Jaime Zulueta June 5, 2018

57176006-8 Venture Capital Financing

Case Analysis: Netscapes’s IPO

Brief Overview
The case takes place in 1995, in the middle of the dotcom boom. Netscape, the leader in the web browser market, is about to
conduct its Initial Public Offering. There is an unexpected development as the lead underwriters have proposed to
Netscape’s Board of Directors that the offering price be doubled from $14 to $28 per share. At 44.7M shares (5M shares
plus the 33M existing shares), the valuation of the company would be over $1Billion. The Board is concerned as to whether
this valuation can be justified by Netscape’s fundamentals. There is also tension as the IPO market has been volatile in the
past (biotech) and among other internet companies.

Why has Netscape been so successful to date? What appears to be its strategy? What must be accomplished if it is to be a
highly successful going concern in the long run? How risky is its current competitive position?
Netscape is the undisputed leader in the Web browser market with 75% market share. The company appears to be one of the
earliest players in this industry. At the same time, the company carries one of the founders of Mosaic, the original web
surfing program. The strategy of Netscape / Marc Andreessen (Mosaic founder) is to distribute the software for free to
anyone who can use it, then make money afterwards. This enables mass adoption of the product.

In order for the company to be successful in the long run, it must be able to expand its services to other markets such as the
commercial market and continuously serve the increasing number of users. For this it will need cash as the company is still
in the growth stage and is losing money annually. The competitive position is quite risky as industry giants such as
Microsoft and AOL are set to enter the stage. These companies currently make at least 10x more revenue than Netscape and
possess the financial resources to wage a war on Netscape.

The case points out that the IPO market is sometimes characterized as a “hot issue” market, and that many IPOs are
viewed in retrospect as having been “underpriced.” What might explain these phenomena? Should the Netscape board be
concerned about underpricing? Why or why not?
A hot issue market is where many popular or hyped up companies go public. Usually these companies will initially offer a
limited number of shares, which will result to oversubscription which in turns reinforces the belief that this company is
highly sought after by investors. The Underwriters will then increase the number of shares to be issued to accommodate the
demand. Hot issues belong to young and upcoming industries. Nobody really knows the size of the industry at first as it is
still in its infancy. Thus a company that goes public at the time can be seen as underpriced as the market it operates in is
much bigger than anyone could imagine. This has occurred in the biotechnology and internet technology markets.

I do not think the Netscape board should be concerned with underpricing. If the stock is truly underpriced, then the market
will eventually come to realize this and shore up the price in the future. The Board should be concerned with raising enough
funds to continue growing the company or at least maintaining its long-term prospects. If the Board is with this company for
the long-term and is not seeking to encash their shares immediately, then underpricing should not be a concern unless it
affects the funding necessary to achieve growth.
Can the recommended offering price of $28 per share for Netscape’s stock be justified?

Discount Rate: 12%

Annual Revenue Growth Rate: 55.75%
Number of Stocks, including 5M issuance: 38M
Target Valuation at $28/share: $1,064,000,000
a) The sum of discounted cashflow from Year 1 to Year 10 is $162M
b) In 2005, the perpetuity formula with a perpetual growth rate of 4% will result to the following:
o (FCF Year 10*1.04%)/(12%-4%) = $2.8B, discounting this by 10 years will result to USD902M
c) Sum of the results in a) and b) will add up to $1,064,298,098
As an executive of Netscape, what would you recommend with respect to the proposed offering price? As an investor in
Netscape, what would you recommend? As the manager of an institutional fund who was willing to buy and hold Netscape’s
stock at the originally proposed price of $14 per share, would you willing to buy and hold at an initial offering price of $28
per share?

The answer to these questions is all relative to the goal and strategy of the Netscape Board, the investor, and the fund
manager.

As an executive of Netscape, the doubling of the offer price signals that investor sentiment is high on the company. This
sentiment should be balanced however with what the company can reasonably achieve. A price too high, that cannot be
sustained by fundamentals, will eventually crash which will lead to other problems. A stock price crash could lead to
negative sentiment from people beyond shareholders such as regulators, bankers, customers, etc. Only pursue a price
increase if it can be justified by financials and future plans.

For an investor of Netscape, he/she should consider selling or buying based on goal and belief. If the investor believes the
potential of the company and industry can support higher prices, then he/she should buy hold. However, if he/she does not
support the price but believes a quick profit can be made, then the investor can buy and sell upon open. If the investor
believes the price is too high regardless of market sentiment, then he/she should not buy at all.

The fund manager should act according to his/her research and investment strategy. If the research shows the price can be
supported, then he/she should recommend buying and holding at a higher price, and vice versa. If the fund strategy is to be
conservative, then maybe he/she should not purchase at all.