Andre Waldron Netscape Ipo Project = Fin 160

THE NETSCAPE IPO PROJECTBy Andre WaldronFIN 160

THE NETSCAPE IPO PROJECT

TABLE OF CONTENTS

Internet History…………………………………………………………………………….

SWOT Analysis………………………………………………………………………………..

ANALYSIS OF COMPETITORS…………………………………………………………

Microsoft Corporation

Browser Software Competitors………………………………………………..

NetManage Inc

QuarterDeck Office Systems Inc

Network Computing Devices Inc

PC Software Competitors………………………………………………………

IBM……………………………………………………………………..

Online Service Providers

AOL………………………………………………………………………………..

CompuServe………………………………………………………………………..

Sensitivity Analysis ……………………………………………………………………………

Valuation Assumptions

Balance Sheet – Assets

Balance Sheet – Liabilities

Balance Sheet – Shareholder’s Equity

Income Statement Assumption

Netscape’s Final IPO Valuation Results and Assumptions …………………………………..

NETSCAPE IPO QUESTIONS………………………………………………………………….


INTERNET HISTORY

The Internet Industry’s start could be traced back to the Cold War Era in 1969. During

that year, the first ever known version of the Internet was created. It was known as the

“ARPAnet”. ARPA stood for Advanced Research Projects Agency Network. ARPAnet

created a network that was dispersed geographically and which exchanged information via the

Network Control Protocol. The system was created collaboratively by a research team at MIT as

well as the U.S Department of Defense. The first-ever Internet connection was between four

computers from major universities. The universities were UCLA, Stanford, University of

Calfornia-Santa Barbara and Utah. There are innovations that are popular today that were

developed under ARPAnet. E-mail was first created under the ARPAnet network in 1971

by an individual by the name of Ray Tomlinson. File transfer protocols were first developed two

years later. Today’s current standard of data transfer, TCP-IP, was developed in the 1970’s and

would become widely accepted by 1983. The term “Internet” was defined as any network that

involved the use of TCP/IP. The National Science Foundation established an Internet backing

by the name of NSFNET. This opened up Internet use to academic researchers and university

professors. The National Science Foundation would sponsor the Internet for use by institutions

of higher learning from 1986 to 1995. It was funded by the U.S government. The U.S

government banned commercial use of the Internet until commercial networks started to increase

in the early 1990’s. Commercial usage of the Internet was popular by the time the National

Science Foundation finished sponsoring the Internet.

Web Browser Industry:

A landmark event in Internet History was the invention of the World Wide Web by Tim-

Berners Lee and other researchers at CERN. (European Organization for Nuclear Research)

The first ever commercialized web browser. He also had a hand in the making of a browser

called Libwww shortly thereafter. Several other browsers were released until the making of the


landmark web browser: the Mosaic. The Mosaic Web Browser was the first browser to use a

graphical user interface. It is widely considered as the beginning of the Web as we know

today. It garnered two million users and owned 60% of the Internet market by the time Netscape

was born as a firm. As we know, Netscape entered the Internet Industry through the web

browser market and blew away the Mosaic web browser immediately with its industry defining

browser: Netscape Navigator. It quickly captured a dominant portion of the web browser

market share in only 16 months of operation. At the time of its IPO, Netscape recognized that

they were in a market that has only recently developed and that they were in an industry that was

still young. The firm was uncertain about the Internet’s future as well as the future of the

overall market. Technological change and new product innovations within the industry was still

growing at a rapid pace. Netscape had several new products set for release after the IPO.

Based on these factors, it is clear that Netscape was in the start-up or introduction stage of the

industry life cycle.


SWOT ANALYSIS

STRENGTHS:

- Netscape Navigator was Netscape’s biggest strength. Netscape Navigator spearheaded the

firm’s revenues for the first two operating quarters of 1995 leading up to the IPO. The

product accounted for 49% of the firm’s total earnings in the first quarter and 65% in the

second quarter. Netscape Navigator had captured 3/4th of the web browser market by the

spring of 1995.

- Netscape Commerce Server was a major success for Netscape as well. This product

accounted for the bulk of the first and second-quarter overall revenues provided y Netscape’s

server software in 1995, which was 36% and 28% respectively.

WEAKNESSES

- High Dependence on Key Personnel who had worked together for a brief period of time- Long Sales Cycle- High Dependence on the Internet

OPPORTUNITIES

- International Expansion- Brand Recognition- Vast number of potential customers (only 14% of customers had accessed information on the

World Wide Web by mid-1995)

THREATS

- Limited Operating History- Existing Competition has Greater Operating History and Brand Recognition- Very Competitive Market that was poised to Intensify in the Future - Threat of new Entrants- Unproven Acceptance of Netscape Products- Uncertainty in the Adoption of the Internet as a Medium- Difficulty in predicting Future Growth Rate of Market- Evolving Channels of Distribution- Lack of Product Liability Insurance for products that Incorporate Security Features.- Government Regulation and Legal Uncertainty.


ANALYSIS OF NETSCAPE’S COMPETITION

Microsoft Corporation:

History:

Microsoft Corporation was founded by Bill Gates and Paul Allen on April 4th, 1975. The

company was founded in Albuquerque, New Mexico. Microsoft founded immediate success

upon their founding. They developed an implementation of the programming language

BASIC was jumpstarted by a successful sale of the BASIC computer language program to

an electronics company by the name of Micro Instrumental and Telemetry Systems. Later,

Microsoft would restructure the firm and become incorporated on June 25th, 1981. Microsoft

would gain great success with its release of DOS. MS-DOS boosted Microsoft’s profile as a

software provider in the computer industry. Microsoft would continue to expand its product

line and venture into new markets. Microsoft would venture into the book publishing market

in 1983 by releasing a product by the name of Microsoft Press. Microsoft would release its

first version of Windows to coincide with its DOS operating system in August 1985.

Microsoft would officially go public on March 13th 1986 at a stock price of $21.00.

Microsoft would gain further success with such as Microsoft Office, Visual Basic, Encarta

and other products and product upgrades. It was clear that Microsoft saw Netscape as a

competitive threat around the time of their IPO. Bill Gates made this clear in a famous

memorandum that he released to his fellow executives known as “The Tidal Wave

Memorandum”. In this memo, he made the Internet as the company’s greatest priority.

Microsoft’s Competitive Advantages:

An immediate competitive advantage for Microsoft over Netscape is it’s significantly longer

operating history. Up to the time of the IPO, Netscape’s operating history was a grand total of


16 months while Microsoft had an operating history of 20 years. Microsoft had many more

employees. While Netscape claimed that they would be operating in debt for the near

future, Microsoft was in solid financial condition. Therefore, they had a greater number of

assets and resources at their disposal. Therefore, it is clear that Microsoft was Netscape’s

greatest competitive threat at the time of its IPO.

BROWSER SOFTWARE COMPANIES

NETMANAGE INC

History:

NetManage Inc was a software company founded in 1990. It was founded by Zvi Alon,

an Israeli Engineer. The firm was based in Cupertino, California. NetManage Inc developed

and supported an integrated set of applications for TCP-IP internetworking connectivity.

The applications and development tools were primarily designed for Microsoft Windows

applications. In addition, it was a pioneer in terms of networking and e-mail solutions. In

1994, NetManage Inc developed a web browser by the name of Chameleon and used a

chameleon as its company logo. Like Netscape Navigator, the web browser offered a wide

variety of inter-networking applications such as e-mail and file sharing. NetManage Inc was

not without success. In 1994, NetManage Inc acquired a software company by the name of

Arabesque software for $6 million. Arabesque software’s main product was productivity

applications software called ECCO that had won numerous industry awards. NetManage Inc

made the acquisition in hopes that Arabesque’s products would complement their own.

NetManage Inc’s Chameleon Desktop played a huge role in NetManage’s 183% increase in


net revenues for the first operating quarter of 1995. It was clear that NetManage Inc was in

a strong position for growth.

NetManage Inc’s Competitive Advantage:

Similar to Microsoft, NetManage Inc had a longer operating history than Netscape.

NetManage Inc began its operations in 1990 while Netscape only began its operations in

1994. As mentioned earlier, NetManage Inc is a strong growth position while Netscape was

doubtful about its growth prospects after the IPO.

NETWORK COMPUTING DEVICES INC

History:

Network Computing Devices Inc was founded by six different individuals in 1987. The

company was founded in Mountain View, California. The company was founded by six

individuals and its initial headquarters were in Mountain View, California. It was found for

the purpose of introducing a line of thin client products, which was an innovation at the time.

These devices were known as network terminals. The network terminals were the earliest

examples of thin client software at the time. Network Computing Devices supported TCP/IP

as well as a variety of other network protocols. In 1992, Networking Computing Devices

made its initial public offering. Networking Computing Devices purchased a company by the

name of Z-Code software in 1994. With this purchase, the company was able to obtain e-

mail client software by the name of Z-mail. This acquisition aided the company’s efforts to

compete. Therefore, Network Computing Devices Inc was not competing with Netscape

with a competing web browser, but with competing client-based software. Around the time

of Netscape’s IPO, Network Computing Devices reported net revenues of 35.5 million in the


second quarter of 1995. This was a decline from the net revenue earned a year earlier.

However, the firm reported a positive net income of $745,000 for the first six months of

1995 as opposed to a 9 million dollar net loss for the first six months of 1994. The company

was in the midst of operations restructuring for the purpose of sparking continued growth.

It downsized its current X terminal market division and consolidated its software divisions to

create one large overarching software division. With these actions, Network Computing

Devices sought to improve its competitive position in order to reflect the rapidly changing

conditions in the market.

Networking Computing Devices Inc’s Competitive Advantage

Networking Computing Devices Inc owns a competitive advantage in terms of operating

history. Network Computing Devices Inc had 8 years of operating history. Netscape had

only been in operations for 16 months. Networking Computing Devices Inc was also in

better financial condition based on the fact that they operated with a positive net income

while in the job. On the other hand, Netscape was expected to operate at a net loss for the

foreseeable feature.

