Jetblue airways ipo valuation pdf

Jet Blue Airways Case Study

This case was prepared by Professor Michael J. Schill with the assistance and cooperation of John Owen (JetBlue), Garth Monroe (MBA ’05), and Cheng Cui (MBA ’04). It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright © 2003 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e- mail to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation.

JetBlue Airways IPO Valuation

My neighbor called me the other day and she said, “You have an interesting little boy.” Turns out, the other day she asked my son Daniel what he wanted for Christmas. And he said, “I want some stock.” “Stock?” she said. “Don’t you want video games or anything?” “Nope,” he said. “I just want stock. JetBlue stock.”

—David Neeleman CEO and Founder, JetBlue Airways

It was April 11, 2002, barely two years since the first freshly painted JetBlue plane had been rolled out at the company’s home base at New York City’s John F. Kennedy Airport (JFK). JetBlue’s first years had been good ones. Despite the challenges facing the U.S. airline industry following the terrorist attacks of September 2001, the company remained profitable and was growing aggressively. To support JetBlue’s growth trajectory and offset portfolio losses by its venture-capital investors, management was ready to raise additional capital through a public equity offering. Exhibit 1 through Exhibit 4 provide selections from JetBlue’s initial public offering (IPO) prospectus, required by the SEC to inform investors about the details of the equity offering.

After nearly two weeks of road-show meetings with the investment community, the JetBlue management team had just finished its final investor presentation and was heading for Chicago’s Midway Airport. With representatives of co-lead manager Morgan Stanley and the JetBlue board patched in on a conference call, it was time for the group to come to an agreement on the offering price of the new shares. The initial price range for JetBlue shares, communicated to potential investors, was $22 to $24. Facing sizable excess demand for the 5.5 million shares planned for the IPO, management had recently filed an increase in the offering’s price range ($25 to $26). But even at that price range, most of the group thought the stock faced “blow-out” demand. After months of preparation, it was time to set the price. The underwriters were anxious to distribute the shares that evening, and NASDAQ was prepared for JBLU (the company’s ticker symbol) to begin trading on the exchange in the morning.

JetBlue Airways

In July 1999, David Neeleman, 39, announced his plan to launch a new airline that would bring “humanity back to air travel.” Despite the fact that the U.S. airline industry had witnessed 87 new-airline failures over the previous 20 years, Neeleman was convinced that his commitment to innovation in people, policies, and technology could keep his planes full and moving.1 His vision was shared by an impressive new

1 Jeff Sweat, “Generation Dot-Com Gets Its Wings,” Information Week (January 1, 2001).

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management team and a growing group of investors. David Barger, a former vice president of Continental Airlines, had agreed to become JetBlue’s president and COO. John Owen had left his position as executive vice president and former treasurer of Southwest Airlines to become JetBlue’s CFO. Neeleman had received strong support for his business plan from the venture-capital community. He had quickly raised $130 million in funding from such high-profile firms as Weston Presidio Capital, Chase Capital Partners, and Quantum Industrial Partners (George Soros’s private-equity firm).

In seven months, JetBlue had secured a small fleet of Airbus A320 aircraft and initiated service from JFK to Fort Lauderdale, Florida, and Buffalo, New York. By late summer of 2000, routes had been added to two other Florida cities (Orlando and Tampa), two other northeastern cities (Rochester, New York, and Burlington, Vermont), and two California cities (Oakland and Ontario). The company continued to grow rapidly through early 2002, and was operating 24 aircraft flying 108 flights per day to 17 destinations.

JetBlue’s early success was often attributed to Neeleman’s extensive experience with airline start-ups. As a University of Utah student in his early 20s, Neeleman began managing low-fare flights between Salt Lake City and Hawaii. His company, Morris Air, became a pioneer in ticketless travel, and was later acquired by low- fare leader Southwest Airlines. Neeleman stayed only briefly at Southwest, leaving to assist in the launching of Canadian low-fare carrier WestJet while waiting out the term of his noncompete agreement with Southwest. Simultaneously, Neeleman also developed the e-ticketing system Open Skies, which was acquired by Hewlett- Packard in 1999.

