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FINE 7600 VALUATION AND FINANCIAL ENTERPRISES October 24, 2012 Authored by: Xian Sophie Li, Yu Charlotte Pei, Tiancheng Toby Sun, Adrian Townsend, and Yu Yvonne Wang
Over the last 50 years, I.P.O.s in the United States have been underpriced by 16.8 percent on average. This translates to more than $125 billion that companies have left on the table in the last 20 years. I.P.O. underpricing is also a worldwide phenomenon. In China, the underpricing has been severe, averaging 137.4 percent from 1990 to 2010. This compares with 16.3 percent in Britain from 1959 to 2009. In most other countries, I.P.O. underpricing averages above 20 percent. (Davidoff, 2011)
However, using trailing indicators we calculated the current share price to be substantially lower at $28.84. The wide variance is due to: 1) Increased price earnings ratios in 2002 for low-cost carriers; and 2) Increased earnings per share for JetBlue. The range is made wider when using the average P/E multiple from the sample group: $28.46 to $37.28.
Price / Earnings Multiple
Trailing Price/ Share $6.60 $17.00 $32.05 $18.48 $15.85 Earnings/ Share 0.26 2.03 0.73 0.67 0.81 0.90 0.73 1.14 PE Multiple 25.29 8.37 44.02 27.59 19.57 24.97 25.29 $25.30 (mult. med.) 1.20 $28.43 (mult. med.) Leading Earnings/ Share 0.33 0.37 0.94 0.65 0.59 0.58 0.59 PE Multiple 20.00 45.95 34.10 28.43 26.86 31.07 28.43
Airlines positive earnings AirTran Frontier Ryanair Southwest WestJet Average Median JetBlue
Tr ailing
$28.84 $34.12
JetBlue Leading
(Trailing EPS supplied Exhibit 3; Leading EPS adjusted for increased earnings and newly issued shares)
F IGURE 1
Total Capital Multiple The total capital multiple company comparison (figure 2) utilized published figures from all low-cost carrier airlines; the sample size for this comparison was the largest of the comparable companies analysis methods. While the total capital multiple uses trailing indicators, the multiple is the least subject to accounting practice variances; debt and equity accounting have fewer GAAP methods of calculation.
Total Capital Multiple Trailing
Price/ Share AirTran Alaska Air America West ATA Frontier Ryanair Southwest WestJet Average Median JetBlue Tr ailing $6.60 $29.10 $3.50 $14.95 $17.00 $32.05 $18.48 $15.85 Book Equity/ Share 0.49 32.12 12.47 10.79 5.36 5.54 5.26 2.82 Book Debt/ Share 3.96 33.80 10.20 32.90 0.01 3.33 1.79 0.97 Total Capital Multiple 2.37 0.95 0.60 1.10 3.17 3.99 2.88 4.44 2.44 2.62 $2.62 (mult. med.)
$27.50
5.16
8.59
F IGURE 2
Again, the median figure was most representative of the sample (as it disregarded unusual outlying high and low performers), and provided a valuation of $27.50 for JetBlue. This valuation is slightly below the range of the leading and trailing values generated by the P/E multiple ($28 to $34). The valuation estimate drops to $24.93 per share when using the average total capital multiple from the sample group. However, the
median figure is still conservative as it is below the 2.88 multiple of Southwest. Southwest provides the closest proxy to JetBlue, because JetBlue duplicated Southwests operational practices in the unclaimed New York hub market. EBIT Multiple The EBIT multiples (figure 3) provide a useful comparison with low-cost airline carriers with different capital structures. However, the EBIT multiple had the widest range between trailing and leading estimates; and the widest range between the EBIT multiple average and median. For these calculations, the average of the sample represented JetBlue most closely.
EBIT Multiple
Trailing Airlines positive earnings AirTran Frontier Ryanair Southwest WestJet Average Median JetBlue Tr ailing JetBlue Leading Price/ Share $6.60 $17.00 $32.05 $18.48 $15.85 Book Debt/ Share 3.96 0.01 3.33 1.79 0.97 EBIT/ Share 0.81 2.99 0.92 1.09 1.32 1.43 1.09 1.42 EBIT multiple 13.04 5.69 38.45 18.60 12.74 17.70 13.04 $17.70 (mult. ave.) 1.97
$19.12 (mult. ave.)
Leading EBIT/ Share 0.76 0.64 1.17 1.42 1.59 1.12 1.17 EBIT multiple 13.89 26.58 30.26 14.27 10.58 19.12 14.27
$16.48 $29.08
8.59
(Trailing EBIT 18% greater than net income, Exhibit 3; Leading EBIT $80M / 40.6M shares, Exhibit 13)
F IGURE 3
Similar to the P/E multiple, the large gap between the trailing and leading estimate is mainly due to JetBlues large jump in EBIT for 2002 (over 100 percent). JetBlues increase in EBIT is magnified by the samples increase in the EBIT multiple. The trailing multiple valuation provides a conservative $16.48 per share ($9.87 per share when using sample median multiple). However, the leading valuation is in line with the other multiples at $29.08 per share ($19.54 per share when using the median multiple).
5. The risk-free rate and market premium are as of April 2002 6. Corporate income tax rate remains flat at the 2002 level of 34 percent. 7. A terminal growth rate of 4.5 percent, which is a reasonable estimate of GDP growth, based on official estimates. (Bureau of Labor Statistics projection for GDP by 2005 plus inflation) 8. The levered beta for the Airline Industry is 1.08 (Yale School of Management, 2002); however we chose the higher levered beta of Southwest (1.10) as the best representation of low-cost carriers levered beta (figure 4).