QUARTERDECK OFFICE SYSTEMS INC

History:

QuarterDeck Office Systems Inc was founded in 1981 and was soon incorporated in

1982. QuarterDeck Office Systems Inc was founded by Therese Myers and Gary Pope.

QuarterDeck Office Systems Inc was the first software company to provide remote

computing which covered all common computing platforms. Quarterdeck offered a memory

manager named the QuarterDeck Expanded Memory Manager. This product was a popular

product that was used for MS-DOS and other DOS-based systems. Another well-known


product is a product by the name of DESQview. It was a popular program that enabled users

to multitask. In other words, DESQview allowed users to run multiple programs in DOS

simultaneously. DESQview was released in 1985 and it was the first successful multitasking

program that was released for usage in DOS. Quarterdeck was awarded a patent for its

multitasking programs in April 1989. Quarterdeck Office Systems Inc offered a form of the

Mosaic Web Browser called the Quarterdeck Mosaic. The Quarterdeck Mosaic web browser

was a part of a line of Internet products released by the firm around the time of the Netscape

IPO. Such products included QuarterDeck Web Server, WebAuthor and Internet Suite.

QuarterDeck’s target markets for their Internet products included individual users, small

businesses and corporations. QuarterDeck Office Systems was very successful around the

time of Netscape’s IPO. In June 30th 1995, the company acquired a firm by the name of

LandMark Research International Corporation for 3.5 million shares of stock. Quarterdeck

reported $17.2 million in revenues for the quarter ended June 30th 1995. This was an

increase of 110% from last year’s total. In addition, its net income was a net gain of 3.6

million. This was in contrast to a net loss of 2.2 million in 1994. It is clear that Quarterdeck

Office Systems was in a state of growth based on the numbers. It is clear that Netscape

Navigator viewed QuarterDeck Office Systems as a main competitor due to the QuarterDeck

Mosaic Browser competing directly with the Netscape Navigator web browser.

QUARTERDECK OFFICE SYSTEMS INC COMPETITIVE ADVANTAGE:

QuarterDeck Office Systems Inc has had a much longer operating history than Netscape.

QuarterDeck Office Systems has been operating since 1981 while Netscape had only

operated for 16 months prior to their IPO. Thus, Quarterdeck has far greater experience as


an operating firm. In addition, Quarterdeck has a broader product line as it had 10 products

in the market. Netscape had only 6 products at the time of their IPO. QuarterDeck will

have greater access to distribution channels due to their vast advantage in experience over

Netscape.

PC SOFTWARE COMPETITORS

IBM

History:

IBM is a U.S multinational technology and consulting firm that was founded in 1911. No

company has had more of an affiliation with computers throughout U.S History such as

IBM. IBM was involved in the early computer market during the 1950’s IBM controlled

the computer business via the office products segment. Its main product was a 705 general

purpose computer that was released in 1955. IBM would face and win numerous antitrust

lawsuits from competitors in the 1960’s. IBM would release a line of “360” computers in

April 1965. IBM would continue to dominate the computer market during the 1970’s with

its line of “360” personal computers. However, IBM began to lose a significant amount of

momentum in the 1980’s. A major reason was IBM’s slow reaction to the creation of the

microcomputer by rival Digital Equipment Corporation. The slowdown continued in the

1990’s and could be attributed to the rapid change within the computer industry. IBM

would restructure its operations in hopes of keeping up with a rapidly changing marketplace.

Netscape saw IBM as a potential threat due to its offering of the IBM WebExplorer web

browser. IBM Web Explorer released its web browser alongside was released with the third

version of IBM’s OS/2 operating system in 1994.


IBM’S COMPETITIVE ADVANTAGE:Like most of Netscape’s Competitors, IBM has a huge advantage in terms of operating

history. As a matter of fact, IBM has the greatest advantage in terms of operating history out

of all of Netscape’s competition. IBM had been in operations since 1911 while Netscape

had been in operation for 16 months. IBM had a tremendous advantage in terms of brand

recognition due to their prolonged history with computers. IBM has a unique advantage

over Netscape in terms of niche specialization. With the IBM Web Explorer, IBM was able

to offer web client and web browser functionality as major features of its operating system.

IBM also was in better financial condition and was in a stronger position to sell and market

their products as opposed to Netscape.

ONLINE SERVICE PROVIDERS

AMERICA ONLINE

History:

America Online had a pretty solid history before it had even obtained its company name.

It was originally named Quantum Computer Services. Quantum Computer Services was

formed in 1985 and founded by Steve Case and Jim Kimsey. Its main purpose was

originally to provide online services for users of a trendy brand of computers named

Commodore Computers. Later, Quantum Computer Services would provide online services

for IBM users in 1988 and Apple users in 1989. That year, America Online was introduced

as a nationwide network for computer users under the umbrella of Quantum. In 1991,

Quantum would run out of capital due to high costs. Jim Kimsey was replaced as CEO by

his co-founder, Steve Case. Quantum Computer Services would change the name of the

firm to America Online within the same year. AOL for DOS was launched in 1991 followed

by AOL for Windows a year later. AOL became public in 1992. The firm spent $66


million dollars on their IPO and its opening stock price was only $1.64. AOL outpaced

competitors such as Prodigy and CompuServe by offering lower membership prices. The

firm grew dramatically in membership by shipping out significant amounts of software disks

to users. The software disks offered users a free trial period for use of the AOL service. It

is clear to see why Netscape saw AOL as a potential competitor. AOL made key

acquisitions in 1994 so that its members would be given access to the World Wide Web.

They acquired BookLink Technologies, a web browser firm. They also acquired a web

server company by the name of Navisoft. Clearly, AOL wanted to make Internet access

easier for its users such as Netscape did with the Netscape Navigator.

AMERICA ONLINE’S COMPETITIVE ADVANTAGES

AOL poses a significant advantage in operating history. The firm has been operating

since 1985 when it was named Quantum Computer Services. Thus, it had been in operations

for 10 years. Netscape had only 16 months in operation. Another competitive advantage that

AOL has over Netscape is that is provided online services as well as access to the World

Wide Web. None of Netscape’s client software had access to online services. It only

provided access to the World Wide Web. Thus, AOL holds a competitive advantage in

product differentiation and niche specialization.

COMPUSERVE

History:

CompuServe was established in 1969 and it was known as Compu-Serv Network Inc. It

was founded in Columbus, Ohio. It had started as a subsidiary of a firm called Golden

United Life Insurance. The idea for the firm came from a man by the name of Jeffrey

Wilkins. Compu-Serv had provided in-house computer processing support to Golden


United and operated as an independent business. It became a separate company in 1975.

Later, Compu-Serv would become CompuServe Inc in 1977. CompuServe would begin

providing services to PC users in 1978. Its main emphasis was to gain profits by putting

their time-sharing computers to use during evening hours in which their computers were

mostly idle. CompuServe was responsible for providing the first online newspaper to

customers in 1980. The Columbus Dispatch provided the online content. Several other

newspapers would provide their content later on. Even though the online newspaper venture

was an experiment, CompuServe tripled their total number of subscribers by 1982.

CompuServe would become a subsidiary of H&R Block in 1980 CompuServe became one

of the strongest information services around during the mid-80s. They sold services to major

U.S firms. It’s only main competitor was an online service named The Source. It was

purchased by CompuServe’s subsidiary in 1980. In addition, CompuServe was the first

online service to offer an Internet connection. CompuServe continued to make major strides

during the 1990’s. It became the first online service from the U.S to expand its customer

base to the continent of Europe. CompuServe launched an application in March 1992 in

order to give individuals online connectivity and e-mail access. Netscape saw CompuServe

Inc as a competitive threat due to its acquisition of Spry Inc on March 14th 1995. Spry Inc

provided software and had a web browser by the name of Mosaic-In-a Box. With this

acquisition, CompuServe positioned itself strongly to compete with Netscape in the Web

browser market.

COMPUSERVE’S COMPETITIVE ADVANTAGE

Like most of Netscape’s Competitors, CompuServe owns a significant advantage in

terms of operating history. CompuServe had been around for 26 years while Netscape had


only existed for 16 months. Similar to AOL, CompuServe provided online services as well

as World Wide Web Access. Netscape is at a competitive disadvantage due to the fact that

it only offers Internet access. Due to its longer background as a company as well and it’s

longer history within the industry, CompuServe also holds a significant advantage in terms

of brand recognition.

SENSITIVITY ANALYSIS

In order to provide more of a foundation for my valuation, I decided to perform a wide-

ranging sensitivity analysis in which different key parameters were altered. Sensitivity Analysis

could be easily defined as a “what-if analysis.” It is a method that is used to conclude how

different variables will affect the main contrasting variable of a mathematical or financial model.

This method helps for the building of confidence in a financial model that is constructed. In my

spreadsheet labeled “Sensitivity Analysis”, I altered some key parameters of my financial model

under nine different scenarios to determine what would ultimately happen to the main variables:

Netscape’s NPV and share price. This was done to test the sensitivity and legitimacy of my

financial model.

1st Scenario: 1% Increase in Market Risk Premium and Terminal Value Growth Rate

In my original valuation, the Capital Asset Pricing Model was used to determine the

discount rate for the valuation. I determined that the Market Risk Premium was 7.29% as it was

the average market risk premium for 1994, which was the year before the Netscape IPO. The

Terminal Value Growth Rate was 4.071%. This value was the annual GDP Growth Rate for

1994. The first scenario was to determine what would happen to Netscape’s projected NPV and

share price if I had found that the Market Risk Premium and Terminal Value Growth Rate were


1% higher with all other variables remaining the same. In other words, what would happen to

the share price if the Market Risk Premium was 8.29% and the Terminal Value Growth Rate was

5.071%? In my original valuation, the NPV was $709,589,857.79 and the original projected

share price was $18.59. Under this scenario, the NPV would decline to $601,204,241.76 and the

new projected share price for Netscape would be $15.75.

Original NPV: $709,589,857.79 Scenario NPV: $601,204,241.76

Original Share Price: $18.59 Scenario Share Price: $15.75

2Nd Scenario: 1% Decrease in Market Risk Premium and Terminal Value Growth Rate:

As discussed earlier, the market risk premium and terminal value growth rate that was

used for my valuation of Netscape was 7.29% and 4.071%. This scenario tested the sensitivity

of Netscape’s projected NPV and share price if I had found that the Market Risk premium were

1% lower: (6.29% and 3.071 %.) Of course, all other variables remain the same. Under this

scenario, the NPV would increase to $838,170,193.00 and the original share price was $21.98.