Neeleman acknowledged that JetBlue’s strategy was built on the goal of fixing everything that “sucked” about airline travel. He offered passengers a unique flying experience by providing new aircraft, simple and low fares, leather seats, free LiveTV at every seat, preassigned seating, reliable performance, and high-quality customer service. JetBlue focused on point-to-point service to large metropolitan areas with high average fares or highly traveled markets that were underserved. JetBlue’s operating strategy had produced the lowest cost per available-seat-mile of any major U.S. airline in 2001—6.98 cents versus an industry average of 10.08 cents.

With its strong capital base, JetBlue had acquired a fleet of new Airbus A320 aircraft. JetBlue’s fleet not only was more reliable and fuel-efficient than other airline fleets, but also afforded greater economies of scale because the airline had only one model of aircraft. JetBlue’s management believed in leveraging advanced technology. For instance, all its pilots used laptop computers in the cockpit to calculate the weight and balance of the aircraft and to access their manuals in electronic format during the flight. JetBlue was the first U.S. airline to equip cockpits with bulletproof Kevlar doors and security cameras in response to the September 11 hijackings.

JetBlue had made significant progress in establishing a strong brand by seeking to be identified as a safe, reliable, low-fare airline that was highly focused on customer service and by providing an enjoyable flying experience. JetBlue was well positioned in New York, the nation’s largest travel market, with approximately 21 million potential customers in the metropolitan area. Much of JetBlue’s customer-service strategy relied on building strong employee morale through generous compensation and passionately communicating the company’s vision to employees.

The Low-Fare Airlines

In 2002, the low-fare business model was gaining momentum in the U.S. airline industry. Southwest Airlines, the pioneer in low-fare air travel, was the dominant player among low-fare airlines. Southwest had successfully followed a strategy of high-frequency, short-haul, point-to-point, low-cost service. Southwest

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flew more than 64 million passengers a year to 58 cities, making it the fourth-largest carrier in America and in the world. Financially, Southwest had also been extremely successful—in April 2002, Southwest’s market capitalization was larger than all other U.S. airlines combined (Exhibits 5 and 6 provide financial data on Southwest Airlines).

Following the success of Southwest, a number of new low-fare airlines emerged. These airlines adopted much of Southwest’s low-cost model, including flying to secondary airports adjacent to major metropolitan areas and focusing on only a few types of aircraft to minimize maintenance complexity. In addition to JetBlue, current low-fare U.S. airlines included AirTran, America West, ATA, and Frontier. Alaska Air, an established regional airline, adopted a low-fare strategy. Many of the low-fare airlines had been resilient in the aftermath of the September 11 attacks. (Exhibit 7 shows current market-multiple calculations for U.S. airlines.) Low- fare airlines had also appeared in markets outside the United States, with Ryanair and easyJet in Europe and WestJet in Canada. (Exhibit 8 provides historical growth rates of revenue and equipment for low-fare airlines.)

The most recent IPOs among low-fare airlines were of non-U.S. carriers. Ryanair, WestJet, and easyJet had gone public with trailing EBIT multiples of 8.5×, 11.6×, and 13.4×, respectively, and first-day returns of 62%, 25%, and 11%, respectively.2

The IPO Process

The process of going public (selling publicly traded equity for the first time) was an arduous undertaking that usually required about three months. Exhibit 9 provides a timeline for the typical IPO.3 A comment on the IPO process by JetBlue CFO John Owen can be found at http://www.youtube.com/watch?v=X1SWfL_NI7Y and http://www.youtube.com/watch?v=p3e_b0GFGdA.4

Private firms needed to fulfill a number of prerequisites before initiating the equity-issuance process. Firms had to generate a credible business plan; gather a qualified management team; create an outside board of directors; prepare audited financial statements, performance measures, and projections; and develop relationships with investment bankers, lawyers, and accountants. Frequently, firms held “bake-off” meetings to discuss the equity-issuance process with various investment banks before selecting a lead underwriter. Important characteristics of an underwriter included the proposed compensation package, track record, analyst research support, distribution capabilities, and aftermarket market-making support.

