CASE STUDY

JetBlue Airways corporation

by-

Praveen Rai

About the company:-

•JetBlue Airways corporation was formed in Aug.1998.. by DAVID NEELMAN , a veteran in low fair airline industry, with providing low fair ,low cost, but high service passenger airline serving in US market.

•The initial investors provided amount of $175M in start up equity capital. JetBlue began flying in FEB-2000. & $158M additional capital was raised through its IPO in April 2002

•.Due to strong financial results & good value of their shares, Jet blue perceived successful business model. On 30 June 2003, JetBlue’s shares closed at $41.98

• Operations:-• JetBlue’s operation were deigned to achieve low operating cost

and give pleasant flying experience to customers through-• Utilizing aircraft efficiently- JetBlue operated its aircrafts

average 12.9 hrs a day rather than 9 hrs as competitor done, it generate more revenue per plane.

• Operating one type aircrafts- JetBlue used single type of Airplane, that’s why it reduced maintenance cost, lowered required investment on parts and lower training cost.

• Developing more productive work force- JetBlue’s have multitasking employees, they could perform multiple task , so fewer employees were needed in comparison of other airline companies with more restricted work rules.

• Lowering distribution cost- JetBlue didn’t provide paper tickets. It provided through web site, by this it reduce printing and back office operation cost.

• The company also focused on improving the flying experience for its customers through more comfortable and additional things.

JetBlue’s Market- Choose to fly densely populated cities

( metropolitan cities) where JetBlue’s low air fares stimulate new demand from passengers.

  Finacial results- At the time of 2000-2003 when US carriers

struggled and giant players were demolished, at that time JetBlue posted strong revenue growth and became more profitable airlines.

• Growth opportunities-• In early 2003 , JetBlue tends to grow by adding both new

markets(middle cities-100 to 600 passengers per day) and new flight to existing destination.

• JOHN OWEN, Chief Financial Officer of JetBlue at time of expansion of business, sign contract to purchase additional new aircraft from Airbus and Embraer ,the main features were-

• For purchasing of 65 new airbus A320 (120 seats) aircrafts delivered till 2011,which costs $2.5 b.

• For purchasing 100 Embraer E190 (100 seats) aircrafts delivered from 2005-2011 which costs$ 3b.

• For purchasing of these aircrafts company needed $5.5b. for which John Owen got two suggestion from investor bankers .which were- 

1. Offering a new public equity of 2.6 m shares at an estimated $42.50 per share. It enabling to raise $110.5 m.

2. Issuing $150m in a private placement of 30 years convertible debentures which have coupon rate of 3.5% and it will be convertible into share of JetBlue @$63.75 per share.

 

• Financial alternatives-• According to company’s policy it has option to choose secured debt or

operating leases.• Owen believed that there were some reasons to raise additional capital-• 1. New capital would ease JetBlue’s ability to finance short term

obligations.• 2. Additional capital would strengthen the company’s balance sheet at

time when JetBlue’s would be carrying amount of debt for new aircraft. • Equity and Debt consideration-• Owen assembled a financial forecast for JetBlue’s and considered

financial policies appropriate for company in the future.• When Owen go for the equity then it get financial flexibility but it will

make adverse effects on BOD because they sensitive about dilution of shares.

• Now Owen moves to the debts options ,JetBlue’s investment banker had proposed private placement of convertible debt ,it will make happy BOD who were particular concern about dilution but it would be unsecured and subordinated to the company’s existing secured debt.

 

• DESCRIBE THE EXISTING BUSINESS AND FUTURE PROSPECTS OF JETBLUE?

Current business:-1.Net income($ thousands)-553152.Net revenue($ thousands)-4618313.Operating 73 flights per day.4.Useing in single type of airplane, that’s name is airbus-A320, which has 120 seats. It provide high service at low cost.It focuses on highly condensed populated area.

FUTURE PROSPECTS OF JETBLUE:-

1. Increase the no. of planes( from 45 to 252)and flight,

2. Targeting new customers by giving more facilities.

3. Focusing on new middle segment market or small cities , with Embraer E190 (100 seats capacity) In small cities where 100-600 passengers travelled daily.