Share Price: $18.59 Scenario Share Price: $21.98

It is clear from these two scenarios that there is an inverse relationship between the NPV

and share price and the subsequent increase of both the risk premium and terminal value growth

rate. In the 1st scenario, the NPV and share price decrease from its original valuation as the risk

premium and the growth rate increase by 1%. However, the NPV and share price increases as

the market risk premium and growth rate decrease at the same time in the 2nd scenario. The NPV


and share price was slightly more sensitive in the 2nd scenario as opposed to the 1st scenario. The

share price increase was $3.39 while the share price decrease in the 1st scenario was $2.84.

3rd Scenario: 1% Increase in Growth Rate, 1% Decrease in Market Risk Premium.

In this scenario, the sensitivity of the NPV and share price are determined if the terminal value

growth rate and market risk premium are to go in opposite directions at the same rate. From its

original rates of 4.071% and 7.29%, the growth rate will increase by 1% to 5.071% while the

market risk premium will decrease by 1% to 6.29%. As a result of this scenario, the NPV

increased significantly to $969, 303, 157, 01 and the share price increased to $25.40.



4th Scenario: 1% Decrease In Growth Rate, 1% Increase in Market Risk Premium

This scenario is similar to the previous scenario yet has slight differences. It is a measure of the

sensitivity of the NPV with the altering of the growth rate and market risk premium in different

directions at a rate of 1%. The difference is that the growth rate decreases by 1% and the market

risk premium increases by 1%. In this scenario, the growth rate would decrease to 3.071% while

the market risk premium would increase to 8.29%. All other variables from the original

valuation remained constant. As a result of this scenario, the NPV decreased to $537,305,568.85

and the share price would decrease to $14.08.



It is clear that some direct and inverse relationships can be drawn from these two similar

scenarios. There is a direct relationship between the growth rate and the NPV and projected


share price. In the third scenario, the NPV and share price increased along with the 1% increase

in growth rate. The fourth scenario showed that the NPV and share price decreased when the

growth rate decreased by 1%. On the other hand, the third scenario showed that the NPV and

share price increased when the percentage rate of the market rate decreased. The fourth scenario

showed that the NPV and share price decreased when the percentage rate of the market rate

increased. There was a greater difference in sensitivity for the NPV and share price among the

third and fourth scenarios as opposed to the first and second scenarios. There was a greater

sensitivity in the NPV and share price increase in the third scenario as opposed to their

subsequent decline in the 4th scenario. The share price increased by $6.81in the third scenario

while the share price in the 4th scenario declined by $4.51. Overall, it can be said that there

could be a greater sensitivity of the NPV and share price when the market risk premium and

terminal growth rate move in opposite directions (3rd and 4th scenarios) as opposed to when the

two parameters move in the same direction. (1st and 2nd scenarios)

5th scenario: (Economic Recession: Negative Terminal Value Growth Rate, Increased

Market Risk Premium, Decreased Risk Free Rate)

This scenario involves the significant altering of parameters to represent a scenario in

which the economy was experiencing a recession. One characteristic of an economic recession

is that there e is a quarter in which a negative GDP growth rate occurs. The GDP growth rate was

used to obtain the 4.071% used in the original growth rate. In this scenario, I changed the GDP

growth rate to -2.071%. In an economic recession, the stock market risk increases significantly.

Companies are more vulnerable to economic shocks. Thus, there will be a greater increase in

risk premiums. Risk-averse investors will demand greater premiums to compensate for the

increased economic risk. Thus, I increased the market risk premium by 5% to 12.29%. Investors


will run to the safety of risk-free treasury bonds. As a result, it will be more expensive for

individuals to purchase risk-free securities such as treasury bonds. The risk free rate (10-year

treasury yield) will decrease as a result. After all, bond prices and yields have an inverse

relationship. As a result of these significant changes in these parameters, the NPV and share

price dramatically decrease. The NPV dramatically decreased to $298,844,734.93. Netscape’s

projected share price decreased to $7.83.



These results show the significant sensitivity that this financial model has towards

macroeconomic conditions.

6th Scenario: Economic Boom (Increased Terminal Value Growth Rate, Decreased Market

Risk Premium, Increased Risk Free Rate)

This scenario involves the altering of parameters to determine what would happen to the

NPV and share price if the U.S economy was thriving. A main characteristic of an economic

boom would be a rapid economic expansion of the U.S economy. The GDP is a key

macroeconomic indicator. The terminal value growth rate is representative of the GDP annual

growth rate for 1994. In my original valuation, the terminal value growth rate was 4.071%. In

this scenario, I increased the terminal value growth rate to 7.071%. An economy with a GDP of

7% is representative of massive economic expansion. In an economic boom, stock market risk

would be limited. Investors will be more willing to invest in stocks and bonds. Thus, they will

have less of a need to be compensated for risk in their investments through risk premiums. As a

result, market risk premiums will increase. In my original valuation, the market risk premium

was 7.29%. I decreased the market risk premium to 4.29%. In a thriving economy, investors


will not have as much of a thirst to run to the safety of risk-free treasury bonds. Treasury bond

prices will decrease as a result. Therefore, the yields of risk-free treasury bonds will increase.

As a result, I increased the risk free-rate yield by 3% to 9.72% from its percentage value in my

original valuation. There was a significant increase in the terminal value growth rate and NPV.

The NPV increased to $1,132,491,553.81. The share price increased to $29.68.

Original NPV: $709,589,857.79 Scenario NPV: $1,132,491,553.81.


7th Scenario: Decline of Revenues During Projection Period

The key component and driver of the valuation of Netscape was its revenue growth.

Many of the main assumptions made in my valuation were made with an eye towards how those

assumptions would relate to total revenues. Netscape was part of an industry that was still in the

early stages of its existence and that was experiencing a rapid change in technology. It would be

assumed that Netscape’s rapid revenue growth would rise subsequently with the rapid growth of

the budding industry. Netscape’s success depended on the industry’s longevity in the period

after its IPO. Through most of the projection period in my valuation, the industry would still be

in the industry life cycle’s early stages. However, this scenario seeks to determine if Netscape

were to experience a steady decline of revenue growth over its projection period. What if they

were attempting to go into an established industry as opposed to an industry in its early stages?

In my original valuation, Netscape experienced a 55% revenue increase that occurred

consistently over the projection period. I altered the revenue growth to decline at a rate of 5%

from 55% in 1996 to 20% in 2003. The revenue growth remained at 20% for the years 2004 and

2005. From the results, there is no doubt about the sensitivity of the revenue total to the NPV


and share price. The NPV sharply declined to $126,334,031.64 and the share price sharply

declined to $3.31.



8th Scenario - Beta reduced to Industry Average

In my valuation, the original industry average for Netscape’s competitors was 0.72. This

was based on the industry average for competitors such as AOL and Microsoft. However, my

assumption for my valuation was a beta of 1.44. A beta of 0.72 is an indicator is that a stock is

beta that was less risky and less volatile than the risk of the overall market in the industry.

Netscape was a new company with a lot of uncertainty. Thus, they had to be more volatile than

the market. In this scenario, I have given Netscape the same beta as their industry average

competitors. All other valuation components stay the same. In this scenario, the NPV

dramatically increases to $1,832,263,056.26. The share price increases to $48.01. It is clear that

the NPV and share price are very sensitive to a significant change in beta.

Original NPV: $709,589,857.79 Scenario NPV: $1,832,263,056.26.


9 th Scenario: Decline in Research and Development Expenditures to 15%

It was clear that Netscape had to devote a tremendous amount of its expenses to research

and development in the future. Competition was rampant and they were in a competitive

position that was risky. It was expected to intensify in the near future and new entrants could

enter very easily. Thus, Research and Development Expenses had to grow at a significant rate

consistently over most of the projection period. My growth rate in the valuation was for

research and development to cover up 35% of sales for the first 8 years. By 2004, Research and


development expenditures would be reduced a bit to make up 20% of total revenues. In this

scenario, I have reduced research and development expenditures to where it made up only 15%

of total revenues over the entire projection period. The reduction to this key operating

expenditure provides a potent increase to the NPV and the share price. As a result of this

scenario, the NPV is increased to $847,392,145.68 and the share price was $22.21.



ANALYSIS OF SENSITIVITY ANALYSIS TABLE

I performed a more sophisticated sensitivity analysis of the NPV and share price based on

its sensitivity to a change in the market risk premium and growth rate change. The sensitivity

analysis measures the change in NPV and share price with every 0.50% increase and decrease in

the market risk premium and each 1% increase or decrease in the growth rate. When the growth

rate was constant and there was a subsequent increase in the market risk premium, the NPV and

share price would decline significantly. The base market risk premium was 7.29% and 4.071%,

which was what was used for the Netscape valuation. As seen in the earlier scenarios, an

increase in the market risk premium led to a decrease in the NPV and share price while a

decrease in the market risk premium increased the NPV and share price. As the market risk

premium decreased further and further from the base risk premium of 7.29%, the NPV and the

share price increased at an increasing rate. Each successive increase in the market risk premium

would result in a decrease of the NPV and share price at a decreasing rate. According to the

chart, the sensitivity of the change in the NPV and share price had a direct relationship with the

growth rate. As the growth rate lowered, the sensitivity of the overall change in the NPV and

share price lowered and vice versa. There was a 348% difference between the minimum and


maximum NPV and share price at a 0.071% growth rate. The difference between the minimum

and maximum NPV and share price gradually increases with each growth rate until it reaches the

maximum 568% difference at the 8.071% growth rate. The sensitivity of the NPV and share

price can also be determined by its successive increase or decrease that occurs with each

successive change in the growth rate along the same market risk premium. The base market risk

premium was 7.29% and the base growth rate was 4.071%. There was a 168.98% difference

between the minimum and maximum NPV and share price when the market risk premium was

7.29%. As expected, the difference between the minimum and maximum NPV and share price

would increase with each successive decrease of the market risk premium and vice versa. Thus,

the sensitivity of the NPV and share price would increase with a lower market risk premium and

decrease with a higher market risk premium. Within each market risk premium, the NPV and

share price increases at a greater rate with each growth rate increase and vice versa. This is

indicated in the sensitivity analysis graph.