After the firm satisfied the prerequisites, the equity-issuance process began with an organizational or “all- hands” meeting, which was attended by all the key participants, including management, underwriters, accountants, and legal counsel for both the underwriters and the issuing firm. The meeting was designed for planning the process and reaching agreement on the specific terms. Throughout the process, additional meetings could be called to discuss problems and review progress. Following the initiation of the equity-

2 The “first-day return” was the realized return based on the difference between the IPO share price and the market share price at the close of the

first day of exchange-based trading. The term “trailing EBIT (earnings before interest and taxes) multiple” was defined as (Book debt + IPO price × Post-IPO shares outstanding)/(Most recent year’s EBIT). The term “leading EBIT multiple” referred to an EBIT multiple based on a future year’s forecast EBIT.

3 This section draws from Michael C. Bernstein and Lester Wolosoff, Raising Capital: The Grant Thornton LLP Guide for Entrepreneurs; Frederick Lipman, Going Public; Coopers and Lybrand, A Guide to Going Public; and Craig G. Dunbar, “The Effect of Information Asymmetries on the Choice of Underwriter Compensation Contracts in IPOs” (PhD diss., University of Rochester, n.d.). 4 “IPO_Process,” YouTube video, 1:30, posted by “DardenPublishing,” July 19, 2011, http://www.youtube.com/watch?v=X1SWfL_NI7Y (accessed Aug. 1, 2017); and “Timing Decision,” YouTube video, 1:45, posted by “DardenPublishing, July 19, 2011, http://www.youtube.com/watch?v=p3e_b0GFGdA (accessed Aug. 1, 2017).

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issuance process, the Securities and Exchange Commission (SEC) prohibited the company from publishing information outside the prospectus. The company could continue established, normal advertising activities, but any increased publicity designed to raise awareness of the company’s name, products, or geographical presence in order to create a favorable attitude toward the company’s securities could be considered illegal. This requirement was known as the “quiet period.”

The underwriter’s counsel generally prepared a letter of intent, which provided most of the terms of the underwriting agreement but was not legally binding. The underwriting agreement described the securities to be sold, set forth the rights and obligations of the various parties, and established the underwriter’s compensation. Because the underwriting agreement was not signed until the offering price was determined (just before distribution began), both the firm and the underwriter were free to pull out of the agreement anytime before the offering date. If the firm did withdraw the offer, the letter of intent generally required the firm to reimburse the underwriter for direct expenses.

The SEC required that firms selling equity in public markets solicit its approval. The filing process called for preparation of the prospectus (Part I of the registration statement), answers to specific questions, copies of the underwriting contract, company charter and bylaws, and a specimen of the security (all included in Part II of the registration statement), all requiring the full attention of all parties on the offering firm’s team. One of the important features of the registration process was the performance of due diligence procedures. Due diligence referred to the process of providing reasonable grounds that there was nothing in the registration statement that was significantly untrue or misleading, and was motivated by the liability of all parties to the registration statement for any material misstatements or omissions. Due diligence procedures involved such things as reviewing company documents, contracts, and tax returns; visiting company offices and facilities; soliciting comfort letters from company auditors; and interviewing company and industry personnel.

