Week 8 Case Study – JetBlue
Man Hon Chan 22002960
An initial public offering (IPO) refers to the initial stage of shares offering to the public market for subscriptions by a company to raise capital for the purpose of expansion. It is considered as a big issue for companies as an IPO does not necessary guarantee the success of a company as it is merely a tool of raising capital while its costs of issuance and consecutive monitoring costs (due to diluted shareholdings of the company by public investors) are relatively higher than the cost of issuing corporate debt. Yet IPO is still a popular tool for infant firms due to the fact it creates strategic market exposure. JetBlue was attempting to issue an IPO in 2002 after the subsequent event of 9/11 terrorist attack. This report attempts to calculate and evaluate the IPO valuation of JetBlue’s stocks and provide recommendation and adjustments where necessary to reflect the true value of JetBlue. Assumptions made in Exhibit 13
There were several valuation techniques used by analysts and underwriters to value an enterprise’s share, they are respectively the Discounted Cash Flow Method (DCF) for instance, Free Cash Flow to Equity (FCFE), Free Cash Flow to Firm (FCFF), and Dividend Discount Model, and the Relative Valuation Techniques, for instance Price Earnings Ratio (P/E) and Price Book Value Ratio (P/BV). Dividend Discount Model requires input of next year’s expected dividend distributed, a required rate of return by shareholders and an estimation of growth rate. Since JetBlue does not pay out dividend before listed (despite dividend distributed to preferred shares shareholders), such model is considered as inapplicable. The FCFE and FCFF method were developed for firms which does not distribute dividend and their valuation is based on the free cash flow available to the equity holders or to the firm, and thus calculate the share price of a firm after attributing outstanding shares. The difference between the FCFE and FCFF method lies on the discount rate uses, where the latter uses cost of capital as the discount rate, the former uses cost of equity as the discount rate. A significant and largely assumed factor is used in two models is the expected growth rate of the firm, which is not provided in text in the case though can be examined from Exhibit 13, which is JetBlue’s revenue per plane is assumed to grow at a rate of 16% in the first year, and at a constant rate of 4% forever, align with inflation expectation. Yet the revenue growth of JetBlue experiences a higher growth rate when accompanying the growth rate in the number of aircrafts. Another assumption has been made in Exhibit 13 was the expected growth in capital expense per aircraft as well as depreciation per aircraft are expected to be growing at a constant expected inflation rate of 5%, the validity of the assumption is largely based on the investment decision of JetBlue on aircraft purchasing would be the same model type. In addition, the operating margin of JetBlue is assumed to grow at 58% for the first year, 14% for the second year and stayed constantly at a margin of 15.2% forever. Also the calculation of cash expense is equated as the difference between revenue minus depreciation expense and earnings before income tax (EBIT), which thus produce a net operating profit after tax (NOPAT) different to the unaudited income statement provided by JetBlue (NOPAT of $18m in Exhibit 13 compared to NOPAT of $39m in Exhibit 3) and in reality this may not be true. Despite the assumptions made, the data provided allows analyst to determine the value of JetBlue via either FCFF or FCFE. Yet when attempts have been made through FCFF, it appears that the annual free cash flow to the enterprise are negative for the entire forecast period and thus the inability to calculated the Net Present Value (NPV) and hence the market value of the firm via either FCFE or FCFF approach. WACC and Required Rate of...
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