BALANCE SHEET ASSUMPTIONS - ASSETS

RATIO ANALYSIS:

Total Asset Turnover Ratio:

The total assets to sales ratio is a ratio that measures a firm’s ability to manage its assets

in relation to its generated revenue. If the ratio is high, it is an indicator that the firm

was able to generate revenue while reducing investing expenditures. It is a measure of a firm’s

efficiency. Needless to say, a higher ratio is an indicator of a firm’s higher profitability. A low

asset turnover ratio is an indicator that a firm is not utilizing their assets in an inefficient and

unorganized manner. The formula for total asset turnover ratio is the following:Revenue

Sales

In my balance sheet, I have garnered a total asset turnover ratio for each year of Netscape’s


projection period. The total asset turnover ratio was gained by Microsoft’s total asset turnover

ratio for the second quarter of 1986 to the second quarter of 1995. Microsoft’s total asset

turnover ratio increased overall from 0.83 to 1.21 during the overall time period. There were

years in which the total asset turnover fluctuated up and down. As a result, I assumed that the

total asset turnover ratio for Netscape during the projection period would increase from 0.80 to

1.20 overall.

ACCOUNTS RECEIVEABLES TO SALES RATIO.

The receivables turnover ratio is an indicator of the overall sales relationship between

unpaid sales and overall revenue. It is ideal if this ratio is as low as possible, preferably at a rate

much lower than 1. It is considered high if it is near to 1. A high ratio is an indicator that a

large portion of the firm’s cash is tied up with customers who were too slow to pay. In order to

come up with a reasonable accounts receivable to sales ratio for Netscape, I used comparative

analysis by comparing the accounts receivable to sales ratio for Microsoft and Apple Inc. For

Microsoft, I used the accounts receivable scenario from the period 1985 to 1995. For Apple Inc,

I used the accounts receivable scenario for the periods 1987 to 1995. Most of the ratios for

Microsoft and Apple Inc were either at 0.15% or near 0.15 throughout the period. Based on

this information, I have assumed that the accounts receivable to sales ratio for the projected

period of Netscape would be 0.15. An accounts receivable to sales ratio of 0.15 is an ideal ratio.

In other words, Netscape’s accounts receivable would make up 15% of sales for the entire

projection period. After a decrease of the accounts receivable from 1995 to

1996, overall accounts receivable would increase for the rest of the projected period. Accounts

receivable increased from $3,865,403.41 to $199,608,995.30.

Cash and Cash Equivalents:

Cash and Cash Equivalents have the greatest liquidity of all the assets in the asset portion

of the balance sheet. It is an item that reports the worth of a firm’s assets that are either cash or


can be easily converted into cash. It is made up of cash on deposited in banks as well as money

market instruments. Maturities are usually 3 months or less. Other examples of cash and cash

equivalents include Treasury Bills and Marketable Securities. At the time of the IPO,

Netscape’s main sources for cash inflows were from increased deferred revenues and accounts

payable. Purchases of short-term investments and capital expenditures accounted for Netscape’s

main cash outflows. It is also assumed that Netscape will receive a potential influx of cash from

its public sale of their securities after the IPO. In my valuation, deferred revenues and accounts

payable increase every year of the projected period. Taking all these assumptions into account,

cash and cash equivalents is expected to increase with each year of the projected period. Cash

and Cash Equivalents increases from $8,848,336.00 in 1995 to $632,095,151.78 in 2005. These

same cash and cash equivalents can be seen as the final line item in my Pro Forma Cash Flow

Statement Excel Worksheet.

Short Term Investments

Short Term Investments is in the current assets section of the balance sheet. Typically,

short-term investments consist of stock and bond investments that are set to end within a year.

Netscape’s short-term investments consisted of first-rate debt securities that have maturities that

are greater than 3 months and less than 12 months. It is assumed that Netscape will be in an

increasingly strong cash position over the length of the projected period after the IPO. Thus, it is

assumed that Netscape would take advantage of its cash position and increase the number of

stock and bond investments with each year of the projected period. Netscape would gain a

greater accumulation of assets from those investments. In my balance sheet, short-term

investments increase from a total of $16,567,300 in 1995 to a total of $951,469,544.26.

Accounts Receivable:


Accounts Receivable is defined as money that is owed to a firm by a consumer for

services and products that were purchased on the basis of credit. These services and products

may have been already used by the consumer, but they are unpaid. Based on the above ratio

analysis, I have assumed that Netscape’s accounts receivable to sales ratio is 0.15 based on the

comparative analysis of Microsoft Corp and Apple Inc that is discussed in the ratio analysis This

is an ideal ratio due to the fact that is far below 1. Based on this result, accounts receivable

increased from $3,865,403.41 to $199,608,995.30. In every year of the projected period,

accounts receivable is 15% of sales.

Other Current Assets

Other Current Assets is the value of all non-cash assets that are owed within a year.

Other current assets can include prepaid expenses and supplies. It can even include deferred

income tax recoveries. In the second quarter of 1995, other current assets took up nearly 5% of

total revenues. (4.84%) It is assumed that other current assets will be 5% for the entire projected

period. The total amount of other current assets increased from $804.971.00 in 1995 to

$66,536,331.77.

Net Property and Equipment

It is defined as Gross Property, Plant and Equipment minus the accumulated

Depreciation. It represents the portion of PP&E acquisition cost that has not been determined as

an expense. Property, Plant and Equipment consists of land, buildings, machinery, tools,

equipment and other items. It is considered a long-term asset as it cannot be easily liquidated.

Netscape’s PPE consists of computers and equipment, furniture and improvements that needed to

be made on leased assets. With Netscape’s increased growth in the future, Netscape will have to

expand their headquarters and look for new locations to operate. Thus, it is assumed that


Netscape will gain an increase in terms of buildings and land. In addition, it is assumed that

Netscape’s customer base will increase over the projection period. Netscape will have to

provide an increased amount of maintenance and support services. Thus, they will have an

increased numbers of computers and equipment as a result. There is no question that Net PPE

will increase dramatically over the valuation period. Net PPE increased from $6,761,045 to

$864,972,312.96 over the projection period. NET PPE takes up 50% of sales for most of the

projection period. However, it takes up 65% of sales for the last three years.

Deposits and Other Assets

Other Assets are assets that are not classified as a current asset or a fixed asset. This

category usually includes deposits, prepaid expenses and intangible assets that the firm does not

directly use. It can be assumed that the items within this asset category is expected to increase

as Netscape grows as a firm over the projected period. Netscape’s deposits and other assets

increased from $1,281,582.00 in 1995 to $210,254,808.38 in 2005.

BALANCE SHEET ASSUMPTIONS – LIABILITIES

RATIO ANALYSIS

Accounts Payable to Sales Ratio

The accounts payable to sales ratio demonstrates the relationship between a firm’s unpaid

dues to suppliers or business partners. A low number for this ratio is desired. A high number

for this ratio is a sign that the firm may be having liquidity issues. I used the accounts payable

to sales ratio for Apple Inc and Microsoft in different periods in order to come up with a

comparative accounts payable to sales ratio. Third quarter totals from the years 1985 to 1994

were used for Apple Inc. The accounts payable to sales ratio increased from 3.89% to around


9.59%. For Microsoft, second quarter totals from the years 1986 to 1995 were used. The

accounts payable to sales ratio increased from 3.46% to 9.48%. Therefore, my assumption is

that the accounts payable to sales ratio would steadily increase from being 3.5% to 9.5% for each

year of the projected period in the self-balancing balance sheet. In other words, accounts

payable would increase from 3.5% to 9.5% of sales the projected period. Despite the range in

the ratio, these ratios are considered ideal.

Accounts Payable

Accounts Payable consists of money which a company owes to vendors and suppliers for

products and services purchased on credit. This item appears on the company's balance sheet as a

current liability, since the expectation is that the liability will be fulfilled in less than a year.

When accounts payable are paid off, it represents a negative cash flow for the company. A firm

has accounts payable when one have not yet paid for the assets or services you have received.

As Netscape grows as a firm in an industry with rapid technological change, it is going to

develop an increased reliance on suppliers for technology and other aspects of their products in

the future. As described in the ratio analysis, I came up with a suitable assumption for

Netscape’s accounts payable to sales ratio through the comparative analysis of Apple and

Microsoft’s comparative account payable to sales ratio. Accounts payable will increase from

3.5% to 9.5% of sales over time. Accounts payable decreases in the first year of the projected

period from 4,607,174.00 to 901,927.46 in 1996. It steadily increased until it reaches a total of

$126,419,030.66.

Accrued Compensation and Related Liabilities


Accrued compensation is money that a firm owes to its employees for hours worked as

well as hours worked, earned but unpaid bonuses and benefits such as unpaid time off: Accrued

Liabilities are liabilities that have taken place, yet have not been accounted as accounts payable.

This usually occurs when invoices have not received by a firm in spite of the fact that the firm

has provided goods and services. Netscape will have to increase its number of employees in key

department such as R&D, sales and marketing during its growth as a firm. Thus, Netscape may

end up with more cash owed to its employees for bonuses, benefits and even hours worked. In

the self-balancing sheet, it is assumed that accrued compensation and accrued liabilities will

increase steadily over the entire projected period.

Other Accrued Liabilities

These are accrued liabilities that are not covered under the Accrued Liabilities

column. This is also expected to increase under the projected period. Other accrued liabilities

were projected to increase from $1,897,819.00 in $1995 to $93,150,864.47 in 2005.

Deferred Revenues:

Deferred Revenues is revenue that is considered a liability until it becomes applicable.

For instance, a firm may receive a payment received for work that has not yet been performed. It

is sometimes called unearned revenue. Deferred revenue refers to an item that will initially be

recorded as a liability, but is expected to become an asset when the company completes the work

that they have been paid for. Netscape’s deferred revenues mainly consisted of unearned service

revenues from providing maintenance and customer support and unrealized product revenues

that stem from products that Netscape has not released to the customer. In other words, a

customer may have paid for a product that they may have not received. It is assumed that

Netscape will gain an increased amount of work as they will have to provide more maintenance


and customer support as their customer base increases. As a result, service and maintenance may

not be performed as efficiently as before. The projected increase in product revenues will

subsequently lead to an increase in unrealized product revenues. In my self-balancing balance

sheet, deferred revenues are assumed to increase overall over the course of the projection period.

However, deferred revenues decreased as a percentage of total revenues in every year of the

projection period.

