on cash generation potential of a business. This valuation method uses the future free cash flow of the company (meeting all the liabilities) discounted by the firm’s weighted average cost of capital (the average cost of all the capital used in the business, including debt and equity), plus a risk factor measured by beta.
Steps1.Calculate WACC.
2.Calculate free cash flow. This is calculated using operating cash flow less investments necessary for growth.
3.Discount the cash flows by WACC, which reflects both the firm’s capital structure and the tax deductibility of its interest payments.
4.Add the present values of the free cash flows and that of the horizon value.
5.Since, we need the value of the equity, subtract the value of the outstanding debt.
6.Divide the result obtained in step 5 by the number of shares.
Assumptions Made for Free Cash Flow to the Firm Method1.Preferred stock yields as much as debt.
2.The underwriters were on the spot about the information that the stock prices should be $263.The cost of debt is 8.68% (Refer to Appendix 1.6 for cost of debt assumption).
4.Assuming that beta is 1.15.Assuming tax to be constant for all the years at 34%.
6.The growth rate is assumed to be 0.081=8.1% for the horizon year. The growth stabilizes at 8.1%.
7.The net change in assets is considered constant and is assumed to be absorbed in the net working capital.
Total DebtFrom exhibit 3 (Balance Sheet-values in ‘000s)Types of DebtValues in Year 2001Long Term Debt290,665Deferred Credits and other liabilities10,708Convertible redeemable preferred stock210, 441Assumption: Since, dividends of the preferred stock is not given we cannot find the cost of the preferred stock. We assume that the preferred stock yields as much as debt.
Since the value is in ‘000s =Total EquityFrom Exhibit 1 (Selections from JetBlue prospectus)Information about EquityNumber of Shares outstanding40578829Price of the share (value from case study)$26Assumption: Assuming that underwriters were on the spot about the information that the stock prices should be $26.
The total equity isTotal Equity=Shares outstanding *price of each share =Total Value=Cost of DebtAssumption: The cost of debt is 8.68%. Since, the cost of debt is not given in the case study we either can take a conservative estimate of 8.68% or take the average of the entire yield to maturity given in the table. The average of the maturities is 6.91%. We will consider the conservative estimate of 8.68% as JetBlue had recently started and is not as established as Southwest.
Cost of Equity (Ke)Assumption: Since, it is commented in the case study that the net proceeds after issuing the IPO, will be used together, with existing cash, for working capital and capital expenditures, including capital expenditures related to the purchase of aircraft.
Since JetBlue is not going to be giving out dividends we cannot use the dividend discount model to calculate the cost of equity.
Assuming that beta is 1.1 (given for South West). We assume Beta to be 1.1 as Neelman worked for Southwest Airlines. We assume him to have some insider information about Southwest Airlines. He is also modelling JetBlue based on Southwest. So we, assume that Beta for JetBlue is 1.1.
We use the formula:Calculation of WACCAssumption: Assuming tax to be 34%.
Calculation of the Free Cash Flows to the Firm (FCFF)Formula UsedFCFF= EBIT * (1-T) + depreciation-capital expenditure-change in NWC-change in net assetsAssumption: The tax rate is assumed to be constant in all the years at 34%.
Assumption: The growth rate is assumed to be 0.081=8.1% for the horizon year. The growth stabilizes at 8.1%. This has been assumed as the average of the year on year growth in revenues given in exhibit 13, is 29.65%. This value is very large and it is not possible for the firm to grow indefinitely at this rate. That is why a more reliable estimate of 8.1% is used. This value of 8.1% has been calculated on Y-O-Y growth in revenue from 2009 to 2010.
Assumption: The net change in assets is considered constant and is assumed to be absorbed in the net working capital.
Present value of equity = PV of FCFF – Total Debt=926167067.138- = 8764353067.14Price of share = PV of equity/Number of outstanding shares= 8764353067.14/40578829.000 = $215.983Sensitivity Analysis of the Share Price ObtainedIt is important to note that result obtained from the above calculation is subject to sensitivity of inputs that are used. The sensitivity of the data is caused by the assumptions that we make on cost of debt, beta and perpetual growth rate. Changing any of these factors alter the final share price. As JetBlue is a relative new company, figures obtained from Exhibit 13 are also subject to reliability. It cannot be guaranteed that the data will be as projected in the future. For detailed discussion on sensitivity analysis, refer to Appendix 1.7.
In all cases, once, the IPO is offered, the market only will determine as to what the price of share is.
Multiple MethodSteps1.Choose comparables.
2.Calculate the valuation multiples of the target company.