4.Increasing no of employees and enhancing the skills of existing staff.

NEED OF FINANCING

1. To increase its aircraft fleet

2. To maintain operational expenses

3. To raise Additional capital

1. To increase aircrafts fleet(45 to 252)To accommodate the company’s growth opportunities Adding new markets (mid sized market segment) Adding new flights to existing destinations

Aircraft Purchases• Airbus Aircraft Purchase (2004 to 2011) • Embracer Aircraft Purchase(2005 to 2011 )

Airbus A 320 Embracer E190

Estimated value (millions)

Firm orders

65 100 $6,860

Orders on option

50 100 $5,000

2. TO MAINTAIN OPERATIONAL EXPENSES

Investment in spare partsNew hangarsFlight training centerSkilled employeesMarketing campaigns

TO RAISE ADDITIONAL CAPITALNew capital wouldease its ability to finance its short term obligations

Strengthen the company’s balance sheet

EQUITY VS DEBT CONSIDERATIONEquity consideration Debt consideration

$ 110.5 million $ 150 million

Distribution of Ownership Remain same

Dividends / floating rates Interest 3.5% *

Low cost Burden of regular interest

Growth in its share price Adverse Effect of hiking fuel prices

Good balance sheet will attract subscription to equity

Due to market interest prevailing rates on higher side can affect the subscription of debentures on comparatively low rate

It will help in expansion of business

Enhance financial flexibility Less financial flexibility

Availability of liquidity for shareholders

Money is blocked for 30 years for the holders

2003 2004 2005

Operating revenue

999.5 1397 1846.7

Total operating expenses

822.1 1,144.9 1,846.7

EBIT 177.4 252.1 333.3

Operating Revenue

Total Operating Cost

EBIT0

400

800

1200

1600

2000

200320042005

Financial Forecast prepared by Morgan Stanley (in $ millions)

Market interest rats as of June 30, 2003 30 years Treasury bonds @ 4.70% Corporate bonds AA @ 5.19% A @ 5.35% BBB @ 6.84%

+ive pointsRaise $110millionDividendsRetained earningsPast performance of share priceFinancial forecastFinanacial flexibility

-ive pointsDistribution of ownershipRetained earnings

POSITIVE AND NEGATIVE POINTS OF EQUITY

POSITIVE AND NEGATIVE POINTS ABOUT DEBT CONSIDERATION

+ive points Low interest rat Unsecured Convertible debentures Ownership will remain same 30 years maturity date Conversion at $63.56

-ive points High market interest rates less financial flexibility Burden of regular interest

Q.Which proposal should be preferred ?

Mr. Owen should go for second proposal because…..

1. Board of directors are highly sensitive about dilution so they would not prefer equity consideration.

2. “Retained earnings” or no dividend is the major reason which can let down the firs proposal.

3. In the second proposal investors will a have an option to convert it into shares, this gives an edge to second proposal over first.

4. For acquiring assets long term borrowings are preferred.

5. Although second proposal seems good but it will reduce financial flexibility of firm because

Quantitative analysis

Quantitative analysis. 1. net income approach

Degree of leverage

Cost

of

capit

al

ke

ko

kd

This approach says cost of debt is lesser than cost of equity , so this approach supports second proposal

Mm hypothesis and NOI approach

degree of leverage

Ke

Ko

Kd

Cost

of

cap

ital

This approach says that cost of equity increases with increase in degree of leverage

(debt equity ratio) , so firms financing should look this issue that equity share capital is slightly more risky and costly while debt is safer and cheaper.

ke= dividend per year * 100/market value of share

kd= interest paid per year * 100/market value of

debt

Suggestions for the firm

As funds are needed for working capital and acquiring assets, a single method would not be fruitful because

equity will not get right valuation , on the other hand debt consideration

will reduce financial flexibility so the company should go for the

mixture of both thing i.e. working capital should be acquired

by equity and for purchasing planes debt should be considered.