During this period, the lead underwriter began to form the underwriting syndicate, which comprised several investment banks that agreed to buy portions of the offering at the offer price less the underwriting discount. In addition to the syndicate members, dealers were enlisted to sell a certain number of shares on a best-efforts basis. The dealers received a fixed reallowance, or concession, for each share sold. The selling agreement provided the contract among members of the syndicate. The agreement granted power of attorney to the lead underwriter, and stipulated the management fee that each syndicate member was required to pay the lead underwriter, the share allocations, and the dealer reallowances or concessions. Because the exact terms of the agreement were not specified until approximately 48 hours before selling began, the agreement did not become binding until just before the offering. The original contract specified a range of expected compensation levels. The selling agreement was structured so that the contract became binding when it was orally approved via telephone by the syndicate members after the effective date.

The SEC review process started when the registration statement was filed and the statement was assigned to a branch chief of the division of corporate finance. As part of the SEC review, the statement was given to accountants, attorneys, analysts, and industry specialists. The SEC review process was laid out in the Securities Act of 1933, which aspired to “provide full and fair disclosure of the character of securities sold in interstate commerce.”5 Under the Securities Act, the registration statement became effective 20 days after the filing date. If, however, the SEC found anything in the registration statement that was regarded as materially untrue, incomplete, or misleading, the branch chief sent the registrant a letter of comment detailing the deficiencies. Following a letter of comment, the issuing firm was required to correct and return the amended statement to the SEC. Unless an acceleration was granted by the SEC, the amended statement restarted the 20-day waiting period.

5 Preamble, Securities Act of 1933.

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While the SEC was reviewing the registration statement, the underwriter was engaged in book-building activities, which involved surveying potential investors to construct a schedule of investor demand for the new issue. To generate investor interest, the preliminary offering prospectus, or red herring (so called because the prospectus was required to have Preliminary Prospectus on the cover in red ink), was printed and offered to potential investors. Underwriters generally organized a one- or two-week road-show tour during this period. The road shows allowed managers to discuss their investment plans, display their management potential, and answer questions from financial analysts, brokers, and institutional investors in locations across the country or abroad. Finally, companies could place tombstone ads in various financial periodicals announcing the offering and listing the members of the underwriting syndicate.

By the time the registration statement was ready to become effective, the underwriter and the offering firm’s management negotiated the final offering price and the underwriting discount. The negotiated price depended on perceived investor demand and current market conditions (e.g., price multiples of comparable companies, previous offering experience of industry peers). Once the underwriter and the management agreed on the offering price and discount, the underwriting agreement was signed, and the final registration amendment was filed with the SEC. The company and the underwriter generally asked the SEC to accelerate the final pricing amendment, which was usually granted immediately over the telephone. The offering was now ready for public sale. The final pricing and acceleration of the registration statement typically happened within a few hours.

During the morning of the effective day, the lead underwriter confirmed the selling agreement with the members of the syndicate. Following confirmation of the selling agreement, selling began. Members of the syndicate sold shares of the offering through oral solicitations to potential investors. Because investors were required to receive a final copy of the prospectus with the confirmation of sale and the law allowed investors to back out of purchase orders upon receipt of the final prospectus, the offering sale was not realized until underwriters actually received payment. Underwriters would generally cancel orders if payment was not received within five days of the confirmation.

SEC Rule 10b-7 permitted underwriters to engage in price-stabilization activities for a limited period during security distribution. Under this rule, underwriters often posted stabilizing bids at or below the offer price, which provided some price stability during the initial trading of an IPO.

The offering settlement, or closing, occurred seven to ten days after the effective date, as specified in the underwriting agreement. At this meeting, the firm delivered the security certificates to the underwriters and dealers, and the lead underwriter delivered the prescribed proceeds to the firm. In addition, the firm traditionally delivered an updated comfort letter from its independent accountants. Following the offering, the underwriter generally continued to provide valuable investment-banking services by distributing research literature and acting as a market maker for the company.

