Company Introduction From the mid 1990s to the beginning of the new millennium, the airline industry experienced

one of its biggest booms in history. The deregulation of the industry and a greater demand for travel resulted in many new airline carriers entering the market. The trend of the industry was moving towards low-cost, no-frills airlines. JetBlue Airways was created with this concept at the center of its business model. David Neeleman launched the airline in 1999 with the aim to offer a low-fare option that emphasized both high-quality customer service and a unique flying experience. Neeleman had previous experience in airline start-ups and was a pioneer in the low-fare airline business. JetBlues early success was fueled by a strong management team and $130 million in funding provided by various venture-capitalist firms. Initially, the company operated a small fleet of Airbus A320 aircraft and offered service from JFK to Fort Lauderdale, Florida and Buffalo, New York. Currently, the company operates with 24 aircraft and offers 108 flights per day to 17 destinations. JetBlue directly competes with the pioneer in low-fare flying, Southwest Airlines as well as full-service carriers such as Delta, Northwest, Continental and United Airlines. Following the September 11, 2001 terrorist attacks, economic growth stalled and major full-service airline careers suffered. However, JetBlue was able to generate profits and grow because of its unique business model. JetBlue focuses on offering passengers an experience that cannot be matched by any other airline. Passengers of JetBlue receive low fares, leather seats, free LiveTV service, preassigned seating and exceptional customer service. Centered in New York, the airline serves metropolitan areas that have traditionally had higher average fares or are underserved. It is able to be the most reliable, fuel-efficient airline because it uses only one model of aircraft, the Airbus A320. JetBlue has also leveraged its strong capital base to make continued improvements in technology. JetBlue was the first company to install bulletproof Kevlar doors and security cameras in cockpits following the September 11, 2001 attacks. As a result of its innovation, the company has produced the lowest cost per available-seat-mile of any airline in the United States at 6.98 cents versus the industry average of 10.08 cents. Current Company Analysis Issue JetBlues rapid growth has exposed the need to raise additional capital through a public equity offering. The JetBlue management team has just concluded a two week road show and must come to an agreement on the offering price of the available 5.5 million shares. Financial analysts have praised the company and its business model. The demand for the shares is sizeable and management feels that a price between $25 and $26 is appropriate. However the initial price communicated to the investment community was $22 to $24. Given that the demand for the shares exceeds the supply available, management does not want to price the initial public offering too low and miss out on potential funding. A higher price would also communicate a strong signal of confidence to the market. On the other hand, if the price is increased it may compromise the success of the offering. Maintaining access to future capital markets and providing significant return to employees and investors hinged on an underpriced offering. Additionally, the industry as a whole is suffering. Taking these factors into consideration,

JetBlues management team must use various valuation methods to arrive at an appropriate offer price. Advantages and Disadvantages to Going Public There are many advantages and disadvantages for Jet Blue to consider when making the decision to go public with their company. The major advantages for Jet Blue if they were to go public would be the large amount of cash the company would retain. Jet Blue could use the cash to increase its competitiveness by increasing its asset base, hiring more staff, and continuing research and development. Going public will also lower Jet Blues cost of capital, because Jet Blue would now be a publicly traded company, investors will be more willing to pay a higher price for shares of the company solely because it is easier to trade the shares in the future. Along with having a lower cost of capital, going public will also drastically lower the debt to equity ratio because of the amount of equity received in the process. A lower debt ratio will be looked kindly upon by lenders who will now be more apt to lend Jet Blue an increasing amount of money at a lower rate than previously offered. However, not everything about a company choosing to go public is good for the company. There are several disadvantages that Jet Blue must consider such as the cost of the process. The proportionally cost of gaining equity may be extremely high depending on the size of the initial offering due to underwriting fees. Another disadvantage to Jet Blue is the loss of control experienced in the process. A private company has complete control over all decisions but a public company must answer to a shareholder elected board of directors. Unless the initial owner retained a large portion of stock in the IPO, shareholders now have the right to direct the decisions of the company. With shareholders taking over the company, there will also be increased pressure to perform well every quarter and produce earnings; management will need to understand that they are no longer performing for themselves but instead for shareholders. If there is displeasure with the Board of Directors, the shareholders hold the power to unseat the current board and elect a new one. Lastly, going public presents the accounting department with a significant amount of work to organize and provide the SEC with an excessive amount of information which will soon be available to competitors if the IPO goes through. Jet Blue will need to consider all of these disadvantages and weigh them against the advantages to make the decision. IPO Process The IPO process starts with a company (such as Jet Blue) attempting to raise capital by deciding to perform an Initial Public Offering in which they establish shares of stock which can be traded on the public secondary market. The IPO raises capital needed and also deleverages the company. The company selects an Investment Bank who is known as the underwriter. The underwriter will then help the company with the issuance by setting a preliminary price and helping to assign value to the company. The reputation of the investment bank may be