Current Portion of Long-Term Debt Obligations:

Current Portion of Long-Term Debt Obligations is a balance sheet item that represents

the total amount of long-term debt that must be paid within the next year. The balance sheet has

a liability section, which is broken down into long-term and current debt. When a debt payment

is set to be made in longer than a year's time, it is recorded in the long-term debt section, and

when that payment becomes due within a year, it moves to the "current portion of long-term

debt" section. The current portion of long-term debt must be identified so that the firm can

budget appropriately to pay off the within a year’s time. The “Current Portion of Long-term

Debt" line item which reflects how much of their long-term bonds are maturing within the next

12 months. It is very essential that a firm has a strong flow cash position so that it can be readily

able to pay off the debt within the 12-month timespan. In the self-balance sheet valuation, the

current portion of long-term debt remains the same for the first few years (1995-1999). Netscape

is expected to invest in a hefty amount of PPE and other long-term assets over the projected

period. It is clear that Netscape will find itself in a great deal of long-term debt that eventually

will become due within a year. In my balance sheet, I have assumed that Netscape will owe

some long-term debt within a year from the year 2000 to the rest of the projection period.


Within those years, Netscape maintains a cash strong cash flow position that is sufficient enough

to pay off the debt.

Installment Notes Payable (Current Liabilities)

An installment note is a promissory note that underlies an agreement for a Credit

Installment. It calls for periodic interest and principal payments to pay off the debt. Since this

is in current liabilities, it means that these payments must be made in less than a year. In the

second quarter of Netscape, installment notes take up 3.32% of sales. My assumption is that

installment notes will take up 3.32% of sales for the entire projected period. Overall installment

notes payable will increase from $551,449.00 in 1995 to $44,180,124.29 in 2005.

LONG TERM LIABILITIES

Long Term Obligations

Long term obligations are the total face amount of outstanding long-term bonds issued by

the company, plus the expected interest due to be paid on them. A company's long-term

liabilities are accounted for by its debt obligations to other parties that last longer than one year.

Installment Notes Payable (Long-Term Liabilities)

Since this is in Long Term Liabilities, It means that the company’s obligations to these

payments lasted more than one year. In the financial quarter that Netscape had before the IPO,

Netscape’s long-term installment notes payable took up 9.09% of sales. Therefore, I have

assumed that installment notes payable will take up 9.09% of sales for the entire projected

period. Overall installment notes payable totals will increase from $1,511,331 to

$120,963.051.15.


BALANCE SHEET ASSUMPTIONS – EQUITY

Preferred Stock

Preferred Stock is defined as an equity security that has properties of both an equity as

well as a debt instrument. It is an ownership class in a firm in which one that has a greater claim

on earnings than those who own common stock. At the time of the Netscape IPO, preferred

stock converted to common stock at a rate of 2:1 via the option of the preferred stockholder. At

the time of the Netscape IPO, the ratio of preferred stock to common stock as a % of sales was

(1- 1.68). Preferred stock was 901.00 while common stock was 1514.00. It is assumed that

preferred stock will operate at a rate of 0.01% of sales for each year of the projected period.

Preferred stock proceeds grew from 901.00 in 1995 to $13,307,266.35 in the year 2005.

Common Stock

Common stock is a security that represents equity ownership in a corporation. With

this stock, shareholders obtain voting power in a corporation to vote on important things such as

the election of the board of directors. Through common stock, shareholders share in the success

of the company via an increase in a firm’s stock price or through dividends. It is assumed that

Netscape’s proceeds of common stock will increase due to an overall increase in investor

confidence with the firm. In Netscape’s stockholder’s equity for June 30th 1995, the preferred

stock to common stock ratio as a result of its % of sales was (1:1.68) Thus, I have assumed that

preferred stock will grow at the same ratio throughout the projection period. I have already

assumed that preferred stock takes up 0.01% of sales for the projection period (1996-2005).

Thus, I have assumed that common stock take up 0.0168% of sales for each year of the projected

period. As a result, Netscape’s projected common stock increases from $1514.00 in 1995 to

$22,356,207.47 in 2005.


Additional Paid in Capital

Additional paid in capital is defined as the excess capital contributed to a firm by

investors that exceed the par value of stock. It is the reported amount that a firm receives when

shares of stock are issued. It is included in the contributed surplus account in the shareholders'

equity section of a company's balance sheet. It is also known as capital surplus. Additional paid-

in-capital can consist of either preferred stock or common stock. Additional Paid in Capital is

calculated by taking the difference between the issue price and the share price and multiplying

by the number of issued shares of stock. As Netscape is expected to increase in overall revenue

growth and eventually gain a positive net income in the future, investors will gain more overall

confidence in terms of buying Netscape stock in the future. Needless to say, Netscape will have

more and more investors over time. Thus, it is assumed that Netscape’s investors will increase

the amount of capital that is contributed to the firm with each year of the projected period. The

total amount of additional paid-in capital will increase with every year of the projected period. It

increases from a total of $39,683,666.00 to $166,340,829.42. In order for a more realistic

valuation of the total, additional-paid in capital took up less and less of a percentage of total

overall total revenues over the valuation period.

Deferred Compensation

An arrangement in which a segment of an employee’s income is paid to the employee at a

time after the income was earned. Retirement plans, pensions and stock options are poignant

examples of deferred compensation. The major benefit of deferred compensation is that it allows

one to defer tax. It is clear that Netscape can be projected to have an increase in the number of

employees in key areas and departments in which growth is needed. Research and Development,

Sales and Marketing are examples of departments in which Netscape could potentially need a


significant increase in staffing in the near future. An increased number of employees will bring

along an increased number of employee retirement plans and pensions. Thus, I have projected

that Netscape will have to provide their employees with an increasing amount of deferred

compensation for each year of the projected period. Deferred compensation is a contra-equity

account. An increase in deferred compensation will result in an overall decrease in

stockholder’s equity. Deferred compensation increased from -$9,812,151.00 to -

$166,340,829.42.

Notes Receivable from Stockholders

Notes Receivable is a receivable that is due to a firm. This usually takes place when the

firm has made some sort of loan. In the case of a notes receivable from a shareholder or owner,

the shareholder usually borrows a loan from the firm. The borrowed money must be paid back to

the firm promptly. Netscape’s investors and shareholders are sure to increase dramatically as

Netscape grows as a firm over the projected period. An increase in shareholders will lead to an

increase in the potential opportunities for shareholders to borrow loans from Netscape in the

future. Based on this assumption, I have valuated that there will be an increase in the overall

amount of notes receivable from shareholders on my balance sheet. Thus, overall amount of

notes receivable increased with each year of the projected period. Notes receivable increased

from -638,065.00 to $79,843,598.12

Accumulated Deficit (Retained Earnings)

Accumulated Deficit is a term that is used when a firm has a negative balance of retained

earnings. Retained Earnings is the percentage of net income that is not paid out in the form of

dividends. Retained earnings are used by the firm to reinvest in particular operations in which


growth is needed. Retained earnings are calculated by taking the retained earnings at the

beginning of the period and adding net income as well as subtracting any dividends. For each

year of the projected period of the valuation, retained earnings have been added by adding the

retained earnings at the beginning of each period and adding it by the net income of the projected

income of each period. In my valuation, retained earnings are negative for the first five years of

the projected period. Retained earnings became positive in 2000 and would increase

significantly for the rest of the projected period. Retained Earnings would increase from a total

of $-12,577,561.00 to a total of $935,880,986.00.

Accumulated Translation Adjustment:

Accumulated Translation Adjustment is an entry that was used after currency translation

in which foreign exchange gains and losses are summarized from a particular period of time.

Currency translation involves the process of quoting the amount of money that was denominated

in one currency in the value of another currency. At the time of the IPO, Netscape expected its

foreign currency exposure to increase over time. Netscape was set to adopt an international

strategy of localization in order to tap into overseas markets. Thus, Netscape was expecting a

greater share of their overall revenues to come from overseas. Therefore, I have assumed that

Netscape would have an increase in foreign currency translation gains over time. This would

come as a result of increased activity overseas. In my valuation, Netscape is expected to

increase in accumulated translation adjustment over time. It increases substantially with each

year of the valuation of the projected period.

INCOME STATEMENT ASSUMPTIONS AND RESULTS


Product Revenues:

Product revenues took up a significant portion of Netscape’s total revenues in the income

statement period. At the time of the Netscape IPO, product revenues came as a result of

increased sales of popular products such as the Netscape Navigator and the Netscape Commerce

Server. Other Netscape products such as the Merchant System and the Proxy Server contribute

to revenues. Netscape Navigator dominated the web browser market share and was Netscape’s

most popular product. Thus, it makes up most of Netscape’s product revenues. In addition,

Netscape enhanced its product distribution methods in the quarters leading up to the IPO. It

had started the process of offering its starts via retail sale distribution, which was an upgrade

from offering products via direct sales and Internet sales. Netscape’s product revenues is set to

increase as Netscape increased its method of product distributions over the projected period. It

is assumed that product distribution methods will only increase over the projected period.

Product revenues are sure to increase as it is assumed that Netscape will come up with innovative

products in order to differentiate themselves from competitors. Upgrades of existing products

such as the Netscape Navigator are sure to occur over the existing period. In the projected

income statement, product revenue expenditures increased from $15,580,258.00 in 1995 to

$898,240,479.00 in 2005. Despite the increase in product revenue expenditures, product

revenues decrease as a % of total revenues with each projected period. Product revenues

increased from 90% of sales in 1995 to 67.5% of sales in 2005.

Service Revenues:

Netscape’s service revenues consisted of fees that were paid for Netscape in order to

provide support, maintenance and consulting for their customers. Service revenues were also

derived from the increasing advertising space that Netscape provided for companies on their

browsers. Netscape was in an industry that was in the earliest stages of its growth. Netscape’s

success was highly dependent on the Internet’s success. The Internet and the World-Wide Web


was not considered a mainstream medium in the U.S at the time of the IPO. Thus, Netscape

had many more potential customers to reach in order to establish more of a customer base after

the IPO. Therefore, it is assumed that Netscape will increase its customer base over the course

of the projected period of the IPO. Netscape will have to provide increased customer service

and increased maintenance. As a result, it is assumed that they will receive increased service

revenues from customers. It is also assumed that service revenues will increase as a percentage

of total revenues due to the assumption that Netscape’s customer base will be enlarged each year.

