Casestudy Netscape 1995 (Simulation)

Casestudy re-resolved by Richard L.A. Meijs, M.B.A. [Founder NeoMinds Consulting]

1. Introduction

Netscape Communications
Netscape was found in 1994, where it provided a comprehensive line of client, server, and integrated applications software for communications and commerce on the Internet and private Internet protocol (IP) networks. The company’s most popular product, Netscape Navigator, was the leading client software program that allowed individual personal computers (PC) users to exchange information and conduct commerce on the Internet. Netscape’s server software provided enterprises with the basic capabilities necessary for creating and operating Web server “sites,” or places on the Web which browsers could visit.

Background
The demand for Netscape’s products had evolved out of the development of the Internet in the late 1960’s. The Internet was a global network designed to facilitate communication between some 35,000-computer networks using the enabling code termed Internet protocol. Engineered in the early 1990s, the Web was a technology that linked one bit of information on the Internet with another so those users could share “webs’ of ideas. The Web consisted of a network of Web servers that posited information in a common format described by the Hypertext Markup Language (HTML). Internet users were able to access information on the web by implementing the appropriate Hypertext Transfer Protocol (HTTP).

Netscape’s Entrance
Meanwhile at the University of Illinois at Urbana-Champain, a group of computer science students working at the National Center for Supercomputing Applications (NCSA) developed the graphical software program that gave rise to the notion of “surfing.” Named NCSA Mosaic, the software program enabled nontechnical users to access and retrieve information on the Web. Netscape entered the broad Internet market via the Web browser market, where it faced two challenges: it had to set a new industry standard, and it had to make money. The former challenge was the immediate concern. To set a new standard, Netscape had to create a new program that would destroy Mosaic, which in 1994 ended wielded 60% of the Web browser market.

Competition
Netscape was the indisputable leader of its kind. As the Internet community and its demands continued to increase, however, so did the multitude of competitors. Spyglass, Inc. was Netscape’s nearest competitor with its Enhanced Mosaic Web browser technology. As the facto gatekeeper of computing, Microsoft was perhaps the most formidable of Netscape’s competitors in the long-term. The online computer service also had made strides recently to move into Netscape’s market.

Initial Public Offerings
Young. Rapidly growing companies facing intense competition typically raise equity capital in two broad ways. One way is through a private equity transaction, and the other is through a public offering of stock. A public issue entails the sale of a company’s equity to the public at large. While the monetary benefits of going public are potentially sizeable, so too are the associated costs. The human capital resources involved in the process of an initial public offering include the company’s founder and senior management, the underwriters, and institutional investors.

The “Going Public” Process
In the United States, companies issuing stock to the public for the first time typically use what is known as a “firm commitment contract.” (Another type of contract between the issuer and the underwriters is known as a “best efforts” contract. Unlike a firm commitment in which the underwriters assume risk, a best efforts contract only requires the investment bankers to make their best efforts to sell the minimum number of shares. In the event there is insufficient demand to fully subscribe the minimum number of shares, the issue is withdrawn. This type of contract is typically used in smaller, more speculative offerings.) This contract describes the relationship between the issuing firm and the investment bankers underwriting the offering. At times, the IPO market is characterized as a “hot issue” market because of the high returns earned by initial buyers of the shares.
In response to its growing capital needs, in early 1995 Netscape began to explore the option of raising money through an initial public offering (IPO). The IPO market in the first half had generated proceeds totaling nearly $12 billion for some 300 companies, which saw their stock prices increase on the first day of trading by an average of 20%.
Since Clark’s initial investment, Netscape had been injected with various forms of investment capital. Sillicon Valley venture capital firm of Kleiner, Perkins, Caufield & Byers invested $5 million.

The Board Decision
The time had come when Clark and the other Netscape board members had to approve or reject their underwriters’ vote of high confidence. In going over the new valuation of the company, the board struggled to disregard the wild speculation surrounding what had been called the hottest IPO of the year. Perhaps most unavoidable in the minds of the board members, the subscription for such a hot stock had the potential of reaching many times five million shares by the time offering the next morning. The board’s responsibility was to determine the appropriateness of the proposed increase in price after balancing the potential risks and rewards that might accompany such a move.

