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Executive Summary
Netscape was founded in 1994 and it provided internet applications for communications and commerce. In 1995, Netscape decided to raise capital by initial public offering.
Although initial price for shares was at first $14, underwriters suggested increase the price to $28 one day prior to the initial public offering. The board of Netscape was not sure of the high price and fell in dilemma because the firm didn’t have a long track record and IT industry was not easy to predict. Other than initial public offering, Netscape could raise capital from debt and private stock offering, or from angel investors.
But going public seemed to be the best option to take advantage of due to its liquidity and accessibility.
It was calculated that in order to justify the price of $28 per share over 10 years, Netscape’s revenues must have grown by 44% every year. If the price were $14, the growth rate should be 35%, price of $54, it was 54%. While grown rate of 44% seems to be high level of growth, it can be frequently observed in IT industry.
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The average annual revenue growth rates were 37% for Microsoft(1990-1999), 78% for Amazon(1997-2006), and 41% for Google(2004-2013). They are all IT industry companies but comparing Netscape with those companies directly has some problems because the product and market condition is quite different.
IPOs are often underpriced because underpricing lowers risks, guarantees a positive return for investors, helps future business, and rewards the trustworthy investors. HPR of Jim Clark, Kleiner Perkins, and Media companies were 32,932.95%, 12,314.88% and 3,348.58%. Annualized HPR of Jim Clark, Kleiner Perkins, and Media companies were 2,650.42%, 4,633.19% and 19,623.55%. 1. What risks did Netscape face in 1995?
In 1995, Netscape decided to issue their initial public offering. They needed more capital for future growth, and tried to obtain visibility and credibility in their industry by going public. Then Netscape was confronted with the situation of their lead underwriters suggesting the board double the offering price from $14 to $28 one day before the initial public offering. It was a big dilemma to Netscape’s board because Netscape was a new firm, and investors might interpret such a high increase of the price per share as unjustifiably opportunistic therefore decreasing demand. Moreover, the industry was also unpredictable and at that time, some competitors like Spyglass and Microsoft were emerging and threatening Netscape. So these all circumstances made the board’s decision very difficult.
2. Other than the IPO, what are Netscape’s alternative sources of capital? Are these alternative sources likely to be suitable and/or sufficient? Netscape’s original angel investor was Jim Clark. He contributed $3 million originally and an additional $1.1 million in the 1994. The venture capital firm Kleiner, Perkins, Caufield & Byers also invested in Netscape with $5 million. Lastly, Adobe Systems and five other media invested in Netscape in its largest round of financing. They could also raise capital through private stock offering and debt (bonds). However, going public was better option to Netscape for several reasons. Once they go to public, they will be able to access capital markets easily.
And through initial public offering, people who already have an ownership can lower their risk. It will also reduce the information asymmetry, so Netscape can offer more information about their company. 3a.) How fast must Netscape’s revenues grow on an annual basis over the next 10 years in order to justify the price of $28 per share? In order to determine the growth rate that would justify a $28 per share price, we created an Excel model that projected Netscape’s revenue over 10 years for a given growth rate as well as all of Netscape’s expenses and tax obligations given the assumptions provided (Appendix I). By using Excel’s goal seek tool, we were able to calculate the required annual growth rate to be 44% in order to result in a $28 value per share.
3b.) What is the revenue growth rate implied by the original price of $14 per share and what is the revenue growth rate implied by Netscape’s stock price of $54 at the end of the first day of trading? By utilizing the same Excel model mentioned above, we were able to again use the goal seek tool to
determine both growth rates. The original IPO price of $14 per share implies an annual revenue growth rate of 35% (Appendix II). The $54 stock price would imply a growth rate of 54% (Appendix III).
3c.) How does your estimated revenue growth rate from part a). compare with Microsoft (1990-1999), Amazon (1997-2006) and Google (2004-2013)? What are the problems of making such comparisons? In part A, we determined the necessary revenue growth rate to be 44%. While this is a high level of growth to expect in one year, it is not unusual when compared to other technologies companies like Microsoft, Amazon and Google. The average annual revenue growth rates during these periods were 37% for Microsoft, 78% for Amazon, and 41% for Google (Appendix IV). Given the performance of these similar technology companies, it’s not unrealistic to expect Netscape’s revenue to grow by 44%.
One issue with making these comparisons is that although all four companies operate in the technology sector, Netscape’s product and service offerings are much different than those of Microsoft, Amazon, and Google, making it difficult to predict how closely Netscape’s performance will mirror theirs. Another problem with comparing Netscape to these companies is the difference in competitive landscape each company finds itself in. At the time of Netscape’s IPO, there were already several other companies with market share in the web browser segment. Microsoft was also preparing to launch its own browser in 1995 s well. Because of this, there is a high degree of unpredictability in the future success of Netscape. This means that it’s highly unlikely that Netscape would experience a stable rate of revenue growth over the 10 years following its IPO.
4. The case points out that IPOs are often underpriced. Provide four reasons for why this may be the case? Firms tend to underprice IPOs. This is particularly true for young firms. These young firms are considered risky investments. There is no way to be sure what they will produce as information and previous sales figures are limited. Thus, information asymmetry plays an important factor. There will be limited informed investors as the company has just recently gone public. To attract the average investor, who may not be as well informed, the firm must lower the share price. A second reason for underpricing is that it can be a way to guarantee a positive return for investors. This protects the company from risk as well. Investors might be able to sue if there is a large negative return on the IPO.
Therefore, lower price means assurance that customers will earn a positive return. In addition to that a successful IPO can mean a successful follow up offering. Those investors that had made a nice profit will be likely to want more shares in the future. If the IPO price was higher the return wouldn’t be as large, or might even result in a loss for customers. That would mean less interest in the firm in the future. Lastly, underpricing is also a way that the underwriters can reward investors. During the waiting period, while on the road show underwriters meet with potential buyers to try to get an understanding of the demand for shares and price per share. Those investors that were truthful will then be offered the stock at the lower price. 5) We were able to calculate the holding period returns and annualized returns for each investor using the formulas for HPR and annualized return. These calculations can be found in Appendix V.
Netscape IPO Case Study. (2016, Sep 07). Retrieved from https://studymoose.com/netscape-ipo-case-study-essay
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