Netscape took up 6.29% of overall sales revenue in the quarter before the IPO in 1995. In my

projected income statement, service revenues would increase from 10% of overall revenues in

1996 to 32.5% of overall revenues in 2005. Service revenues would increase from

$1,045,133.00 in 1995 to $432,486,156.00 in 2005.

Cost of Product Revenues:

A great deal of material is accounted for in Netscape’s cost of product revenues.

Netscape’s cost of product revenues consisted of the media for potential products. It also

consisted of product manuals and material that is used for packages. This also consists of costs

that Netscape had paid for technology that it licensed for its products. It also consists of costs for

duties performed by third-party suppliers. It is assumed that product revenues will increase

significantly over the projected period due to the potential for Netscape to come up with

innovative products as well as upgrades of existing products. An increase in new products as

well as product upgrades will lead to an increase in product manuals and packaging material. In

addition, Netscape was in the early stages of an industry that was going through a rapid amount

of technological change. It is assumed that Netscape would increase their efforts to buy licensed

technology for innovative products or existing upgrades. This would also help to increase

Netscape’s cost of product revenues over the projection period. Netscape’s cost of product


revenues increased over the projected income statement period. Netscape’s overall cost of

product revenues increased from $1,222,045 in 1995 to $86,497,231 in 2005. In our valuation,

the cost of product revenues increase slightly as a percentage of product revenues for each year

from 1995-2000, then it declines slightly each year for the rest of the projection period.

Cost of Service Revenues:

Netscape’s cost of service revenues would primarily consist of costs that are related to its

employees. It was assumed that service revenues would increase mainly as a result of the fees

from increased consulting, customer support, maintenance and customer training that Netscape

would have to provide due to an assumed increase in customers in the future. Netscape’s cost of

service revenues primarily consist of the expenditures that Netscape would have to spend in

order to hire more employees so that it can provide the increased services mentioned above. This

will aid Netscape in keeping up with the projected increase in customers. It is assumed that

Netscape’s cost of service revenues will increase due to the increased costs

Netscape will incur by increasing its number of employees in each projected period. Overall cost

of service revenue expenditures increase from $513,777 in 1995 to $73,189,965 in 2005.

Research and Development – (See IPO Valuations and Assumptions)

Sales and Marketing

Netscape was in an industry that was just beginning to scratch the surface. Competition

was fierce and was expected to intensify in the future after the IPO. Netscape was in a risky

position as it was susceptible to competition by new entrants. Netscape’s sales and marketing

expenses consisted of expenditures such as employee salaries, advertising and marketing

literature. Sales commissions were part of Netscape’s sales and marketing expenditures.


Netscape paid a great deal of attention to marketing prior to the IPO with its targeting of three

key target markets: Individual PC users, The Enterprise and Internet Commerce. Netscape’s

sales and marketing expenditures increased partly due to an employee increase before the IPO.

It is assumed that Netscape will have to increase hire more employees for its sales and marketing

department over the course of the projected period. Most likely, Netscape will engage in an

increased amount of advertising and need more marketing literature. Thus, sales and marketing

expenditures will increase overall over the projection period. In my valuation, sales and

marketing expenditures decrease as a % of total sales with each year of the projected period. As a

result, overall sales and marketing expenditures will decrease slightly in 2003 and 2004 before

increasing in 2005. It is assumed that Netscape would become established and stabilized as a

firm by that time. Sales and marketing expenditures made up 55.67% of total sales in 1995. It

would decrease from being 55% of total sales to 7% of total sales in 2005. Overall Sales and

marketing expenditures will increase from $9,256,066.00 in 1995 to $93,150,864.00 in 2005.

General and Administrative fees

General and Administrative Fees consists of the expenses and fees spent to operate a

business that is not directly linked to a firm’s production of its products or services. Examples

of general and administrative fees consist of rent and overhead. It also consists of executive

salaries. It is assumed that Netscape will significantly expand their headquarters and look to

expand their operations in different locations as they continue to grow. Thus, It is expected that

Netscape will have to increase their expenditures in terms of rent and overhead for general

expenses. It is assumed that Netscape executives such as Marc Andreessen and Jim Clark can

be expected to be paid handsomely as Netscape grows exponentially in terms of revenue growth

over the projection period. In my income statement, general and administrative fees are

expected to increase over the projection period. General and Administrative Fees increased


from $3,693,005 in 1995 to $26,614,533 in 2005 over the income statement projection period.

Property rights agreement and related charges:

Intellectual property is defined as property that is derived from one’s intellect.

Intellectual property rights are defined as the firm’s rights to own ideas or plans without

competition for a predetermined period of time. In other words, Netscape gains exclusive rights

to the intellectual property. Patents, trademarks and copyrights are examples. Netscape’s

property rights agreements consisted of things such as costs used for trademark searches. It is

assumed that Netscape will find itself in more intellectual property rights agreements as

Netscape gains increased popularity as a firm. Intellectual property rights agreement increase

for the majority of the projected period. There was a decrease in 2004. Netscape’s property

rights agreement increased overall from $500,000 in 1995 to $13,307,266.00 in 2005.

Netscape’s intellectual property rights agreements decrease as a % of sales for each year of the

projected period.

Operating Income (EBIT):

Operating income was calculated using the following equation:

Gross Profit−Tot alOperating Expenses: The results showed that operating income was

negative for the first few years from 1995-1998. Operating income went on the positive side in

$7,676,949 and would increase dramatically to $771,821,448.00 in the year 2005. This dramatic

increase in operating income coincides with Netscape’s increased profitability over the

projection period.

Interest Income:

Interest Income is the income that firms use on their income statement in order to report

the interest earned on cash that firms held in savings accounts, COD’s and other investments. It

is assumed that Netscape will increase its holdings of cash equivalents in the aforementioned


accounts over the projected period. Netscape’s increased cash holdings in such accounts will

lead to an increase in interest income over the projected period. In the quarter before the IPO,

Netscape’s interest income made up nearly 3% of sales in the quarter before the IPO. Therefore,

I have assumed that Interest Income will continue to make up 3% of sales for

the entire projected period. Overall Interest Income increases from 495,583.00 in 1995 to

$39,921,799.00 in 2005.

Interest Expense:

Interest Expense is the amount of overall expense reported for the money that a firm

borrows. It represents the amount of money that a firm pays out in terms of interest. With an

expected increase in long-term debt and other essential liabilities over the projected period,

Netscape is assumed to borrow an increasing amount of money through the use of loans

in order to make payments promptly. Therefore, the interest on the borrowed loans will increase

over time. In the quarter before the IPO represented in 1995, Interest expense represented –

0.77% of sales. I have assumed that Interest Expense will continue to take up that same

percentage of sales over the course of the entire projected period. Netscape’s interest

expenditures are expected to increase from -$128,655 in 1995 to -10,297,781.00 in 2005.

Net Income:

Net Income is a company’s total earnings for profit. It is defined as the differential

between a firm’s total revenues and its total expenses. Net income is an essential indicator of the

health of a firm. It is the last item reported on the income statement and it thus often referred to

as the “bottom line”. At the time of the IPO, Netscape was in a very risky position and it was

expected that it would operate at a loss for a significant amount of time after the offering was

completed. After all, Netscape was projected to finance its growth primarily with debt. Netscape

had a negative net income of -$4,307,716 in the quarter before the IPO. After calculating all


revenues and expenses of Netscape for the projected period, Netscape had a negative net income

for the first two years of the projected period before becoming positive in 1998. It would grow

exponentially afterwards. Net In total, Netscape’s Net income grew from a total net loss of –

4,307,716.00 in 1995 to a net income of $801,445,467.00 in the year of 2005. This expanded

increase in net income reflects the success and the growth of Netscape over the period.

NETSCAPE’S VALUATION ASSUMPTIONS AND RESULTS

Revenues:

At the time of Netscape’s IPO, Netscape’s received its product revenues from license fees

that were related to product software as well as service fees for maintenance, support and

licensing. The sale of advertising space was a main component of service revenues. At the time

of the IPO, Netscape had planned to add new server and integrated applications software such as

Netscape News Server and the Netscape IStore. It could be assumed that Netscape would go on

to produce new products as well as frequent upgrades of existing products. Certainly,

Netscape had to have placed a lot of emphasis on its future upgrades of its popular

products such as the Netscape Navigator and the Netscape Communications Server. In addition,

Netscape was already in the process of upgrading its product distribution processes through retail

sale. Netscape can expect to have a significant increase in product license fees in the future.

Netscape is assumed to have an increase in the service revenues. As it becomes established in the

industry, Netscape’s customer base will expand. As a result, it will have to provide more

maintenance, support and consulting to its customers. Thus, they will receive an increasing

number of service fees. In order for a more comprehensive analysis of the revenue growth

rate, the revenue growth rate of Microsoft Corporation was used. The revenue growth rate was

estimated for the period from 1985 to 1995 using totals from the 2nd quarter. Revenues increased

by 40% from the 2nd quarter of 1985 to 1986. There were many fluctuations that took place

during the period. However, Microsoft’s average revenue growth rate was 46% for the overall


period. Netscape was embarking on an IPO as part of an industry that was in its earliest stages.

Industry boundaries were not established. Huge growth was expected. My assumption is that

Netscape will continue to grow at a rate of 55% over the entire course of the projection period

Terminal Value Growth Rate

The terminal value growth rate was derived from using the Annual GDP growth rate for the year

1994. The annual GDP Growth Rate for 1994 was 4.071%.

Beta

Netscape’s original industry average beta was 0.72. The industry average beta was

derived from using the AOL and Microsoft beta. However, a beta of 0.72 would mean indicate

that the potential stock is less volatile than the stock market. Netscape was a high growth and

high-risk firm at the time of the IPO. High volatility was definitely expected in the stock market.

Thus, I multiplied the industry average beta by 2. The assumed beta was 1.44. A 1.44 beta is

more representative of Netscape’s position as a high-growth and high-risk firm.

Risk Free Rate

The Risk Free Rate was derived using the ten-year treasury bond yield. The Risk Free Rate was

derived by using the risk free rate in July 1995, one month before the Netscape IPO. At that

time, the risk free rate was 6.72%.

Market Risk Premium

The Market Risk Premium was derived from the average market risk premium in 1994. The

average market risk premium was 7.29%.