2. Definition of the Problem

Only 16 months after the company’s founding, in April 1994, Netscape completed an initial public offering (IPO). In one way this early IPO was a remarkable step. In another way it was not. Netscape grew faster than any other software company in history in its full year of revenues. It’s initial market value was already around $ 1 billion vs. the 250 million or 300 million fetched by many young, profitless companies. In this case we go deeper into details of the IPO.

Situation before the IPO
Since 1994 the company issued three series of preferred stock to companies directors, executive officers, 5% stockholders and their respective affiliates. Later in 1994 the company issued preferred stock and common stock. These financing activities brought $ 9.5 million to Netscape. At the end of 1994 net revenues were $696.000 and Netscape had a net loss of $ 8.470.000. (Cash flow from operating activities). Because of the financing activities, Netscape had enough cash to pay most of their expenses.

In 1995 Netscape has built up a substantial majority of the global market for client software designed to help navigate and enhance communications over the Internet and private enterprise networks (Intranets). In order to keep this position Netscape had to continue to invest in different projects. So far, the young company used foreign equity to finance its activities. The foresight of needing more brought also the question; how?

Netscape’s Possibilities
Netscape needs to raise capital for the following reasons:

• Netscape Corporation needs to finance activities to compete with the other competitors;
• They need to invest in a new browser or new activities such as web builders;
• They need cash to repay their long term and short term debt;
• The principal reasons for going public was to fund expected future growth, to stockpile cash reserves for potential acquisitions, and to gain visibility and creditability within the industry;
• They already needed capital in April 1994 when they issued the preferred stock for the first time. But what they raised was not enough, so they realized they needed to issue more shares (preferred stock and common stock). They made a stock option plan in 1994, the second stock plan in June 1995, and the third employee stock purchase plan in July 1995;
• They initially need in 1995 $49 million ? 3.5 million shares times $14 per share. The initial stock-price of $14 is too little, because the initial stock-price of $14 was underestimated regarding to the overall opinion of the investors and the evaluation of the value of the company. They decided to raise more capital then the $49 million by raising the share price to $28. Above all they raised the amount of shares issued to 5 million. The total raised capital would be 140 ? 5 million times $28.

3. Raising Equity Capital

Option 1
Raising equity capital through private equity transaction A private transaction involves direct negotiations with various financial or non-financial institutions. In such a case the company raises money from these various entities, which then own a portion of that company in the form of its privately held shares of stock or other securities convertible into stock. If these private investors wish to sell their stakes in the company, they must negotiate the terms of the sale with known buyers given the absence of a liquid market.
Pro
• The power is in hands of a few investors who negotiate the price and interest. Then you always have the possibility to go public later on.
Con
• A few investors have a lot of power with decision making. If you want to buy some of the shares back it would be more easier and less costing then from public investors.

Option 2
Another option to raise equity capital is to get a loan from the bank.
Pro
• There are no more additional owners of the company who would have power in power decision making.
Con
• No bank would give such a loan, because they would make losses. It also expects to have losses in the future. If the company does get the loan from the bank the risk will be too high so the interest rate would be high too.

Option 3
Another option to raise equity is to have a joint venture with another competitor, example Microsoft.
Pro
• If we merge with Microsoft we would be already be the leader on the market, the general costs will be less and the competitor will be eliminated.
Con
• If we share ideas the profit will be shared. Netscape will loose future decision-making.

Option 4
Going Public (IPO).
Pro
• They get cash immediately upon the sale of the stocks
• The underwriters will get some fees.
Con
• Once they set the price and it is too high the people won’t buy the stock, but if the price is set too low during the introduction of the stock the price will go up fast and the company will loose the opportunity to get the difference between the prices.
• Once the stock is out you don’t have immediate control over the buyers action (sell the stock to other people).

