Marko Veckov

Student’s Name Professor’s Name Course Number Date JET BLUE IPO CASE An IPO is a public offering of company’s shares to the public, most notably institutional and retail investors. This paper’s aim is to investigate circumstances of an IPO of a US airline company JetBlue. Company’s share offering to the public was debated between its officials and investment bank, because of the price of the shares. Their decision to lower initially proposed stock price enabled company not just to raise enough capital, but to pave way for any future raise and adequate returns to shareholders. JetBlue IPO and reasons behind it Company initially had strong capital base, but for further expansion, additional funding was needed. With its strong capital base, Jet Blue had acquired a fleet of new airbus A320 aircraft [CITATION Sch17 \p 2 \l 1033 ]. Company initially started with only one aircraft and was now in position to acquire lower costs per-available-seat per mile, due to economies of scale. The main reasons for the IPO are wishes to finance further growth and to cover losses by some of the company’s venture investors. There are two ways in which the company can raise additional funds, through debt or through equity. Debt could be private or bank debt or it could assume bond issuance. In terms of equity, large percentage of private equities are so-called buyout funds, where existing companies are bought, restructured and later sold. There is also venture capital financing, which JetBlue undertook at their initial starting stage, when they were promising new company. Other possible example of financing companies at the early stages of their growth, before they become too large is an IPO. As company is already experiencing losses of its venture financiers, an IPO would be a good way to deal with this issue. Pros and cons of the IPO There are several advantages to the usage of this process to raise capital. An IPO provides access to more capital later, liquidity for the stock as it enables initial investors to cash out, visibility and facilitation of potential mergers [CITATION Ode20 \p 7 \l 1033 ]. On the other side are disadvantages of this way of financing future operations. This is mostly more expensive way of raising cash with gross spread of 7 %. The other negative aspect is the need and obligation to provide financial reports. Company becomes vulnerable and open to hostile takeovers. There is also a legal liability for all the information about the IPO, which are in the prospect. Process itself distracts the attention from business and there is also the question of confidentiality act is the company that raises capital has annual gross revenues below 1 billion dollars. Since this is the case with JetBlue, it may be accustomed to keep certain information prior to the event private and not disclosed to the general public. The IPO process The IPO process is the process of going public or offering equities to the public for the first time and it usually takes three months to accomplish. Senior management is unbelievably involved in the process of doing an IPO[CITATION Owe11 \l 1033 ]. It is a unique event in the life of any senior management team, to go through this process. The level of work during these three months with various sides, auditors, underwriters or various chancellors, is enormous. Work also involves multiple checking of company’s financial statements and doings of roadshows, where company would be presented to potential investors. This work needs to be coordinated in a way that it allows the company to continue to run its everyday operations, while preparing for this event. One of the crucial moments of deciding to go for a public opening is its timing. We were first told to get moving in July of 2001 and we were prepared to file our initial registration for an SEC on September 11th [ CITATION Owe111 \l 1033 ]. Obviously, we didn’t make that filling based on the events on that morning. The impact of the terrorist attacks was felt immediately, and it took two months for airline industry and stock market to recover. With a little modification of books at the end of the year, company (JetBlue airlines) filed the request for an IPO at the start of 2002. Company’s business model of high growth, low-cost airline has rebounded successfully in the market after the attacks. The idea for an IPO came out of the notice that IPO market will welcome good earnings company with open arms. This would enable the company to follow the path of continuous growth in the future. Initial stage of preparing for an IPO process involves, creation of business plan, gathering of credible management team, preparation of qualified financial statements and projections and establishing cooperation with investment advisors. Before the process itself, company usually holds meetings with various investment banks, in order to choose right underwriter. The initiation of equity issuance process is followed by request from SEC to the company to withhold any information disclosure to the public. Company can continue its normal everyday operations, but any activity during that period that could raise awareness of the company name would be considered illegal. During this period, chosen underwriter will write the letter of intent, which provides information about the company’s