Our answer for Netscape IPO - Harvard Business Case.

1. Corporate Finance
November 2012
The Netscape’s IPO
Gulcin Askin
Michelle Donovan
Kivanc Ozuolmez
Peter Tempelman

2. Question I
Why has Netscape been successful to date?
What is its strategy?
How risky is its current competitive situation?

3. Answer I
Success reasons;
•First Movers advantage;
• Introduced “click-and-point” browser
• Introduced the concept of “Web Surfing”
•Worked on both sides of the market;
Browser for Clients, E-commerce application and service for companies
•Working in growing industry
Strategy;
•Give away today, make money tomorrow.
•They gave the browser for free, and made money on the server side (by selling to
companies)
•Dominate and set the standards, build ecology
Riskiness;
•Although they were a newcomer, the industry has a Equity Beta of 0.73. So the
industry was not that risky.
•Bigger players like Microsoft, AOL, Prodigy were also interested in the browsers
business and entry barriers were not that high. Therefore, Netscape’s position in the
browsers market was not rock solid.

4. Question II
Value Netscape

5. Answer 2
Based on researches on web, and considering industry conditions
around 1995 – 1996, we decided to assume the average growth rate as
19% for Netscape.

6. Answer 2
Based on the assumptions, the free cash flow of Netscape;
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
47,086,432.39 66,679,096.91
Total Revenues 33,250,782.00 39,568,430.58 56,032,854.54 79,348,125.32 94,424,269.13 112,364,880.27 133,714,207.52 159,119,906.94 189,352,689.26
Total Cost of Revenues 4,389,624.00 4,115,116.78 4,896,988.97 5,827,416.87 6,934,626.08 8,252,205.03 9,820,123.99 11,685,947.55 13,906,277.58 16,548,470.32 19,692,679.68
42,189,443.42 59,744,470.83
Gross Profit 28,861,158.00 35,453,313.80 50,205,437.67 71,095,920.29 84,604,145.14 100,678,932.72 119,807,929.93 142,571,436.62 169,660,009.58
17,327,807.12 24,537,907.66
Research & Dvelopment 12,230,304.00 14,561,182.45 20,620,090.47 29,200,110.12 34,748,131.04 41,350,275.94 49,206,828.37 58,556,125.76 69,681,789.65
28,722,723.76 27,338,429.73
Other Operating Expenses 26,933,133.42 28,093,585.71 28,576,755.82 24,597,918.85 19,829,096.52 23,596,624.86 28,079,983.58 33,415,180.46 39,764,064.75
46,050,530.88 51,876,337.39
Total Operating Expenses 39,163,437.42 42,654,768.17 49,196,846.29 53,798,028.97 54,577,227.56 64,946,900.79 77,286,811.94 91,971,306.21 109,445,854.39
Operating Profit/Loss (EBIT) -10,302,279.42 - 7,201,454.37 - 3,861,087.46 1,008,591.38 7,868,133.44 17,297,891.32 30,026,917.58 35,732,031.92 42,521,117.99 50,600,130.41 60,214,155.19
Unlevered net income -10,302,279.42 - 7,201,454.37 - 3,861,087.46 665,670.31 5,192,968.07 11,416,608.27 19,817,765.61 23,583,141.07 28,063,937.87 33,396,086.07 39,741,342.42
Interest Income 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00
Interest Expenses 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00
Interest tax shield - - - 87,485.40 87,485.40 87,485.40 87,485.40 87,485.40 87,485.40 87,485.40 87,485.40
16,072,482.83 14,981,459.49
Capital Expenses 15,228,858.16 15,814,314.65 15,857,858.16 13,199,560.65 10,199,709.55 12,137,654.37 14,443,808.70 17,188,132.35 20,453,877.49
Depreciation 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00
Depreciation tax shield - - - 605,880.00 605,880.00 605,880.00 605,880.00 605,880.00 605,880.00 605,880.00 605,880.00
- 18,281,714.29
Net cash flow -23,879,281.58 -21,363,913.02 -13,452,846.45 - 8,049,150.03 - 43,610.98 11,357,397.45 13,184,828.10 15,359,470.58 17,947,295.12 21,026,806.33
Risk-free rate 6.71% Clark 24%
NPV of cash flows after 2005 $296,569,905.90 Equity Premium 6.00% Kleiner Perkins 11%
NPV of cash flows btwn 1995-2005 -$39,758,106.19 Equity beta 0.73 Media Companies 11%
Total NPV $256,811,799.71 James Barksdale 10%
Tax Rate 34% Public 44%
Cost of Equity=Rf+B(Rm-Rf) 11.09%
Growth rate 19.00%
The market value of Netscape should be; $256,811,799.71

7. Answer 2
The share distribution after IPO is given in the case as below.
Share Holder Percentage
Clark 24%
Kleiner Perkins 11%
Media Companies 11%
James Barksdale 10%
Public 44%
Based on the distribution, and our valuation in previous slide, we calculate
the share price as;
$256.81M * 44% / 5M
=>
$22.60 per share for 5M shares
This calculation doesn’t include under pricing discount. In order to attract
investors, a discount should also be applied.
Assuming the under pricing rate at 20%;
the share price should be at $18 per share for 5M shares

8. Question III
How fast does Netscape have to grow on an annual basis
over the next 10 years to justify the $28 offer price?