3.Comment whether the shares are overvalued or undervalued with reasoning.
Comparables Selected: All the comparables have been selected from US rather than airlines from Europe and other countries. If JetBlue is compared with the airlines of other countries, the economic setting would change. That is why; we will stick to comparing JetBlue with airlines from the US. The comparables selected are Southwest and Air-Tran (low-fare, scheduled, short-haul flights primarily in the eastern United States). These airlines and JetBlue all provide low fare flight services. Year 2001 was JetBlue’s second year of operation, and arguably one of the worst in U.S. aviation history due to the September 11 attacks. During this period, only Southwest and Air-Tran (low cost) carriers along with JetBlue remained profitable.
Since, David Neelman earlier worked for Southwest, it is possible that he had insider information about it which he applied in the airlines that he started i.e. JetBlue.
For information on Southwest and Air-Tran, refer to Appendix 1.5.
Assumptions for Multiple Method1.Only long term debt is considered. This long term debt includes long term credit, deferred credits and liabilities and convertible redeemable preferred stock.
2.The Book Debt is constant in the year 20023.The Book Debt is equal to the market Debt4.In calculating EBITDA, amortization is considered to be 0.
5.Price of the share in the IPO is assumed to be $266.Price of the share remains constant in year 2002Calculated Ratios for JetBlue for Year 2001 (Refer to the excel sheet)Price/Share = $26Book Equity/Share =Book Debt/Share =EBITDA/Share =EBIT/Share =Earnings/Share=Standardized Multiples – For ComparisonMarket to Book Multiple =Market to Book Multiple =EBITDA Multiple =EBIT Multiple=PE Multiple=Since, the ratios have been standardized; they can now be compared with the multiples of other companies. The table below shows the comparison:2001Market to Book MultipleTotal Capital MultipleEBITDA MultipleEBIT MultiplePE MultipleJetBlue-32.799-33.34528.528639.09483.2970Southwest3.52.913.418.627.6AirTran3.52.48.61325.3The comparison of the multiples1.The market to book multiple and the total capital multiple are negative. Negative multiples do not indicate anything. They are meaningless. This is one of the drawbacks of using the multiple method. These multiples are negative because the book equity is negative. This could be because it is a start-up company and may be it does not have it is not recognized to have cash flow generation ability.
2.The EBITDA and EBIT multiple and EBIT are highest for that of JetBlue. This shows that the shares for JetBlue may be overvalued. The firm is overvalued and is not likely to be a takeover candidate.
3.The PE multiple is lowest. This is justified as investors are not ready to spend more than $3 for $1 earnings of JetBlue. Air Tran and Southwest are established firms. If JetBlue does not offer them a higher return, investors are more likely to stay with these established companies.
Calculation of Share Price by Multiple Method (Refer to the excel sheet)Forward PE & EBIT multiples are used as investors focus should be forward looking since the historical record has limited use. While a trailing PE is a good measure of past performance, it cannot indicate future growth prospects or earnings potential.
Using Industry Average PE MultipleNOPAT for 2002 = $53000000Number of Shares = 40578829WACC =0.08941EPS = NOPAT/Number of Shares =Leading Industry Mean PE Ratio = 6.164Price/Share = EPS * PE Multiple = $8.051This share price needs to be discounted for 2001 for comparing it with the 2001 share price of Southwest. The discounted share price is given by dividing the share price/WACC = $7.39Comments on using Industry average: The industry average consists of firms in a particular industry segment, both the good and the poor performers. Comparing a firm with an industry average may be inappropriate. A better approach might be to compute a new industry average that leaves out the performers that are not related to the company in question or compare the ratios of the firms to two or three of its closest competitors11.
Using the average of PE Multiples of AirTran and SouthwestNOPAT for 2002 = $53000000Number of Shares = 40578829WACC =0.08941EPS = NOPAT/Number of Shares =Leading Mean PE Ratio (SW & At) = 24.2Price/Share = EPS * PE Multiple = $31.60This share price needs to be discounted for 2001 for comparing it with the 2001 share price of Southwest. The discounted share price is given by dividing the share price/WACC = $29.00Using the PE Multiples of Southwest onlyNOPAT for 2002 = $53000000Number of Shares = 40578829WACC =0.08941EPS = NOPAT/Number of Shares =Leading PE Ratio (SW) = 28.4Price/Share = EPS * PE Multiple = $37.093This share price needs to be discounted for 2001 for comparing it with the 2001 share price of Southwest. The discounted share price is given by dividing the share price/WACC = $34.048Similarly leading EBIT Multiple can also be used. The results are shown in the tabular format.
