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Group 3 Abdulrahman Alaydaroos, Anjali Maheshwari, Chieh-Ning Li, Virin Yos, Yu-Hsiang Wang Professor M. Cecilia Bustamante BUFN630 Valuation in Corporate Finance Valuation for Corporate Finance Case 4: Netscape Corporation 1. [Strategy] Why has Netscape been so successful to date? What appears to be its strategy? What must be accomplished if it is to be highly successful firm in the future? How risky is its current competitive position? Netscape's success can be attributed to key factors. The introduction of the user-friendly click-and-point web browser, Navigator, was pivotal for its success. The company played a pioneering role in making the internet accessible to a broad audience, facilitating widespread web-surfing. Netscape achieved market dominance by operating on both ends of the market—providing browsers for clients and developing e-commerce applications and services for companies, resulting in a dominant market share. Additionally, its strategic position in a rapidly growing industry further fueled its success. Netscape employed a "Give Away Today, Make Money Tomorrow" strategy, initially distributing its software for free to those with electronic access capabilities. The company's revenue model focused on selling server software to companies seeking marketing success. Netscape aimed to dominate the market and establish an industry standard, driving its strategic partnerships with key players in internet service, computer manufacturing, and content provision to achieve these objectives. For Netscape to sustain its highly successful status, it must prioritize continuous innovation to stay ahead and adapt to emerging trends. Additionally, a strong customer focus is crucial, with products and services needing to meet evolving market demands. To achieve this, Netscape should invest in understanding user preferences, delivering personalized experiences, and actively engaging with its user community to foster loyalty and attract new users. The current competitive position of Netscape faces risks on multiple fronts. The market has experienced increased competition with the growth of the internet community over time. Notably, Spyglass Inc. emerged as a close competitor, aiming to capture the corporate market. To mitigate these risks, Netscape should explore diversification beyond web browsers, considering expansion into areas like e-commerce, cloud services, or digital media. This strategy would enable Netscape to tap into new revenue streams and enhance its overall competitive advantage. 2. [Funding] What are the advantages and disadvantages of going public? How do you weight these for the case of Netscape? Going public has an advantage of access to a much larger liquidity pool that was once not available for Netscape and its private investors. This lack of liquidity usually extends to higher cost of equity or borrowing, and when the investors wish to sell part of their shares, they must find some other private buyers to negotiate their terms of trade. Publicity also means more transparency, making Netscape, its management and employees more accountable toward regulators and the public at large. This has more upside potential for Netscape and its investors as they are now able to raise more funds at lower costs to finance various expansion plans, diversify their portfolio, to level up their playing field against competitors, paying off some of their debts, and/or expanding into new research frontier. However, it also comes at the expense in the form of administrative and underwriting costs during the IPOs, exposing the company to a wider volatile internet market at that time, making it more susceptible to public and regulatory scrutiny, and forcing the company to care more about short-term obligation and expectation rather than the long-term ones. While it was not uncommon for a tech stock at that time to be highly valued during IPOs by turning a million-worth company to a billion-worth company overnight, it also means that the company has to deliver extraordinary performance to justify the valuation; otherwise, it is just another bubble waiting to burst that would enrich just a few at the expenses of a thousand or million others.

3. [Underpricing] The case points out that the IPO market is sometimes characterized as "hot", and that many IPOs are viewed in retrospect as "underpriced". What might explain these phenomena? Should the Netscape board be concerned about IPO underpricing? Why or why not? In the context of IPO underpricing, two primary factors are at play: information asymmetry and risk management by investment banks. Information asymmetry suggests that uninformed investors, crucial for broad market participation, may retreat from IPOs if they consistently face losses from overvalued offerings. This retreat could dampen the overall market enthusiasm, negatively impacting IPO successes in the long run. Therefore, underpricing can be a strategic choice to maintain investor confidence and market participation, particularly relevant in the case of Netscape's IPO, given the emerging and volatile nature of the internet sector at the time. Investment banks, as underwriters, play a pivotal role in this scenario. Their inclination to underprice IPOs, as seen in Netscape’s case, is a reflection of their risk mitigation strategy. Underpricing ensures a successful launch, creating a favorable market perception and potentially leading to a 'first-day pop' in the stock price. This approach not only benefits the banks' major clients but also contributes to a positive debut for the company in the public market. For the Netscape board, the concern about underpricing primarily revolves around the concept of "money left on the table," which represents the potential additional capital that could have been raised if the shares were priced higher initially. However, this concern must be balanced against the benefits of underpricing, such as broader market participation and the subsequent upward price adjustment by the market post-IPO. In Netscape's context, where establishing a strong market presence and ensuring the success of the IPO were crucial, the potential benefits of underpricing likely outweighed the drawbacks. The board's decision would have been influenced by the need to strike a balance between securing sufficient capital for immediate growth and setting a positive trajectory in the public market, crucial for long-term success in a rapidly evolving industry. 4 . [ Offer Price] Can the recommended offering price of $28 per share for Netscape's stock be justified? How fast must Netscape grow in the long run to justify this price? Use DCF and multiples valuation tools to answer this question. Using the DCF method: Assumptions: Asset Beta = 1; Unlevering the given comparable firm’s beta, we got Asset Beta of the industry as 0.68. But we want to be conservative in our valuation. Therefore, we are assuming a much higher beta. Cost of capital is determined from the CAPM model once we have the asset beta. Tax Rate is 34%, as standard. For DCF valuation, we have calculated the valuation in phases: The initial phase is a high growth period with negative Free cash flows as a result of expenses of setting up a new company. Here, we have assumed revenue growth to be 25% as we gradually reduce the other expenses.

Transition phase is where the company starts to settle and the expenses are reduced. We have assumed revenue growth rate in this phase to be 20% and other expenses are constant. For perpetuity, we have assumed the growth rate to be 3% i.e same as the growth of the economy. To justify the price of 28$ per share, we used goal seek function in excel: We got the above results for growth using this. We also performed sensitivity analysis and here are our results:

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5. [Recommendation] As an executive of Netscape, what would you recommend with respect to the proposed offering price? As an investor in Netscape, what would you recommend? Discuss. Assume a risk free rate of 6.5% and a market risk premium of 7%. Bonus Question for Extra Points (Optional): Assess the enterprise value of Netscape using the real options method. What should the offer price of Netscape be, using this alternative valuation approach? How does this estimate differ from your answer in Question 4? Can you incorporate the threat of competition in the analysis?

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