Corporate Tax Rate

The Corporate Tax Rate for my valuation was 39%. This was the U.S corporate tax rate from


1994. It would be unchanged until 2006.

Cost of Revenues

The Cost of Revenues consisted primarily of two main categories: Cost of Service Revenues and

Cost of Product Revenues. Product revenue costs consisted of costs for items such as media for

products, manuals, packaging essentials and other items. Netscape’s service revenue costs

consisted of costs for consulting from outside sources. It also consists of maintenance costs and

costs for customer support. It is to be assumed that Netscape will increase its customer base as

the Internet increases in popularity and the Internet becomes more established as a firm.

Therefore, Netscape’s cost of service revenues will increase as they will have to perform

increased maintenance on their browser and provide more customer support. Netscape will need

an increasing amount of manuals and packaging materials for its products as it will look to have

new products or product upgrades. It is assumed that Netscape will have to hire more

employees. Netscape’s second quarter financials (June 30th 1995) showed that its cost of

revenues represented 10.4% of total overall revenues. I assumed that it will represent 12% of

total overall revenues for the projected period.

Research and Development: -

Netscape was a firm in an industry that was in the very early stages of the industry life

cycle. It is known that the early stages of the industry life cycle are characterized by massive

revenue growth. However, it is also characterized by the speedy development of new products.

A great deal of technological change was taking place. Netscape had a great deal of competition

from many types of vendors at the time of the IPO. In addition, Netscape could have easily had

more potential competitors due to the relative ease in which new entrants entered the industry at

the time. These were all potential risk factors of Netscape. Thus, it was imperative for

Netscape to invest a significant amount into research and development in the future. Netscape


will have to expand the number of personnel by hiring some of the brightest minds within the

industry and placing them in their R&D department. Netscape will have to pay those individuals

significant salaries. Netscape will definitely have to invest in outside consulting. With a strong

emphasis on research and development, they will be able to keep pace with existing competition

as well as fend off new competitors that may come within their industry. Therefore, I have

assumed that Research and Development expenses will increase significantly in the near future.

In my valuation, Research and Development expenses will take up 35% of total revenues from

1996-2003. I have assumed that Research and Development Expenses will decline to 20% for

the last two years on the valuation on the basis that the industry as well as Netscape will be

established in the mainstream by that particular time.

Other Operating Expenses:

Netscape was expected to increase its operating expenditures in sales and marketing,

general and administrative expenses and property rights and related agreement charges over the

projected period. Netscape was in an industry with increasing competition with hardly any

barriers to entry. Thus, the company placed a great emphasis in having top-notch operations.

There is no doubt that Netscape had to invest significantly in the area of sales and marketing due

to its risky position. Sales and Marketing Expenses consists of expenses such as advertising

costs, costs for marketing literature and salaries. General and Administrative expenses consists

of payments for rent and overhead as well as executive salaries. It is to be assumed that

Netscape will continue to expand its headquarters by finding new operating locations. As a

result, rent and overhead expenses will increase as a result. Netscape executives will look to be

compensated appropriately for the future growth of Netscape. Ratio Analysis was used with

this valuation. The operating expense ratio is a measurement of Netscape’s efficiency in

managing its expenses. It is an indicator of whether Netscape can turn its net income into


profit effectively. Netscape’s operating expenses to sales ratio was at 0.80 in the 2nd quarter

before the IPO. This was a very high ratio and a strong indicator of Netscape’s risky financial

position at the time. It was assumed that Netscape would see a steady decline in its operating

expense ratio to exemplify its increased efficiency as a firm. Other Operating Expenses started

to decrease from 75% of total revenues to 10% of total revenues at the end of the projected

period. The 10% of total revenues would represents Netscape’s status as a stable firm that has

achieved maximum efficiency.

Capital Expenditures Growth Rate

Capital Expenditures refer to cash that is spent on acquiring and maintaining tangible

assets such as buildings, equipment and machinery. These tangible assets consists of items that

depreciate over time. Capital expenditures is the difference between the change in total

liabilities from the change in total assets from one year to another. Capital expenditures is

related to the property, plant and equipment (PPE). Netscape’s capital expenditures primarily

consisted of mostly computers and equipment at the time of the IPO. It also consisted of leases

and furniture. Netscape’s growth of computers and equipment will significantly increase. It is

certain to have an increase in the number of leases as it will continue to expand its operating

headquarters. Capital expenditures for Netscape made up 45.8% of revenues in the 2nd quarter of

1995. Capital expenditures will increase overall in value, but decrease as a percentage of total

revenues over time. Over the projected period, Capital Expenditures will decrease gradually

from 40% in 1996 to 10% in 2005.

Depreciation Growth Rate

Depreciation is an expense that is noncash. It reduces the overall value of a tangible asset

due to aging or wear or tear. In my valuation, depreciation was a % of sales. In order to come

up with a comparative growth rate, I looked at the depreciation growth rate of both Apple Inc

and Microsoft Corporation. For Apple Inc, I used the third-quarter period from 1982 to 1994.


The Depreciation rate ranged from 4% of sales in 1982 and gradually increased to a rate of over

8% sales in the third quarter of 1994. Microsoft Corporation’s Depreciation rate grew from 5%

in 1985 to 8% in 1993. It ballooned to 12% in 1994 and 1995. It was interesting to note that the

Depreciation growth rate increased for both companies. It makes sense that as Netscape

becomes more established, it becomes more clear and clear that more and more of it’s older

equipment would become aged. Based on this, my assumption is that Netscape’s Depreciation

growth rate will increase over the projected valuation period. In my valuation, I have assumed

that the depreciation will grow steadily from 4% of sales in 1996 to 8% in 2005 for the projected

period.

Cost of Equity (CAPM)

The Cost of Equity is used to determine a required rate of return of an asset. It is the rate

at which cash flows produced by the asset should be discounted according to the riskiness of the

relative asset. The CAPM formula involves the risk free rate, beta and the risk premium. R = Rf

+ Beta *(Risk Premium) My inputs were that the risk free rate was 6.72%. The beta was 1.44.

The market risk premium was 7.29%. = r = (6.72+ 1.44(7.29)) = 17.22%.

VALUATION RESULTS

In my valuation, the consistent 55% growth rate brought Netscape’s total revenues from

its original value of $16,625,391.00 in 1995 to an estimated $1,330,726,635.32 billion dollars in

2005. Research and Development expenditures increased steadily each year of the projection

period from $6,115,152.00 total in the June 30th 1995 financials to $266,145,327.06 in the year

2005. I believe this accurately reflects the emphasis that Netscape will put on research and

development in order to compete with its significant amount of competitors in the future and to

hold off new entrants and potential competitors in the future. Even though the other operating


expenses decreased as a % of overall revenues with each year, their overall expenditures

increased during the projected period. Other Operating Expenses consisted of a total of

$13,449,071, 00 in the second quarter of 1995 to $133,072,663.53 in 2005. The FCFF model

consisted of the following equation: FCFF=EBIT (1−T )+Depreciation+CAPEX+WCINV .

EBIT (Operating Income) was determined by the following equation: (

Gross Profit−TotalOperating Expenses¿. In my valuation, the total operating income was a loss

for the first few years of the valuation (1995-1998). In 1999, the operating income became

positive at a total of $7,678,948.86. It would increase at an increasing rate every year to a total

of $771,821,448.49. The tax rate was 39%. Thus, (1-0.39) equals 0.61. Depreciation’s

gradual increase as a % of sales throughout the projected period was reflected in the projected

total. Depreciaton increased from $917,566.00 in the second quarter of 1995 to

$106,458,130.83 at the end of the projected period (2005). Capital Expenditures steadily

increased from $7,617,886.00 in 1995 to $133,072,663.53. This is reflective of the increased

emphasis that Netscape will have on property, plant and equipment in the near future. Net

Working Capital involves the annual change in the accounts of working capital accounts. The

change in the total working capital accounts from Netscape’s balance sheet was not reflected on

an annual basis. Thus, the Net Working Capital could not be factored into the valuation. There

was a loss in the total FCFF for the first six years of the valuation. The FCFF would become

positive in 2002. The FCFF decreased for the first few years (1995-1999). It started to increase

in the year 2000 and would increase until 2005. The terminal value came from the following

equation: FCFF 2005

(k−g) The k represents the discount rate from the CAPM, which was 17.22%.

The g represents the terminal value growth rate, which was 4.071%. The total terminal value

that was derived from the equation $3,378,794,143.51. The value that was derived from the


present value of the FCFF was $120, 962,210.05. The formula for the present value of the

terminal value consisted of the following:TERMINALVALUE

1+k n . k = 17.22% n = 11 years.

Terminal Value = $3,378,794,143.51. Overall, the present value of FCFF is $588, 627, 647, 74.

By adding the (Present value of the FCFF) + (Present Value of the Terminal Value) = We get a

total NPV of $709,589,857.79. We take the total NPV and multiply it by the total number of

shares after the IPO. = 38,161,444. ($709,589,857.79)/(38,161,444) = $18.59. Therefore, the

share price that Netscape should give to its shareholders is $18.59. I feel that this is an accurate

share price for Netscape that really reflects its true value.

NETSCAPE IPO QUESTIONS

1. There are many aspects to why Netscape had been successful up to its IPO in 1995.

Netscape’s success was boosted by its excellent decision to enter the Internet Industry through

the web browser industry .At the time of the IPO, the only web browser that was out there was

the Mosaic. The Mosaic had captured 60% of the web browser market by the time Netscape was

born as a company. This, Netscape was successful in entering the Internet Industry through a

market with one main competitor. It is of no surprise that Netscape’s success was boosted with

its release of the Netscape Navigator. The Netscape Navigator created a new industry standard

for current competitors and potential entrants to emulate. After its initial release in December

1994, the Netscape Navigator captured 75% of the web browser market by the spring of 1995.

