Mr. Andreessen’s strategy was: “give away today and make money tomorrow”. The successful intuition of Andersen lied on the fact that Netscape could reach a high degree of success (make money tomorrow) only if its software was known and used by the public. Thus,
Andreessen was committed to distribute of software for free, as well as to a heavy invest in
R&D. This strategy generated initial negative cash flows and clearly it was not sustainable in the long run. In order to become highly successful, Netscape had to be able to find the means to continue the invests in R&D, set the industry standard, outperform the competition, and ultimately be profitable. When Andreessen initiated his strategy the market was not competitive.
However, Microsoft had the financial means and the reputation to potentially become Netscape’s direct competitor. Netscape was able to set the industry standards and create a good reputation.
Ultimately, when the IPO took place, investors perceived the company to be the new leader in the market. Currently, the market is very competitive and the same strategy that made Netscape so successful it may not lead to the same results.
New tech companies who focus on high growth, tend to raise capital in three main ways: creating an alliance, through venture capital or through IPO. A strategic alliance, would have provided not only capital but also assets to create economies of scale. It seems that an alley would provide much more than what Netscape needs. Netscape in fact, has a well functioning
R&D and is setting up the stage to become the leader in the market without the needs for an alliance. Netscape can perhaps consider a merger as a mean of growth after the IPO. Another way to raise capital is through a venture capital however, it is deducible from the case study that
Netscape has been injected with capital from joint ventures multiple times already. These

injections were from Clark as well as from venture capital Kleiner, Perkins, Byers. Netscape chose the IPO which is the most expensive way of raising capital but perhaps the most suiting alternative for the company’s needs. It is worth to mention that IPO however, comes with a cost.
The case study mentions that “underwriters would receive 9.8 million”[1] from the transaction.
IPO is also a very intense commitment for the future: it involves the company to disclose private information on a regular basis (e.i. financial reports) and to bend towards the ‘short term profit’ mentality of the stockholder.

[1] Netscape’s Initial Public Offering. Harvard Business review.

Q5&6

To recommend a price of $28 per share, we had to make some assumptions. Using the list of assumptions provided, we created a discounted cash flow valuation starting with a revenue base of $16.625 million in June 1995. Since the base only accounted for six months of cash flow, we found the growth for the second half of 1995 and then took the combined 1995 total and applied the growth rate on a yearly basis from 1996 through 2005. We subtracted cost of goods sold, operating expenses and research & development from revenue to get net income. We used a straight­line method of decreasing both operating expenses and capital expenditures until 2001 where it remained constant. Depreciation, CAPEX, and NWC were used to adjust net income to get cash flows. To calculate the terminal value, we divided the 2005 cash flow by our WACC minus a 4% long­term growth rate.

To calculate a weighted average cost of capital, we first had to calculate cost of equity

and debt. Since there was little, if any, information provided on the cost of debt and the debt structure, we assumed a cost of debt of 11%. We believe this is reasonable given the risky

nature of the industry and Netscape specifically. The cost of equity was our next calculation. We used the equity beta of American Online since it was closer in terms of assets and revenues to
Netscape. We assumed a large risk premium of 18% because of the riskiness of the industry.
Using the given risk free rate of 6.71%, we used CAPM to calculate the cost of equity to be
19.85%. We kept the same weight of debt and equity of Netscape (61% debt and 39% equity).
Using the above and a tax rate of 34% provides a WACC of 12.14%. The NPV is $140 million and we assumed 5 million shares. Discounting the cash flows at the WACC, a growth rate of at least 16.75% a year for the next ten years is needed to justify a $28 share price. We believe this is unreasonable. Netscape is a high growth company but growing by almost 17% each year for the next ten years sounds quite difficult. We believe the original recommendation seems more feasible and provides more value for shareholders than the larger amount of shares for a higher price. As executives of Netscape, we would be tempted to take the offering for the higher

number of shares and price to generate more initial cash flow. However, not being able to uphold the value will cast a negative shadow on the company and question the ability of the company to produce cash flows in the future. This would deter us from going with the larger offer and share price. As investors, we would want to be compensated for the risk associated with an IPO and therefore would want lower prices that would appreciate. As managers for institutional investors, we would probably be willing to buy and hold the $28 shares under the assumption that the price will eventually appreciate. If the price decreases initially, managers have incentives to hold the shares until they appreciate. This only holds true if the shares appreciate and are not overvalued in the long term.

Paper Being Revisited. Netscape Communications Corporation, founded in 1994, specializes in client, server, and integrated applications software for personal communications and commerce on the Internet and private
IP networks. Netscape’s products allow servers to communicate across the Internet through a variety of mediums including graphics, video and sound. Its’ most popular product is Netscape Navigator, a program that allowed personal computers to exchange information and conduct commerce on the Internet.
Upon its inception, Netscape Navigator generated 49% and 65% of Netscape’s revenues in its first two quarters. In 1995, Netscape began the IPO process and found that demand for their shares far exceeded th expectations. On August 8 underwriters increased the number of shares offered from 3.5 million to 5

million shares. It was recommended to management that they also double Netscape’s initial offer price from $14 to $28. With this offer price Netscape was trading at 62.5 times its net book value.