securities that are supposed to be sold and describes rights and obligations of the parties in the process. As previously stated, the role and the size of senior management team have an influence on the success of the IPO process. Findings show that board size and board reputation measured as a number of multiple board membership are negatively associated with IPO underpricing, while board composition is not negatively associated [CITATION Sem13 \p 326 \l 1033 ]. Investors might perceive larger boards as a signal of higher information availability about the company. Perceptions that investors have about the company, if positive, could improve the entire process. Among the factors that can influence the investors evaluation of the company, the most important one is educational prestige of the board members. Others are corporate board experience, political experience, non-profit experience of the board and prior officer experience. The combination of these factors may signal organization legitimacy and along the way influence investor decisions prior to the IPO. Current IPO environment In 2002, low cost airline companies were just about to gain their moment of glory. Dominant player among them at the time was Southwest Airlines, which had 64 million passengers a year in 58 cities. Their market capitalization in April 2002 was larger than all other main carriers combined. Following their low-cost business model and flying on secondary airports in major metropolitan areas, other similar companies emerged, among them JetBlue. Many of these companies were highly resistant to turbulences in airline industry caused by 9/11 terrorist attacks. Many of these carriers have gone public around the time JetBlue was preparing to do so, including Ryanair and WestJet. Company’s innovative technology approach needed funding to develop even more faster and to capture a larger market share. These new, high-potential and capital-based ventures represent a small part of the startup landscape and a small part of the investment landscape [CITATION Siv14 \p 9 \l 1033 ]. Venture capital represents only a small portion of private equity assets and the one which is relatively risky and that occasionally lead to loss of value. However, an IPO is also a risky decision, as there is equal potential for high losses and high gains. JetBlue arise in this highly competitive industry by offering low cost client-focused service. Company mainly focused on servicing domestic routes, the ones from East to West and Northeast-Southeast parts of the United States. Company grew at a steady pace for two years prior to the IPO event, as evident in their increasing Airbus fleet and yearly revenues. Some Recent IPOs There are numerous examples of successful IPOs across all industry ranges in the years prior to the JetBlue’s management decision to go public. Some of these companies were publicly owned before offering their shares to the public. Usually, the decision to do so was the result of wish to acquire more capital for future expansions. At the height of the Internet hype in the late 1990s, Charter Communications went public in 1999. Company was the fourth largest cable operator in the US with 6.2 million subscribers. Finland’s Sonera, a telecom operator, also went public that year, was previously owned by the Finish government. After going public, government still had 58 % of ownership over it. Other examples in other industries include, for instance China Petroleum & Chemical, in the oil industry. Company went public in 2000, despite being publicly owned prior to the event, as Chinese government wanted to raise money to finance future growth. Agere Systems was a optoelectronic components company, who like many other dot-com bubble companies faced cuts in IT spending. Agere was a unit of Lucent to whom 2.5 billion $ debt was transcribed and so the company issued a warning before an IPO. Jet Blue WACC WACC is weighted average cost of capital and is calculated: E/V * Re + D/V*Rd*(1-Tc). While calculating cost of capital of the company, all sources of capital are incorporated in the equation, including stocks, bonds and other long-term debt. WACC is usually used as a discount rate for future cash flows. It is also used for calculation of return on invested capital or ROIC. In this formula E is market value of the firm’s equity, V is total value of the firm’s financing and D is a market value of the firm’s debt. Re is the cost of equity and Rd is the cost of debt, while Tc is a corporate tax rate. Ratios E/V and D/V show percentage of financing that is equity and percentage of financing that is debt, respectively. With all the data available for the period before an IPO, the only unknown item is the cost of equity. It is calculated using capital pricing asset model or CAPM, risk free rate of return + premium expected for risk. Other way of calculating this measure is, risk free rate of return + Beta * (market rate of return – risk free rate of return). Cost of equity in this case is 0.05 + 1.1 * 0.05 or 10.5 %. Cost of debt before the taxation is equal to 6.91 %. WACC is 16,071,992,000/18,055,457,600 * 0.105 + 1,983,465,600/18,055,457,600 * 0.0691 * 0.69 = 0.093 + 0.0052 = 9.8 %. Discounted cash flow and price multiples calculations By using the perpetuity model, where terminal value is