Southwest Capital Structure
Market Value Equity Market Value Debt Enterprise Value Southwest D/E Ratio SW Levered Beta SW Unlevered Beta Southwest Tax Rate JetBlue Tax Rate Jet Blue D/E Ratio JetBlue Levered Beta 16,071,992 (776.8M shares * $20.69, ex hibit 5) 1,842,000 (Exhibit 5) 17,913,992 0.11
JetBlue Beta
1.10 (Ex hibit 5) 1.02 31% (Ex hibit 5) 34% (Ex hibit 13) 0.31 Estimate using median total capital multiple (ex hibit 7) 1.23
F IGURE 4
Weighted Average Cost of Capital Using the market value capital structure estimate from the total capital multiple (figure 2), we calculated the weighted average cost of capital for JetBlue to be 9.22 percent (figure 5).
Pretax cost of debt Tax rate After-tax cost of debt Dividends of Preferred Stock Convertible Preferred Stock Cost of preferred stock Equity beta Rf RM-Rf Cost of common stock Debt-to-Cap Preferred-to-Cap Common-to-Cap WACC
7.91% (Ex hibit 6) + 0.5% premium for new company w/ 10y r debt 34% 5.22% K d (1-t) 16,970 ( Ex hibit 3) 210,441 ( Ex hibit 2) 8.06% K p = Dp / P p 1.23 5.00% April 2002 long-term U.S. Treasuries 5.00% Market risk premium giv en at 5% 11.15% K e = Rf + b*(Rm-Rf) 23.80% Estimate using median total capital multiple (ex hibit 7) 16.62% Estimate using median total capital multiple (ex hibit 7) 59.58% Estimate using median total capital multiple (ex hibit 7) 9.22% WACC = K d (1-t) * Wd + K p *Wp + K e * We
F IGURE 5
Discounted Cash Flow Share Price Valuation The resulting share price from the discounted cash flow analysis (figures 6 and 7) is $29.89. This figure is within the P/E multiple valuation range (the industrys standard practice for valuation) of $28 to $34. The discounted cash flow analysis price per share is slightly higher than the total capital and EBIT multiples. We subjected the DCF price per share to a sensitivity analysis (figure 8) to calculate the effect of a change in growth and a change in the weighted average cost of capital. An adjustment of 0.5 percent to either the WACC or the terminal growth rate resulted in changes to the share price estimate of 20 to 30 percent. The effect of the WACC rate on JetBlues share price highlights the value of the I.P.O. to JetBlue. The I.P.O. will reduce the cost of equity (by introducing liquidity to private equity holders); additionally the improved debt-to-equity ratio will provide JetBlue with increased access to the debt markets. With a carefully calculated capital adjustment, JetBlue can further decrease its weighted cost of capital by using the tax shield benefits of capital debt and the lower cost of debt.
Year NOPAT Growth (NOPAT) Depreciation Capital expenditure Net working capital Net working capital Free Cash Flows Discounted FCF
F IGURE 6
2002E
52.64 196% 17.71 290.37 63.47 29.56 (249.58) (228.51)
2003E
88.67 68% 26.25 328.34 93.54 30.08 (243.50) (204.11)
2004E
119.57 35% 35.60 344.76 126.14 32.60 (222.19) (170.52)
2005E
148.99 25% 44.62 310.29 157.18 31.04 (147.71) (103.79)
2006E
180.77 21% 54.45 325.80 190.71 33.53 (124.10) (79.84)
2007E
215.06 19% 65.15 342.09 226.88 36.17 (98.05) (57.75)
2008E
247.44 15% 75.38 299.33 261.03 34.15 (10.66) (5.75)
2009E
270.28 9% 82.82 157.15 285.13 24.10 171.85 84.84
2010E
292.16 8% 90.04 132.00 308.22 23.08 227.11 102.66
Terminal
5024.17 2270.95
Share Price
F IGURE 8
Terminal Growth Rate 4.0% 4.5% 5.0% 31.88 39.06 48.17 24.29 29.89 36.81 18.13 22.58 27.98 F IGURE 7
WACC
Terminal Growth WACC NPV Less: Preferred Shares Less: Long Term Debt Add: Cash Equity Value $ Shares (millions)
4.50% 9.22% 1,608 (210) (301) Sensitivity Analysis 117 Price/Share 1,213 8.72% 40.60 9.22% 29.89 9.72%
underpricing (access to future capital; generating goodwill and publicity; enticing uninformed investors), we therefore suggest the conservative range of $27 to $29. The current suggested price of $25 to $26 unnecessarily leaves too much money on the table.
Works Cited
Bruner, R., Eades, K., & Schill, M. (2010). Case 28 JetBlue Airways IPO Valuation. In R. Bruner, K. Eades, & M. Schill, Case Studies in Finance (pp. 381-399). McGraw-Hill. Davidoff, S. M. (2011, May). Why I.P.O.'s Get Underpriced. Retrieved from New York Times: http://dealbook.nytimes.com/2011/05/27/why-i-p-o-s-get-underpriced/ Keloharju, M. (1993). THe Winner's Curse. Journal of Financial Economics, 254-277. Rock, K. F. (1986). Why New Issues are Underpriced. Journal of Financial Economics, 187-212. Yale School of Management. (2002, October 9). JetBlue. Retrieved from http://analystreports.som.yale.edu/reports/JetBlue.pdf