4. Swot Analysis

Strengths
• They have the most popular product, Netscape Navigator. This was a leading client software program that allowed individual personal computer users to exchange information and conduct commerce n the Internet. Navigator. Navigator featured click-and-points graphical user interfaces that enabled users to navigate the Internet by manipulating icons and windows rather than by using text commands. With the user-friendly interface as a guide, Navigator offered a variety of Internet functions including Web browsing, file transfers, news group communications, and e-mail. Initially shipped in December 1994, Netscape Navigator generated 49% and 65% of total revenues for the quarters ended March31, 1995, and June 30, 1995, respectively.
• The second product was the server software of Netscape navigator which provided enterprises with the basic capabilities necessary for creating and operating Web server sites, or places on the web which browsers could visit. This server product combined with integrated applications software programs, which were designed to provide enterprises with the capability to manage large-scale commercial sites on the Internet. Together server and integrated applications software accounted for 35% of total revenues in the first quarter of 1995 and 28% of total revenues in the second. Of these revenues, the majority was generated by one of Netscape’s three server products, Netscape commerce server. Revenues from Netscape’s server and integrated applications products were expected to increase as a percentage of overall revenues in the future.

Weaknesses
• Depended on the Internet.
• Dependence on key-personnel.
• Length of the sales cycles.

Opportunities
• Obtain additional capital.
• Create public market for the company’s common stock.
• Facilitate future access by the company to go public equity markets.
• International expansions.
• Brand recognition of Netscape (new) products.

Threats
• Competition.
• New product development and technological change.
• Involving distribution channels.
• Government regulation and legal uncertainties.
• Security risks and system disruptions ? lack of product liability insurance for products incorporating security features.
• Possible future payments; uncertain protection of intellectual property.
• Concentration of stock ownership.
• No prior public market.
• Dilution.
• Limited operating history; accumulated deficit.
• New entrants; unproved acceptance of the companies products; price erosion; uncertain adoption of Internet as a medium of commerce and communications.

5. The Decision

Netscape choose the option to go public
While the monetary benefits of going public are potentially sizeable, so too are the associated costs. The total costs are compromised of ongoing costs associated with being a publicly traded company and one-time costs associated with the IPO itself. Monetary of going public are potentially sizeable, so too are the associated costs. Specifically, ongoing costs result in need the report timely information to investors and regulators. One time costs, which attributable to direct cost (legal, auditing, and under writing fees.) and indirect costs (management time invested in the process, and the dilution associated with selling shares at an offering price that is, on average below the selling price prevailing in the market shortly after the IPO), which are the floatation costs. All of the above reflect the time and financial commitments associated with the IPO process. If the Underwriters over-allotment opinion were exercised in full the total raised capital would be ranging between $129.3 and $148.8 million. The floatation costs will be approximately $10.7 million » $140 million - $129.3.

Was the price of $28 reasonable?
Looking at the other companies in the same industry, see exhibit 6, the price per share offered varied between $12 to $17. Looking at this data, our price is quite high. The question is they really our competitors. We think they are not, because we are the only one providing these products, so we are able to set the price ourselves as high as we want it to be.

The first offering price was between 12 and 14, but the information gathered from the Road show showed there is a potential demand for Netscape’ s shares. This 28 was based on calculations we were not provided with. At its initial price of $28 Netscape was among the highest priced IPO’s ever, based on such traditional measures as price-to-sales and price-to-forward earnings. The fact is that the company had only a couple of quarters of revenues, and they had done only $11 million in the most recent quarter. When you are in a situation like that, you’re torn between pricing at a level you know can clear the market today, rather than at a level that can be sustained over a longer period of time. As it stands Netscape’s initial market value was around $1 billion versus the $250 million or $300 million fetched by many young, profitless companies.