The IPO Decision

There was some debate among the JetBlue management team regarding the appropriate pricing policy for the IPO shares. Morgan Stanley reported that the deal was highly oversubscribed by investors (i.e., demand exceeded supply). Analysts and reporters were overwhelmingly enthusiastic about the offering. (Exhibit 10 contains a selection of recent comments by analysts and reporters.) Given such strong demand, some members of the group worried that the current pricing range still left too much money on the table. Moreover, they believed that raising the price would send a strong signal of confidence to the market.

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The contrasting view held that increasing the price might compromise the success of the deal. In management’s view, a successful offering entailed not only raising the short-term capital needs, but also maintaining access to future capital and providing positive returns to the crew members (employees) and others involved in directed IPO share purchases. Because maintaining access to capital markets was considered vital to JetBlue’s aggressive growth plans, discounting the company’s IPO price seemed like a reasonable concession to ensure a successful deal and generate a certain level of investor buzz. Being conservative on the offer price seemed particularly prudent considering the risks of taking an infant New York airline public just six months after 9/11. (Exhibit 11 provides forecasts of expected aggregate industry growth and profitability; Exhibit 12 shows the share-price performance of airlines over the previous eight months.)

By April 2002, the U.S. economy had been stalled for nearly two years. The Federal Reserve had attempted to stimulate economic activity by reducing interest rates to their lowest level in a generation. Current long-term U.S. Treasuries traded at a yield of 5%, short-term rates were at 2%, and the market risk premium was estimated to be 5%.

Based on the JetBlue management team’s forecast of aircraft acquisitions, Exhibit 13 provides a financial forecast for the company.6

6 In pricing IPO shares, it was appropriate to divide the total equity value of the firm by the premoney shares outstanding. In the case of JetBlue,

the number of premoney shares outstanding was 35.1 million. This number included the automatic conversion of all convertible redeemable preferred shares into common shares.

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Exhibit 1

JetBlue Airways IPO Valuation

Selections from JetBlue Prospectus

The Offering

Common stock offered 5,500,000 shares

Use of proceeds We intend to use the net proceeds, together with existing cash, for working capital and capital expenditures, including capital expenditures related to the purchase of aircraft.

Dividends We have not declared or paid any dividends on our common stock. We currently intend to retain our future earnings, if any, to finance the further expansion and continued growth of our business.

Proposed NASDAQ National Market symbol

JBLU

Results of Operations

Three Months Ended

Dec 31, 2000 Mar 31, 2001 Jun 30, 2001 Sep 30, 2001 Dec 31, 2001 (unaudited)

Operating Statistics:

Revenue passengers 523,246 644,419 753,937 791,551 926,910

Revenue passenger miles (in thousands) 469,293 600,343 766,350 863,855 1,051,287

Available seat miles (in thousands) 623,297 745,852 960,744 1,131,013 1,370,658

Load factor 75.3% 80.5% 79.8% 76.4% 76.7%

Breakeven load factor 79.4% 73.2% 70.6% 74.6% 76.2%

Aircraft utilization (hours per day) 11.8 13.1 13.1 12.8 11.8

Average fare $ 90.65 $ 96.15 $ 101.01 $ 101.66 $ 99.37

Yield per passenger mile (cents) 10.11 10.32 9.94 9.29 8.76

Passenger revenue per available seat mile (cents) 7.61 8.31 7.93 7.10 6.72

Operating revenue per available seat mile (cents) 7.85 8.56 8.16 7.30 6.97

Operating expense per available seat mile (cents) 8.03 7.55 7.01 6.93 6.68

Departures 4,620 5,283 6,332 6,936 7,783

Average stage length (miles) 833 871 937 1,007 1,087

Average number of operating aircraft during period 9.2 10.5 13.2 15.9 19.4

Full-time equivalent employees at period end 1,028 1,350 1,587 1,876 2,116

Average fuel cost per gallon (cents) 103.38 86.03 83.24 79.53 60.94

Fuel gallons consumed (in thousands) 8,348 9,917 12,649 14,958 17,571

Percent of sales through jetblue.com during period 32.6% 37.6% 39.4% 45.1% 51.3%

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