Netscape Communications Corporation Case Study

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        Founded in April 1994 by Marc Andreessen, Netscape Communications Corporation operated in the internet and software industry through its client, server and integrated application software products and services. Netscape had a competitive edge since Mosaic, a software program or web browser that did not require HTML coding to surf the web, was developed by Netscape’s founder and by far had acquired 60% of web browser market through a “give away today and make money tomorrow” strategy. Following the same business strategy, Netscape entered the internet market in Dec 1994 through its latest product Netscape Navigator which was an improved version of Mosaic. By mid-1995 Netscape had successfully captured 75% of web browser market. Now that Netscape had set an industry standard it planned to generate revenues by selling the software to companies that wanted access to their potential consumer.

        Although Netscape had acquired a considerable share of web browser market and the Netscape Navigator generated 49% and 65% of total revenues in the first and second quarter of 1995, the company was still far away from generating profit. Given the increased demand of the industry, Netscape was also facing direct and indirect competition from firms like Microsoft, AOL, Prodigy and Spyglass. These firms had developed their own web browser products that will compete into Netscape’s market. Hence going forward, it was inevitable for Netscape to raise capital in order to expand and start realizing profits.

        In case Netscape planned to raise capital through an IPO, one can argue that institutional investors will be most interested in investing since they have the capability i.e. cash to buy large amounts of shares. Institutional investors also have the access to these shares at offering price and can make the most of the first day trading gains before other individual investors can begin trading.

        The case text states that originally Netscape had planned to offer 3.5 million shares at a share price of $12-$14, which was later speculated to change into 5 million shares at a price of $28 per share. There was no indication in the case text regarding shareholders offering their shares in addition to the new share offerings by Netscape. However, there was always a possibility of secondary offerings through SEO once the IPO was completed. Hence we can conclude that Netscape’s management was planning to conduct this IPO through primary offering.

        The case text suggests that the IPO market in early 1990’s looked extremely positive with an average gain of about 10% after the first day of trading, (See Exhibit 4 of case text). The first half of 1995 maintained the upwards trend where firms on an average saw a 20% increase on the first day of trading. Most of these gains were attributed to IPO’s of venture backed high tech firms, which accounted for more than half of all venture backed IPO’s at the time, especially the ones related to the internet industry. So, the market looked ideal for Netscape to raise money through initial public offering.

        Prior to planning an IPO, Netscape went through the third and final round of private equity financing from Adobe Systems and five other media companies. Netscape raised a total of $18 million in this financing round and the investors ended up with a stake of 11% in Netscape. Based on this information and the total number of outstanding shares before the IPO, the post money share price of the last financing round was estimated using the following equation:

Post-Money Value = Pre-Money Value + Amount Invested in the latest financing round

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and was estimated to be $4.96. (See Exhibit A of Report). The post financing stock price of Netscape is way less than the proposed IPO price because the IPO price takes into account firm valuation through expected future growth.

         In order to meet their capital needs, firms can raise capital either through debt or equity financing. Debt financing is a viable option when the firm is certain about being profitable almost immediately. Since Netscape was a startup firm operating in losses, raising debt is not a viable option. Furthermore, Netscape being in the type of industry could potentially not offer collateral as a security to its debt investors. Moreover, unlike equity investors who can own stake and access control rights in the firm, debt investors are entitled to limited gains on their investment. Hence equity financing was much more viable option for Netscape to raise capital at the time. As far as equity financing is concerned, Netscape could raise capital through private sources. However given the growth potential of the industry, Netscape’s growing capital needs & competition and lucrative IPO market at the time, raising capital through an IPO seemed to be the most apt option for Netscape.

        However going public has comes with its own advantages and disadvantages. On one hand IPO provides a firm with greater access to free capital markets, most often than not increased market capitalization, lower cost of capital due to diversified public investors and greater liquidity and potential exit strategy for its founders and private equity investors. On the downside it dilutes the current shareholders’ control, makes it difficult to monitor management due to widely dispersed equity holders, requires the firm to comply with the government requirements of a public firm such as SEC filings etc. and is under more scrutiny because of publicly available information.

        There are also considerable direct and indirect costs associated with IPO’s such as underwriter’s fees & discounts and costs pertaining to an underpriced IPO. The average IPOs are underpriced by 10-20% and underpricing has its own direct incentives for underwriters but in the present case, Netscape’s board of directors might be concerned with the indirect cost of underpricing which simply means not being able to raise enough capital so as to maximize on the opportunity provided by the IPO or as you said “money left on the table”. On the other hand Netscape’s board seems hesitant at raising the offer price from $14 to $28 due to the uncertainty involved in the realization of what potentially looked like an oversubscribed IPO. The board was also concerned about the potential negatives of an overpriced IPO not going through as planned which could include selling stock at discounted prices in case investors decided to withdraw offers, facing a lawsuit for overpricing and negative publicity.