particularly important to the company when it comes time to find investors and convince them of the profitability of the company. The investment bank will then set a commitment and an underwriters charge to lessen the risk to the underwriter. During this stage the accounting department of the company must be working on SEC filings to provide information to the government and future investors. Next, the underwriter and the company go on a one to three week roadshow to promote the company and its IPO in many different cities to potential investors. The issuer and the company are allowed to answer questions during this period but are not permitted to put anything in writing but a book-building may occur where the investment bank keeps track of the number of shares each institutional investor is willing to purchase. The issuing price is then set on the evening before the offering and the shares are brought to the public in the morning. Underpricing Anomaly IPOs are often underpriced because it reduces the risk to the investment bank and rewards institutional investors through large commissions. Although the issuing companies are aware that this happens, it is often times acceptable because of the hype and excitement produced for the company around the time of the offering. The companys management may also have a large portion of shares and therefore personally benefit from the transaction and do not mind the underpricing because of the run-up of price in the following months. Companies hope the excitement and run-up will create confidence in the stock. The challenge for the investment banks and issuing companies is to price the IPO low enough to generate excitement and interest but high enough to raise an acceptable level of capital for the company. Valuation Methods for Jet Blue There are two main approaches to valuating a company: Discounted Cash Flow Techniques and Relative Valuation Models. Discounted Cash Flow Techniques use the projected future cash flows to the investor through future dividends and the free cash flows. These provide a very accurate value of the company due to they are an estimation of how much money the shareholder will be receiving directly. The other type of valuation method is Relative Valuation Models. Relative valuation models are effective for they provide the market perspective of an industry and comparable companies. These valuation models are able to provide how much the markets favor more, for though companies may have a different intrinsic value their actual market value is determined by the faith an investor has, or doesnt have, in a company. Both of these types of measure will be used to value Jet Blue for their Initial Public Offering Price.