Netscape’s Vice­President of Technology Mr. Andreessen’s strategy was to “give away today and

make money tomorrow”. This strategy relied on the network effect; Netscape could create value and reach a higher degree of success (make money tomorrow) only if its software was known and used by the many. Andreessen was committed to distributing the software for free as well as to a heavy investment in research and development (R&D). Initially, this strategy generated negative cash flows and did not appear to be sustainable in the long run. In order to become successful, Netscape had to have the financial capital to invest heavily in R&D, set the industry standard, outperform the competition, and ultimately, be profitable. When Andreessen first initiated his strategy the market was not competitive. However,
Microsoft had the financial capital and the reputation to become Netscape’s direct competitor. When
Netscape’s IPO took place, investors perceived the company to be the new leader in the market. Netscape

was thus able to set the industry standards and create a good reputation. Currently the market is very competitive and the same strategy that made Netscape so successful it may not lead to the same results.

High growth, new, technology companies commonly raise capital in two ways: creating an

alliance or through a venture capital. Although strategic alliance would provide financial capital and assets to create economies of scale, it would go beyond real needs of Netscape. Netscape, in fact, has a well functioning R&D unit and is gathering momentum to become a leader in the market without the need for an alliance. Our best recommendation for a strategic alliance would be for Netscape to consider a merger as a mean of future growth after the IPO has stabilized. A joint venture offers Netscape a second way to raise capital. Netscape has been injected with capital multiple times already from Clark as well as from venture capitalists Kleiner, Perkins, Byers. In the end, Netscape chose an IPO in order to meet their capital requirements.

A company will have an IPO in order to generate capital to grow and expand their business. With

these excess funds a company can increase capital expenditures and further invest into research and development. A company also greatly benefits from the increased publicity their brand and products receive due to the IPO. Venture capitalists and early investors in a company use an IPO as a way to cash out and realize the gains of their investment. In Netscape’s case we can see that there is high investor demand. Investors are clearly optimistic about Netscape’s future performance since they are willing to pay such a premium for its stock. Companies can take advantage of market hype and overvaluation of their shares.

IPO’s are not without their disadvantages, however and management must consider all the factors

when deciding to seek public funding. Once a company goes public they are subject to much stricter regulations and oversight from the SEC. Periodic financial reporting requirements have greatly increased the cost companies must spend on internal auditing. Furthermore having public shareholders also places

increased pressure on management to focus on activities that produce short­term stock gains at the cost of long­term growth. While an IPO is the most expensive way of raising capital, it is likely to be the most suitable alternative for Netscape. Although, Netscapes’ “underwriters would receive 9.8 million” from
[1]
the transaction an IPO is a very intense commitment for the future.

To recommend a price of $28 per share, we had to make some assumptions. Using the list of

assumptions provided, we created a discounted cash flow valuation starting with a revenue base of
$16.625 million in June 1995. Since the base only accounted for six months of cash flow, we found the growth for the second half of 1995 and then took the combined 1995 total and applied the growth rate on a yearly basis from 1996 through 2005. We subtracted cost of goods sold, operating expenses and research & development from revenue to get net income. We used a straight­line method of decreasing both operating expenses and capital expenditures until 2001 where it remained constant. Depreciation,
CAPEX, and NWC were used to adjust net income to get cash flows. To calculate the terminal value, we divided the 2005 cash flow by our WACC minus a 4% long­term growth rate.

To calculate a weighted average cost of capital, we first had to calculate cost of equity and debt.

Since there was little, if any, information provided on the cost of debt and the debt structure, we assumed a cost of debt of 11%. We believe this is reasonable given the risky nature of the industry and Netscape specifically. The cost of equity was our next calculation. We used the equity beta of American Online since it was closer in terms of assets and revenues to Netscape. We assumed a large risk premium of 18% because of the riskiness of the industry. Using the given risk free rate of 6.71%, we used CAPM to calculate the cost of equity to be 19.85%. We kept the same weight of debt and equity of Netscape (61% debt and 39% equity). Using the above and a tax rate of 34% provides a WACC of 12.14%. The NPV is
$140 million and we assumed 5 million shares. Discounting the cash flows at the WACC, a growth rate of at least 16.75% a year for the next ten years is needed to justify a $28 share price. We believe this is unreasonable. Netscape is a high growth company but growing by almost 17% each year for the next ten

years sounds quite difficult. We believe the original recommendation seems more feasible and provides more value for shareholders than the larger amount of shares for a higher price.

As executives of Netscape, we would be tempted to take the offering for the higher number of

shares and price to generate more initial cash flow. However, not being able to uphold the value will cast a negative shadow on the company and question the ability of the company to produce cash flows in the future. This would deter us from going with the larger offer and share price. As investors, we would want to be compensated for the risk associated with an IPO and therefore would want lower prices that would appreciate. As managers for institutional investors, we would probably be willing to buy and hold the $28 shares under the assumption that the price will eventually appreciate. If the price decreases initially, managers have incentives to hold the shares until they appreciate. This only holds true if the shares appreciate and are not overvalued in the long term.

A hot issue is when the security is selling at a premium over the issue price on the first day of

trading causing initial buyers to earn very high returns. A hot issue is prevalent in IPOs and results from underpricing or oversubscription of shares. The Netscape board should be concerned about the
[2]
possibility of their IPO being a hot issue. While initially the price of hot issue securities may increase dramatically, over time, the price of the majority of these securities ends up falling back to the issue price if not below it. PixTech, for example, was an IPO with a 15% decline in the stock price following the offering. The allure for the senior management was preferred stock with the option to convert them into common stock once the company went public. While it appeared they “stood to gain millions on paper in the face of a highly oversubscribed IPO within a ‘hot issue’ market” , once the price stabilizes in the
[3]
market it is more likely that investors will come out with significant losses.

[1]
Netscape’s Initial Public Offering
, Harvrd Business Cases. 3
[2]
Netscape’s Initial Public Offering
, Harvrd Business Cases. 5

[3]
Netscape’s Initial Public Offering
, Harvrd Business Cases. 5