9. Answer 3
The share distribution after IPO is given in the case as below.
Share Holder Percentage
Clark 24%
Kleiner Perkins 11%
Media Companies 11%
James Barksdale 10%
Public 44%
• 5M public shares, as price of $28 = $140M for 44% of Netscape.
• The total equity value of Netscape is, as estimated by underwrites;
$318.18M
• But, as the underwriters underprice the stock price, the $28 per share
doesn’t lead to a good valuation. We assume underpricing ratio is 20%.
And therefore; the estimated Netscape’s market value by underwriters
should be aprox $397.7M.
Then question is to find the growth rate that sets the NPV of Netscape equal
to $397.7M

10. Answer 3
When we apply the same assumptions, and look for a growth rate that
sets the NPV = $397.7M, the free cash flow of Netscape;
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
51,043,973.71 78,358,675.97
Total Revenues 33,250,782.00 41,197,718.90 63,243,483.43 97,086,399.53 120,290,049.02 149,039,370.73 184,659,780.34 228,793,467.84 283,475,106.65
Total Cost of Revenues 4,389,624.00 4,284,562.77 5,308,573.27 6,577,322.28 8,149,302.30 10,096,985.55 12,510,165.10 15,500,094.56 19,204,617.16 23,794,520.66 29,481,411.09
45,735,400.45 70,209,373.67
Gross Profit 28,861,158.00 36,913,156.13 56,666,161.16 86,989,413.98 107,779,883.92 133,539,276.18 165,455,163.18 204,998,947.18 253,993,695.56
18,784,182.33 28,835,992.76
Research & Dvelopment 12,230,304.00 15,160,760.55 23,273,601.90 35,727,795.03 44,266,738.04 54,846,488.43 67,954,799.16 84,195,996.16 104,318,839.25
31,136,823.97 32,127,057.15
Other Operating Expenses 26,933,133.42 29,250,380.42 32,254,176.55 30,096,783.85 25,260,910.29 31,298,267.85 38,778,553.87 48,046,628.25 59,529,772.40
49,921,006.29 60,963,049.91
Total Operating Expenses 39,163,437.42 44,411,140.97 55,527,778.45 65,824,578.88 69,527,648.33 86,144,756.28 106,733,353.04 132,242,624.41 163,848,611.65
Operating Profit/Loss (EBIT) -10,302,279.42 - 7,497,984.84 - 4,185,605.84 1,138,382.70 9,246,323.76 21,164,835.10 38,252,235.59 47,394,519.89 58,721,810.15 72,756,322.77 90,145,083.92
Unlevered net income -10,302,279.42 - 7,497,984.84 - 4,185,605.84 751,332.58 6,102,573.68 13,968,791.16 25,246,475.49 31,280,383.13 38,756,394.70 48,019,173.03 59,495,755.38
Interest Income 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00 991,166.00
Interest Expenses 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00 257,310.00
Interest tax shield - - - 87,485.40 87,485.40 87,485.40 87,485.40 87,485.40 87,485.40 87,485.40 87,485.40
17,423,349.99 17,605,627.32
Capital Expenses 15,228,858.16 16,465,492.31 17,898,538.25 16,150,322.56 12,993,731.09 16,099,232.83 19,946,949.47 24,714,270.40 30,620,981.02
Depreciation 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00 918,000.00
Depreciation tax shield - - - 605,880.00 605,880.00 605,880.00 605,880.00 605,880.00 605,880.00 605,880.00 605,880.00
- 19,957,099.83
Net cash flow -23,879,281.58 -22,311,621.15 -15,407,864.26 - 9,763,712.23 - 442,190.00 13,992,085.79 16,920,491.70 20,548,786.63 25,044,244.03 30,614,115.76
Risk-free rate 6.71% Clark 24%
NPV of cash flows after 2005 $431,792,888.06 Equity Premium 6.00% Kleiner Perkins 11%
NPV of cash flows btwn 1995-2005 -$33,224,566.96 Equity beta 0.73 Media Companies 11%
Total NPV $398,568,321.11 James Barksdale 10%
Tax Rate 34% Public 44%
Cost of Equity=Rf+B(Rm-Rf) 11.09%
Growth rate 23.90%
The growth rate of Netscape should be approx. 23.9% to satisfy $28 per
share for 5M shares at IPO.

11. Question IV
What sources of capital other than the public equity
markets could be tapped to satisfy these capital needs?

12. Answer 4
Netscape already had investors like;
• Jim Clark as Angel Investor
•Adobe, and 5 other media companies as Corporate Investors
•Kleiner Perkins as Venture Capitalist Firm
Before going public, they could have contacted;
•Private Equity Firms
•Institutional Investors

13. Question V
What are the advantages and disadvantages of public
ownership?

14. Answer 5
Advantages
•Greater liquidity
•Better and cheaper access to capital
•Better diversification for equity investors
•Visibility
•Knowing market price
Disadvantages
•Loss of confidentiality
•Lack of ownership
•Legal liability and reporting obligations
•Profit sharing

15. Question VI
Why are many IPOs underpriced?

16. Answer 6
• Underwriters want to control their risk
• Reward for investors for taking the risk *
• Premium on market uncertainty *
• “Leave a good taste in investors’ mouth”
* James C. Brau and Stanley E. Fawcett, Feb 2006: Initial Public Offerings: An analysis of Theory and Practice