The success of the Netscape Navigator made up a huge chunk of the company’s revenues for the

first two quarters of 1995. It was leading client software that featured a click and point graphical

user interface as a wide variety of Internet functions. Netscape appeared to have a unique and

sophisticated strategy that poised it for future success. It’s creation of the Netscape Navigator


showed that Netscape appeared to have a strategy to create products with competitive advantage

in terms of niche. Netscape placed a good emphasis on ensuring that its products were user-

friendly. The key behind the Netscape Navigator’s success was that it made Internet navigation

much easier for users. Netscape’s server software emphasized user-friendliness thanks to its

automated installation as well as its configuration. Netscape sought to make products that

performed at a high level. This was evident with the Netscape Navigator and performance was

emphasized in its high performance. Netscape also sought to have their products provide a

greater amount of security than its competitors. Finally, Netscape emphasized that its products

be consistent across multiple platforms. Netscape Navigator and its server software aimed for a

differential advantage due to the fact that it could perform across multiple operating systems and

platforms. Despite its great competitive position that Netscape had with the dominant market

share of the Netscape Navigator, In order for Netscape to be successful, it must continue to

strengthen its relationships with its strategic partners in key areas such as technology and

infrastructure. After all, it was possible that Netscape needed to license its technology in order to

keep up with the competition in the future. This will help Netscape to achieve its product

differentiation. Netscape could also be successful by developing multiple channels of

distribution. Rapid product distribution will help Netscape achieve a strategic advantage over its

competitors. Despite Netscape’s dominant position in the web browser market, they were in a

very risky position competitively. Its limited operating history gives it a very risky position

competitively. Many of Netscape’s competitors such as Microsoft, IBM, and AOL have a

significant advantage in terms of years of operation. Thus, it did not have as much experience as

it competitors when it comes to responding to rapid market and industry changes. Due to its

limited operating history, Netscape did have much of a background in which to properly forecast


its financial condition. Netscape expected a high amount of volatility in its financial condition

after the IPO. Netscape’s success was highly dependent on the Internet’s success and it was

uncertain if the Internet would be widely accepted in mainstream society at the time. This

uncertainty made Netscape’s position very risky. It was not certain that the Internet market

would succeed since it was still in the early stages of development. Netscape’s position was

risky due to its vast amount of competitors. The industry was highly susceptible to new entrants.

This increased Netscape’s risk at the time of the IPO.

2. Netscape did not necessarily need to go to public in order to satisfy its capital needs.

Netscape could have raised their capital through a private equity transaction. A private equity

transaction involves negotiations with institutions that are financial and institutions that are non-

financial. Netscape could finance its assets by buying equity in firms that are not publically

related on a stock exchange. Netscape could have engaged in a venture capital transaction or

leveraged buyout transaction in order to meet its equity needs. I would estimate that the bulk of

Netscape’s needs over the past 3-5 years after the IPO are research and development, sales and

marketing and capital expenditures. Netscape is in an industry with a lot of competition as well

as a great potential for new entrants. Thus, Netscape will have to invest in a significant amount

of research and development in order to continue to develop innovative products that are

industry-defining. This will help to keep competition at bay. Netscape would need to invest

heavily in terms of hiring top-notch software experts for their research and development

department. Netscape needed also need to invest in an increasing amount of sales and

marketing. Netscape was expected to provide product upgrades and make new industry-defining

products after the IPO. Thus, Netscape will need to invest in a greater amount of expenditures

for advertising across different mediums: (TV, Internet, etc) Netscape will have to increase


their level of staffing within the sales and marketing department. In addition, Netscape will have

to come up with sophisticated marketing strategies in order to reach its primary target markets.

Thus, Netscape will increase its emphasis on marketing as well as marketing literature. Netscape

will need to invest in an increasing amount of capital expenditures over time. Capital

expenditures refer to expenditures spent to acquire key tangible assets. Netscape will need to

spend a great deal of cash to buy more computers and equipment as Netscape’s customer base

increases over time. Netscape is likely to spend more money on buildings as it may look to

expand its headquarters and locations over time.

3. Companies such as Netscape generally go public in order to raise a greater amount of financial

capital. Firms usually decide to go public when its capital needs are too great to remain private

and deal with the lack of liquidity for investors. By going public, the firm increases their overall

liquidity at a reduced cost of capital. This results in enormous monetary benefits. Firms can use

the increased capital for expansion and to fulfill pressing needs such as R&D. There are many

advantages and disadvantages that come with a firm’s decision to go public. An immediate

advantage of a firm’s decision to go public is that the firm gains an increased public profile and

prestige. Public companies are more likely to be displayed in different mediums such as the

newspaper, TV or Internet. An increased public profile provides a firm with a competitive

advantage by providing greater brand recognition. This increased public profile can gain to

greater market access as well as more customers. Public firms are generally more famous than

non-public firms. Another advantage is that it set a standard for proper valuation of a firm.

Trading public shares determines a value for a firm that can be used just in case a firm seeks a

merger or an acquisition. In addition, the shareholders are happy because they are made aware

of the share’s present value. There are many disadvantages to an initial public offering. A


primary disadvantage is that is a very expensive process. Initial public offerings range from

$250,000 to $1,000,000. Expensive fees such as filing fees, travel costs and underwriting

expenses are usually factored in. Another disadvantage of going public is that newly public

companies go under increased public scrutiny. When a firm goes public, it is now under the

umbrella of the SEC. A firm has to file essential reports such as the 10K and company

prospectus with the SEC in a timely fashion. A firm faces the increased risk of liability if any

SEC reports are found to be false or misleading. In addition, firms face increased scrutiny on

the part of the shareholders. Shareholders want the firm to deliver solid earnings immediately.

Public firms usually face more pressure by shareholders to deliver solid financial results.

4. The IPO market is referred to as a hot issue market and is often seen as underpriced. There Of

course, the security is underpriced if it is in excess of the offer price at which it was originally

sold to investors. In order to understand why the IPO market is viewed to be underpriced, one

must grasp a sense of the reasons why many firms would choose to underprice their initial public

offerings initially. For instance, many firms end up with underpriced IPOS due to the desire of

company insiders to retain control of the overall allocation of shares. Underpricing allows the

opportunity for rationing while shares are being allocated. Rationing limits the amount of shares

that new shareholders and investors can purchase. It reduces the possibility of a larger

shareholder taking firm control. Firms also engage in IPO underpricing in order to provide a

signal to outside investors and shareholders of the quality of their products. It is often seen as a

marketing decision. Investment banks can directly benefit from the underpricing of the IPO

market Investment banks significantly decrease their chances of being held liable by their clients

by engaging in the underpricing of IPOS. Underpriced shares lead to a decreased chance that a

company’s initial share price will decline after the IPO. Thus, investment banks will benefit


from having a decreased margin of error. Netscape’s board of directors should be very

concerned as there is a high degree of uncertainty over whether underpricing will produce

desired results earned by initial buyers of shares. Boston Chicken was very successful and

sustained its success through underpricing. However, Snapple did not sustain its initial success

over time and Pixtech flopped altogether. These differing results indicate that the success of IPO

underpricing is not guaranteed. This is a definite concern to Netscape’s Board of Directors.

6. According to the assumptions given in Question #5 and started with sales of $16,625 million,

Netscape must grow at a rate of nearly 74% basis over the next 10 years in order to justify a

share value of $28.00. In order for Netscape to achieve its desired share value of $28.00, the

exact rate of growth is exactly 73.545% over the next 10 years.

7. Looking at this issue from an executive’s perspective, an executive will want the proposed

offering price to be at a point in which the company can obtain the maximum amount of

financial profitability in order to offset the expensive IPO costs. If I were an executive, I would

not want to engage in any underpricing of the Netscape IPO. As discussed earlier, it is not

guaranteed that Netscape would achieve success if Netscape were to engage in the practice of

IPO underpricing. Therefore, the IPO price would be over Netscape’s original projected share

price of $28.00. An executive would also have a strong amount of confidence in the prospects

of Netscape at the time of the IPO. Therefore, an executive would recommend a share price that

is around $45.00. As an investor, I would look to buy the projected Netscape IPO price at the

lowest and most accurate price based on its valuation. I would hope that the price is at a

reasonably low level. However, I would place greater concern on an IPO price that is as accurate

and ideal as possible. Internet IPO’s that had recently taken place before Netscape’s IPO ranged

between $12.00-$17.00. Certainly, an investor would not be comfortable with a price at, near or


above $28.00. As an investor, I would pick the projected share price of $18.59. This was the

share price that I derived from doing my own Netscape valuation. I would feel more

comfortable with this price due to the fact that it is much closer to the range of previous Internet

IPO’s. At the same time, the price would still be higher than the aforementioned IPO’s.

Therefore, Netscape’s hype as a company with great future growth prospects would still be

reflected in the price. If I were a manager of a large institutional pension fund, I would be in

charge of managing the retirement income of potential retirees. As a manager, I would be very

delicate with the retirement income of my clients. Therefore, I would be very conservative with

the way that I manage the investments of clients. Thus, I would not be willing to buy and hold at

$28 if I were the manager of a pension fund. I would be leery of buying and holding Netscape

at a share price that was nearly double the rate of Internet-related IPO’s. It is a riskier venture

due to the fact that there is a much greater potential for loss on the downside. As a pension fund

manager, I would place my clients as well as the fund itself at greater risk. It is a much safer bet

to buy and hold at $14.00 then at $28.00.

8. A great deal has happened to Netscape since its IPO in 1995. Right after the IPO, the IPO’s

share price dramatically increased to a record-high $75 on the first day of trading. Netscape’s

early success was confirmed in the fact that its revenues rose significantly for the final two

quarters of 1995. Netscape executive Marc Andreessen landed himself on the cover of Time

Magazine. This signaled that Netscape was thrust into the mainstream. In another key sign of its

growth, Netscape acquired a software company by the name of Collabra Inc in January 1996 as

well as a paper firm by the name of Paper Software one month later. By June 1996, the

“browser wars” between Netscape and Microsoft was well under way. Netscape had Microsoft

investigated by the U.S Department of Justice for anticompetitive practices. It claimed that


Microsoft was using an unfair amount of influence in terms of getting computer manufacturers

and service providers to use the Internet Explorer. Meanwhile, Netscape Navigator 2 did not do

well and spent only 5 months in the market before the next upgrade. Microsoft’s Internet

Explorer would outperform the Netscape Navigator due to Microsoft’s advantage in terms of

labor and capital. Microsoft’s advantage in capital allowed them to offer the Explorer for free.

Netscape’s server software was even challenged via Microsoft’s Internet Information Server.

Netscape was overmatched by Microsoft and would lose the “browser wars”. In January 1998,

Netscape was finally able to match Microsoft’s strategy of releasing their browser for free.

Netscape would make the open source code for Netscape Communicator 5.0 available for

Internet redistribution. In November 1998, Netscape ended up getting purchased by America

Online in a $4.2 billion stock-swap.

Andre Waldron Netscape Ipo Project = Fin 160

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