Netscape's Initial Public OfferCorporate Finance Case Study

Submitted By,

Group B11

Group Members

SRINIDHI K S 14161

SRISTI ROY 14162

SUMAN SADHUKHAN 14163

TONY SEBASTIAN 14171

V H L KASYAPA DAGUUBATIA 14172

Case Facts

• The case is about Netscape Communication Corporation.

• In 1995 they decided to go for IPO because of growing capital needs.

• A Day before the IPO the underwriters proposed to increase the offer price

from 14$ to 28$

• This suggestion was raised because of the remarkable oversubscription.

• The Board of Directors faced a price dilemma, whether to increase the

price or not.

Key Learnings from the Case

• IPO Process of a company

• Beta Calculation for an unlisted company

• Internet Boom of mid 1990s.

Netscape Communications

• Founded in April, 1994

• Had a line of Client, Server and integrated applications software

• Used in communication and commerce over the Internet and private IP

Network

• Most popular product- Netscape Navigator browser.

• In addition to product revenues, Netscape generated service revenues

which includes fees from consulting, Maintenance and support service.

Industry Background

• Information Technology was one of the fastest growing sector in 1990s.

• According to International Data Corporation (IDC), in mid-1995 there were

approximately 57 million Internet users.

• Out of this approximately 8 million were accessing information on the

World Wide Web.

• Mid-1990s also marked the beginning of heavy investment into IT and

Internet related companies.

Financing OptionsYoung rapidly growing companies facing intense competition typicallyraise equity capital in two broad ways.

• Through private equity transaction

• Going Public (IPO)

Reason for Netscape’s IPO

• Growth: Will give the company enough money to scale up.

• Increase visibility: (e.g. listing on the NYSE).

• Transparency: Increase the accountability of the firm and improve thereputation by reducing information asymmetry.

But the biggest underlying reason was Internet Boom.

Key RatiosParticulars Netscape AOL Microsoft Spyglass

Proprietary Ratio 38.7% 53.6% 73.9% 89.0%

Operating Profit Ratio (28.11%) (4.8%) 34.327% 25.74%

ROE (26.14%) (15.43%) 27.24% 4.23%

EPS (0.39) (0.99) 2.32 0.41

Debt – Equity Ratio of Netscape

1993-94 0.665

Till June 30,1995 0.205

• 2,289% increase in sales from 1994 to 1995 (6 months)• Net loss decreased from $0.26 per share to $0.13 per share.

Beta Calculation• For unlisted companies Beta cannot be calculated normally.

• But we can find implied beta from the comparable companies.

Company Levered Beta Debt Equity Ratio Tax Rate Unlevered Beta

America Online, Inc. 0.73 0.20 39.00% 0.64

Microsoft Corp. 0.72 0.29 39.00% 0.60

Spyglass Inc. 0.70 0.16 39.00% 0.63

Mean 0.63

Beta of Netscape

Unlevered Beta 0.63

Debt equity Ratio 0.205

Tax Rate 39.00%

Beta 0.66

Cost of Equity

Cost of Equity = Risk Free rate + Beta x Risk Premium

Risk free rate = 6.5% Risk Premium = 7%

Beta = 0.66

Cost of Equity = 13.5%

The IPO Process

• Underwriters:The company offering its shares, enters into a contract with a lead underwriter to sell itsshares to the public. The underwriter then approaches investors with offers to sell thoseshares. A large IPO is usually underwritten by a "syndicate" of investment banks.

• Allocation and pricing:Public offerings are sold to both institutional investors and retail clients of theunderwriters. The issuer usually allows the underwriters an option to increase the size ofthe offering by up to 15% under certain circumstance known as the greenshoe oroverallotment option.

• Pricing of IPO:

A company planning an IPO typically appoints a lead manager, known as a bookrunner,to help it arrive at an appropriate price at which the shares should be issued. The pricecan be fixed by the company or determined through analysis of confidential investordemand data compiled by the bookrunner.

Netscape’s IPO Process

• The preliminary prospectus suggested an offering of 3.5 million

Netscape shares priced at 12-$14.

• The IPO team made presentations to potential investors in 20 cities

talking to about 2,000 institutional investors.

• Because of overwhelming response the underwriters (Morgan Stanley

and H&Q) suggested offering of 5 million shares at double the initial

price.

Previous Internet related IPO’s

Netcom Online Comm. PSI Inc. Spyglass Inc. UUNet Technologies

Date of IPO 14/12/1994 8/5/1995 27/6/1995 25/5/1995

Price per share offered $13.00 $12.00 $17.00 $14.00

Percentage change in stock price after first

day of trading 31% 27% 60% 96%

Why the company should increase the Price?

• Revenue Growth: The company’s revenue for six month ending June 1995 was approx. 24

times the revenue for previous nine months.

• Losses were not significant as they also included R & D costs which were quite substantial

and can now be capitalized globally.

• Balance sheet of IT companies need not contain large amount of fixed assets as their main

assets are its employees.

• IPO of similar companies was excellent. The price shot up by more than 27% percent for

most of Internet based companies on the first day of trading.

• During mid-1990s most of the investors was going after internet based companies and was

investing heavily.

Actual Scenario – Post IPO

• Netscape shares opened at $28.

• By the end of the trading day, they were going for $75.

• The five-million-share IPO was oversubscribed by 100 million shares.

• Book Value of $16 million was transformed into market value of a billion

dollar.

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