Present Value of Free Cash Flow to the Firm Discounted Cash Flow techniques are a better approximate of the value of a company comparatively to relative valuation models. This is due to they are the epitome of how we describe value, as the present value of expected cash flows. There are mainly two different type of Discounted Cash Flow techniques for valuating a company: Dividend Discount Model and Present Value of Free Cash Flows to the Firm. According to Exhibit 1, Selections from Jet Blue Prospectus, We currently intend to retain our future earnings, if any, to finance the further expansion and continued growth of our business. So it is unable to value Jet Blue through the Dividend Discount Model for it requires dividend payments. Jet Blue is able to be valued through the Present Value of Operating Cash Flows for the management team has produced a forecast for the next ten years. To value a company using the PV of Free Cash Flows to the Firm method, we need to project the Free Cash Flows to the Firm, calculate the Weighted Average Cost of Capital (WACC) for Jet Blue, and determine the terminal growth rate for the company. Management has already forecasted out 10-years for Jet Blue, as seen in Table 1. Table 1 also shows the changes in FCFF each year. From these percentages you can see that Jet Blue is projected to increase rapidly for the next ten years. It would be illogical to add a terminal value after ten years for the companys FCFF would not suddenly decrease to constant, low growth rate. Table 2 shows the projected growth rates for FCFF over the following 10 years. The company would decrease slowly by 1% annually until after 2020 when the company would enter into a terminal growth rate of 5%. The WACC is needed to calculate the present value of these FCFF values. The required rate of return for Jet Blue was determined using the current cost of equity, comparable cost of debt to Southwest Airlines, and the Post-IPO capital structure of the company. While using the Capital Asset Pricing Model formula to determine current cost of equity, the companys beta was required and Southwest Airlines beta was used for it was the most similar company to Jet Blue. Cost of debt was determined through averaging out the four outstanding debts that Southwest is currently paying in interest on them. Southwest Airlines is the most similar airline currently and it is believed we would be able to receive the same interest rates. The best capital structure for Jet Blue to use would be the post-IPO capital structure. For the offer price using these values would provide the best share price value for it would reflect the current price that an investor would purchase the share for. Table 6 shows the project Post-IPO capital structure for Jet Blue. These values were estimated from the market value of outstanding shares and the total amount of debt Jet Blue currently has. The required rate of return for Jet Blue is 8.06%, which is an essential value for the discounted free cash flow to the firm valuation. The final input for the model is determining the terminal growth rate of Jet Blue. The best estimate for this infinite growth rate is 5%, which is the annual expected inflation rate. This value is the best determinant for the infinite growth rate for the company should expect to stay on pace with inflation.

To value Jet Blue through the PV of FCFF, the projected years Free Cash Flows to the Firm need to be discounted back to the present value. Table 8 shows the present values for FCFF for 2001 to 2010, and Table 9 shows the present values for the decreasing rates for 2011 to 2020. Table 10 portrays the terminal growth value of the company for a terminal growth rate of 5%. Table 11 summarizes the present values from every year and the terminal value of the company. To determine the projected share price for Jet Blue, the net debt must be subtracted first for this portion of the companys assets is not available to the investor. This value then will be divided among the 4.6 million shareholders following the IPO. The value of Jet Blue from this method determines a value of $26.89 a share.

Historic Price-to-Earnings Valuation Price-to-Earnings Ratio is one of the most well-known investment valuation ratios. It compares the current price of a companys shares to the amount of earnings in generates. The purpose of the ratio is to allow investors an idea of how much they are paying for a single dollar of earnings. Jet Blue is unable to determine a specific P/E Ratio for they do not currently have a share price. Jet blue is able to value their company using a comparable P/E ratio and their net earnings for the previous year. The best P/E ratio to use is Southwest Airlines, for it is the best determination of how the market is currently valuing the airline industry, and more specifically low-fare airlines. To value the current share price for Jet Blue, the companys earnings need to be multiplied against Southwests P/E ratio. This provides the best relative measure of value for the company because the market should be willing to pay the same amount for a single dollar of earnings for Jet Blue. The product of this is the estimated market capitalization of the company. To determine the individual share price, Jet Blue needs to divide this by their Post-IPO 40.6 million shares to produce a share price of $26.19. This intrinsic value of the company is above the considered offer for the IPO by management.

Historic P/E Ratio Valuation Net Income for 2001 P/E Ratio $21,567,000 49.3

Market Capitalization 1,063,253,100

Shares 40,600,000

Share Price $26.19

Enterprise Value to EBIT Multiple Valuation Enterprise Value to EBIT Multiple method of valuation of Jet Blue provides a perspective of valuation that the P/E Ratio failed to account for. This method measures the