NOPAT for 2002 = $80000000Number of Shares = 40578829WACC =0.08941EPS = NOPAT/Number of Shares =Leading EBIT Multiple (SW) = 14.30Price/Share = EPS * PE Multiple = $28.19This share price needs to be discounted for 2001 for comparing it with the 2001 share price of Southwest. The discounted share price is given by dividing the share price/WACC = $25.87Comparing the price/share obtained by each of the above calculations with that of Southwest and AirTran, it can easily be seen that the share price calculated above for JetBlue is much higher than that of Southwest ($18.5) and AirTran ($6.6). Therefore it can be concluded that JetBlue is overvalued.
Underpricing AnomalyThe calculation of the price of a share using the original assumptions exposes us to the underpricing anomaly that exists. In this case study, the IPO was offered in the price range of $25-$26. During the first day of trading, it faced a 67% increase in price. Measuring the returns over the years after the IPO, the new shares, generally, have no abnormal returns during the period after issuance, but the abnormal returns become negative over time17. Many theories have been developed to explain this phenomenon such as winners curse and Publicity. Refer to Appendix 2.0 for details.
In firm valuation and share price determination, besides the method adopted, it is also important to investigate internal and external environment of the firm as they affect firm and share value.
SWOT AnalysisPorter Analysis (Refer to Appendix 1.8 for Details)Reliability of the Estimates in Exhibit 13In addition, it is important to note that figures obtained from Exhibit 13 are estimates. JetBlue is a relatively new company and thus, the reliability of these estimates is worth considering.
After comparing the annual report of Southwest with the Exhibit 13, it can be concluded that all the values given in the forecasts of JetBlue are less than those of Southwest. This is as expected. Because JetBlue is a start-up company which barely has completed two years of operation. With a 29-year head start, Southwest is much bigger and has a strong position in the market.
It is expected that the JetBlue will have a hyper growth during the first few years. But the growth will also put a heavier burden on marketing to find markets from which to pull more revenue. Costs can consistently be kept low with growth, but eventually the revenues, diluted by their own capacity as well as competition, will not be able to keep up. That’s why, towards the end, it is expected that the JetBlue growth would stagnate.
Refer to Appendix 2.0 for details on the reliability of the estimates.
ConclusionFor a private firm such as JetBlue to become a public listed company, the firm has to undergo various complicated and costly stages. Prior to going public, the firm needs to consider if the benefits outweigh any costs incurred. An agreement is first formed between the firm and the underwriters to plan the IPO process. A registration statement discloses characteristics of the traded securities are lodged with SEC and once this is approved, the trade begins. The main duties of underwriters are to promote the securities and seek potential investors for the firm. Determination of share value may be discussed between the two parties. Valuation of firms is important so that both the buyers and sellers know what they will get and what they’ll pay respectively. This is usually calculated by the two main methods which are discounted cash flow or multiples.
The discounted cash flow method suggests that JetBlue share is valued at $215.983 however; this price is subject to various sensitivities. The method involves the use of value of debt and equity, tax rate, cost of debt as well as cost of equity to calculate Weighted Average Cost of Capital (WACC) for discounting future cash flows to present value. In this case, sensitivity analysis is the alteration of beta, cost of debt and perpetual growth rate. It is seen that share price decreases as beta and cost of debt increase and growth rate declines. By reducing the value of growth by 1%, it was seen that the value of the share fell significantly to $79. The information available does not allow us to be certain of the correctness of these 3 factors and thus, determining share price using the discounted cash flow method is not fully reliable.
Another method that is used for the valuation is the multiples method which suggests a share price of $25.87. The value is close to the real price offered at the IPO however when compared with Southwest and Airtran with share price of $18.5 and $6.6 respectively, it is obvious that JetBlue price of $25.87 is overvalued.
Using the two methods, it is obvious that different figures are obtained under dissimilar assumptions. At a high price of $25 – $26 at the IPO if compared against existing competitors, JetBlue share was still highly demanded by investors. The price even went up by 67% on the first day of trading suggesting that JetBlue share was actually underpriced on the first offering. The values obtained do not give the same price as that at the IPO subjected to sensitivity and reliability. From the reliability analysis of estimates provided in Exhibit 13, it is concluded that the estimates are reliable. However, as JetBlue is a new company, future changes in external environment may also alter these estimates. Therefore, it can be concluded that once the market and investors determine the position of JetBlue which are its strengths, weaknesses, opportunities and threats, they consider how much the share should be worth. Demand and supply then play vital role is setting share price in the market.
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