Crystal Ball

Valuing Netscape

The initial public offering (IPO) of Netscape Communications Corporation on August 9, 1995, is thought to have signaled the beginning of the Internet boom. The underwriters of the IPO planned to offer five million shares at $28 per share, thereby raising $140 million. Up to that point, about $27 million had been invested in Netscape, and the company had yet to show a profit. At $28 per share, Netscape’s market value would be more than $1 billion, despite a book value of just $16 million.

The IPO underwriters calculated the value of the firm by adding the present value of the free cash flows through 2005 to the present value of the firm after 2005. This latter value, known as the terminal value, was calculated under the assumption that the free cash flows after 2005 would grow forever at a constant rate.

The underwriters’ valuation was based on an annual revenue growth rate of 65 percent. Also, the terminal value growth rate was set at 4 percent, and the tax rate was assumed to be 34 percent. Some of the other assumptions included:

Cost of sales 10.4% of revenues

R&D 36.8% of revenues

Depreciation 5.5% of revenues

Operating expenses 80% of revenues in 1995 decreasing to

20% by 2005

Capital expenses 45% of revenues in 1995 decreasing to

10% by 2005

With these assumptions a discounted cash-flow model for Netscape gave a valuation of $28 per share, supporting the underwriters’ plans.

Our deterministic (base) model for this problem is shown in a spreadsheet that was