Enterprise Value of the company, which is the sum of the companys market capitalization and its net debt, less any cash. This equation provides the price of the company after paying off both bank debts and the investors. The use of this method also accounts for capital expenditures and it is preferred for companies with large amounts of debts and possibly negative earnings. This is a great value method for Jet Blue to their vast amounts of debt and the recent years negative net earnings. The Enterprise Value to EBIT Multiple for a valuation of Jet Blue is used by the forecasted EBIT of Jet Blue in 2002. The EBIT Multiple being used to value Jet Blue is Southwests EBIT Multiple of 18.6. This is a comparable company for they are one of the closest in operating margins that Jet Blue should be similar to in the upcoming years. This EBIT Multiple value is multiplied against the EBIT forecast for Jet Blue to produce the Enterprise Value of the company. By adding back the cash and short-term securities and subtracting net debt for 2002, this value is the Implied Equity Value. This is the total value of the company and by dividing it by the 40.6 million shareholders; it produces a share price of $27.82. This share price is the largest of our three valuation models.
Enterprise Value to EBIT Multiple Valuation of Jet Blue EBIT Multiple 18.6 2002 Forecast EBIT $80,000,000 Enterprise Value 1,488,000,000 Add: Cash 311,274,486 Subtract: Debt 669,782,446 Implied Equity Value 1,129,492,041 # of Shares 40,600,000 Share Price $27.82

Weighted Valuation of Jet Blue The use of multiple valuation methods provides the most accurate value of Jet Blue share price by accounting it through the present value of future cash flows along with the relative market values of similar companies. To calculate the most accurate share price for Jet Blue, weighting each method differently will produce the best value. The Present Value of Future Cash Flows to the Firm receives the most weight, at 50%, for it is valuing the projected cash flows the company will receive. Historic P/E ratio and EBIT Multiple both only provide 25% of the valuation of the company for they are more subjective to market perspective and relative valuation from the other firms. This provides the weighted share price of Jet Blue at $26.95 which is higher than the original $25 to $26 dollars that management was considering to offer at the IPO of Jet Blue.

Weighted Valuation of Jet Blue Stock Share Price PV of FCFF $26.89 Historic P/E Ratio $26.19 EBIT Multiple $27.82 Weighted Share Price

Weight 0.50 0.25 0.25

Contribution $13.45 $6.55 $6.96 $26.95

Decision The value that JetBlue management should select for their Initial Public Offering price per share should be $26.95. This price reflects an accurate value of the corporation and allows excess capital to be raised comparatively against lower IPO values. As seen in the table below, a $0.95 increase from $26 will provide JetBlue with an additional $5 million. This is assuming that all 5.5 million offered shares will be purchased.
Capital Raised Comparison Minimum Required Initial Offer: Low Initial Offer: High Filed Offer: Low Filed Offer: Higher Value of Company Capital Raised $125,000,000 $126,500,000 $132,000,000 $137,500,000 $143,000,000 $148,225,000 Shares Purchased 5,500,000 5,500,000 5,500,000 5,500,000 5,500,000 5,500,000 IPO Offer $22.73 $23.00 $24.00 $25.00 $26.00 $26.95

The main concern with increasing the IPO offer price is the possibility that all the shares will not be purchased. If there is a high excess of shares after the IPO, this will not allow the company to reach their capital raised goal and would provide a negative portrayal of the company to the market. The table below shows how many of the IPO offer shares are required to achieve JetBlues capital goal. For the offer price of $26.95, the company can not sell nearly 16% of their offered shares and still achieve their capital goal. This may be concerned with other companies during the IPO process, but JetBlue management has continually needed to increase their share price to keep up with the demand for their shares. A $0.95 increase in the offer price will not decrease enough demand for the company to be nervous of raising at least $125 million in capital.
Sensitivities on Share Purchases Capital Goal $125,000,000 $125,000,000 $125,000,000 $125,000,000 $125,000,000 $125,000,000 Shares Purchased 5,500,000 5,434,783 5,208,333 5,000,000 4,807,692 4,638,219 IPO Offer $22.73 $23.00 $24.00 $25.00 $26.00 $26.95 % Purchase of Offers Required 100.00% 98.81% 94.70% 90.91% 87.41% 84.33%

Minimum Required Initial Offer: Low Initial Offer: High Filed Offer: Low Filed Offer: Higher Value of Company

JetBlue Airways should offer their IPO price at $26.95. This increase in IPO will provide the company a higher amount of capital raised while mitigating the risk with the amount of shares required. This price is a very attractive IPO price for investors for JetBlue has such a potential to increase share price and provide high returns.