6. Netscape’s products as future industry standards

• They have the most popular product, Netscape Navigator. This was a leading client software program that allowed individual personal computer users to exchange information and conduct commerce on the Internet. Navigator. Navigator featured a click-and-points graphical user interface that enabled users to navigate the Internet by manipulating icons and windows rather than by using text commands. With the user-friendly interface as a guide, Navigator offered a variety of Internet functions including Web browsing, file transfers, news group communications, and e-mail. Initially shipped in December 1994, Netscape Navigator generated 49% and 65% of total revenues for the quarters ended March31, 1995, and June 30, 1995, respectively.
• The second product was the server software of Netscape navigator which provided enterprises with the basic capabilities necessary for creating and operating Web server sites, or places on the web which browser could visit. This server product combined with integrated applications software programs, which were designed to provide enterprises with the capability to manage large-scale commercial sites on the Internet. Together server and integrated applications software accounted for 35% of total revenues in the first quarter of 1995 and 28% of total revenues in the second. Of these revenues, the majorities were generated by one of Netscape’s three server products, Netscape commerce server (bundled packages of Netscape Navigator and Netscape Commerce server accounted for about 10% of total revenues in the first quarter, while its contribution in the second quarter was immaterial). Revenues from Netscape’s server and integrated applications products were expected to increase as a percentage of overall revenues in the future.
• In addition to product revenues, Netscape generated service revenues, which were attributable to fees from consulting, maintenance, and support services. These revenues amounted to approximately 5% and 7% of total revenues for the quarters ended March 31, 1995 and June 30, 1995, respectively.

For product 1 (Client Software)
By adding more features and make them more user-friendly we could improve the product. It is also possible to concentrate on building web pages.

For product 2 (Server Software)
If Netscape directs its activities to users of servers (businesses) e.g. by making special packages, and improve the product, it could get higher profits (change of target group orientation).

For product 3 (Service)
Improve services, and providing it for low costs, provide training courses for clients, providing more consultancies, concentrating on larger companies in stead of smaller firms/stores (economies of scale).

7. Future Prospects

Netscape is a leading provider of software that allows computer users to exchange information and conduct businesses on the Internet and other global networks, and the potential for this market is anybody’s guess. Netscape is being evaluated like a biotech company. With biotech you don’t have to worry much about price-earnings multiples, because most companies don’t have earnings. You look strictly at the future. Netscape has a lot of potential. See products mentioned above.

Stock Split
On 14 November 1995 the Mountain View producer of Internet software announced a 2 for 1 stock split just 97 days after going public. That ranks among the fastest few dozen stock splits ever. Netscape’s management wasn’t just showboating: The stock was ripe for a split. It has soared spectacularly since its initial public offering at $28 per share on August 9, and last week it broke through $100. It closed at 96 ½. The split will cut the price by half, but shareholders will get an additional share for every one they hold, so the total value won’t change. Its stock trading was 242% premium to its initial public offering price.

Market Capitalization
After they went public Netscape’s equity was a bit more that $3.5 billion which is $2.5 billion more than they estimated to be. In comparison to the other companies (Apple, Avon, Quaker, etc.…) its $3.5 billion market value is still the lowest, but it doesn’t differ that much from other companies like Kmart and Ingersoll-Rand.
The technologies used by Netscape are very quickly outdated. That means that there always is a need for capital for new instruments. The question is always:

• Is the company investing in the right products and are the cash flows of investments enough to cover all expenses?

Risk for Potential Buyers
There is a risk for investors, and even investment strategists do not know if the shares are overvalued or undervalued. What could be said is that Netscape is acting in an industry with revenues overall of a billion dollars, and it could be $25 billion by the end of the decade. But nobody knows when somebody is going to stick a pin in the hot-air balloon, but may be the price will go up to 150 first. The offering price takes into account that the price could go up after the issue. The risk for the first owners of the shares is not that high as for the later buyers who could be surprised by continuous losses over the future.

8. Appendix

Current position of the company is due June 1995.

Return on Equity: = -0.10 (1995)

Net profit margin = -0.26 (1995)

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