FCF n * (1+g) + (r-g) we can calculate discounted value of future cash flow. The value of r is the discount rate, while g is assumed annual growth rate. The method is used to estimate the value of the investment based on future cash flows. Usually, discount rate used here is the weighted average cost of capital or WACC. When we multiple cash flows from different periods, above mentioned formula can be written as CF1/1+r + CF2/1+r + CF3/1+r + CF n/1+r. In this case it will be -249.58/1.098 – 243.5/1.098 -222.19/-/1.098 - 124.10/1.098 - 98.05/1.098 - 10.66/1.098 + 171.85/1.098 + 227.11/1.098 = -227.3 -221.7 – 202.35 – 134.52 – 113.02 – 89.29 – 9.7 + 156.51 + 206.83 = -634.54. Price to earnings ratio is the share’s relative price divided by its earnings per share. It can be written as market value per share/ earnings per share. Current stock price is 20.69, while earnings per share is company’s net profit divided by the number of common shares and for 2010 it is 292/35.1 or 8.31. Therefore, price to earnings ratio for the year 2010 is 2.48. Price range of company’s shares Price range ratio shows current position of company’s shares in comparison to its yearly range. It shows where the stock is currently relative to its 52-week price range. Price range for stocks based on the data1 for the year 2010 is between 5 and 7 dollars. Since current price is 20.69 $, we can say that there is strong suggestion that the price is overvalued. Underpricing Underpricing is the practice of companies that decide to go public to lower their share prices below real value in the market. Reasons for this decision can be multiple and one of them is certainly a desire to sell all the shares without some of them being unsold. The other possible reason is informational asymmetry of some classes of investors. However, the influence of various factors predominantly depends upon country specific regulations, market microstructure and price discovery mechanism [CITATION Kat16 \p 32 \l 1033 ]. Controlling of these factors does not necessary eliminates the possibility of underpricing. In the case of JetBlue IPO demand for shares caused management team to offer higher price range than initially though, despite it being called “overblown” by some analysts in the company. Company that sells its shares needs to ensure that they will be attractive to all classes of investors. These investors types are categorized based on the informational asymmetry and possible market obstacles they face. Those share offers that are deemed to be unsuccessful are resulting higher costs and negative spillover effect. Need for an IPO requires from the company to sell its shares within certain time frame. All this leads to a situation where different types of investors have different information about the company and its prospects. This can result in some investors giving up and deciding not to pursue company’s shares, thereby reducing demand and share price. This difference between investors’ perception and perceived value of share for the issuer results in underpricing. Usually issuer consults the underwriter before deciding to set price share prior to the IPO. Sometimes, if the issue doesn’t occur in the right period, underwriters can’t estimate issuer’s valuation of this new issuance. Underwriters also sometimes deliberately underprice in order to ensure the success of the issue. Also, due to their smaller capital bases they want this new issuance to be a quick sale. If a higher volatility of shares is expected they would implement this process in order to secure successful emission of shares. They also have a chance to claim some of these shares as they can be rewarded for their service in this way, therefore their desire for successful issuance is even greater. Sometimes, investors would accept underpricing in order to satisfy potential investors and to secure their future cooperation with some new issues. This is vital for the company that decides to go public, as sometimes all capital requirements can’t be met with a single issuance. All these reasons suggest that underwriting occurs when goals and objectives of issuer, investors and underwriters are not aligned. Besides informational asymmetry approach, there are other ones which also deal with this issue, like signal theory or efficient market hypothesis. Works Cited IPO_Process. Perf. John Owen. Darden Publishing. 2011. YouTube Video. Accessed 22 October 2020. . Katti, Supriya and B.V. Phani. "Underpricing of Initial Public Offerings: A Literature Reviiw." Universal Journal of Accounting and Finance 4.2 (2016): 35-52. Accessed 23 October 2020. . Odegaard, Bernt Arne. "Raising Capital." 2020. Accessed 21 October 2020. . Schill, Michael J., et al. "Jet Blue Airways IPO Valuation." Case Study. 2017. Accessed 21 October 2020. . Semmelrock-Picej, Maria Th and Ales Novak. The Proceedings of the 9th European Conference on Management Leadership and Governance. Academic Cobferences and Publishing International Limited, 2013. Accessed 22 October 2020. . Sivan, Yesha. "The Venture Ecosystem Framework: Messy, Fast and Global." Venture Findings (2014). Accessed 23 October 2020. . Timing_Decision. Perf. John Owen. Darden Publishing. 2011. YouTube Video. Accessed 22 October 2020. . Yahoo Finance. JetBlue Airways Corporation. 2020. Accessed 23 October 2020. .