The Volatile Legacy of Netscape - 4 / 21 / 2009

We have a significant perspective issue that over took the equities markets in 1995. And we fear this perspective will haunt the markets for many years to come.

This was the dawning of the the internet bubble, and Netscape was the band leader. It was followed by companies like EBAY, Amazon, and AOL. These Companies were treated by IPO bankers as high risk propositions. And their IPO process and structure were all very standard for unprofitable, modest revenue concerns that were unable to raise the capital their business models needed to become profitable from the private markets. The IPO bankers offered a small amount of shares, typically between 5 and 7 million shares, to the public representing 10 - 20% of the company's total shares outstanding. The thinking was fairly sound at the time, no one knew when or in most cases how these companies would become profitable. All, including the companies, believed that more money would need to be raised in future secondary rounds from the public. So a modest IPO issue of a modest amount of Company equity, leaving more equity on the table for future public offerings was the preferred route. This was a sound model in an uncertain era not yet realizing it was the leading indicator of an explosion of new money, new share structures, new shareholder / management relationships.

The problem began when the demand for Netscape shares exceeded the availability of these shares by multiples. Some bankers believed that for each share offered in the initial offering, 20x that amount was requested by the investment public. Thus created an IPO issuance that doubled from $14 to $28 per share initial pricing and soon, once available for public buying, became $75.00 a share. This for a company who reported revenues of less than $1.0 million US in the 12 months prior to its IPO and had spent nearly all its money invested to date, accumulating losses of nearly $7.0 million dollars.

The question is why did the stock trade to $75.00 within a few days of its IPO given the historic financial performance of the company. The real reason - an imbalance of shares offered to satisfy the public demand. But Wall Street can't tell you that. It would be admitting to a mistake in the greatest IPO in more than 20 years. Instead, Wall Street set about using Netscape as an example of its forward looking genius. Its analysts spoke of new paradigms, future valuation models that proved the stock was under valued. And raving about a market capitalization value which exceeded 6.0 billion dollars based upon expected future earnings.

The reality was that Netscape's market value on a per share basis was more than 80% based upon shares that would never trade or be available to the public, held by insiders who were restricted by both the IPO bankers and the SEC's regulations from selling their shares. Had those insider shares been available for sale, it is highly unlikely that the shares of Netscape would have reached even $30.00.

But what was created was a new model that IPO bankers replicated for years during the tech bubble. By creating supply / demand imbalances in the public markets for interesting tech companies, investors were forced to go to the public markets to acquire shares, rather than the company directly, and share prices for IPO's soared. Now analysts were faced with the task of justifying the public prices and market values of these capitalization challenged firms. They wheeled out Excel spread sheets and began creating new rationale for value. And while this occurred these same valuation applications (Projected Revenue Multiples, Projected future customers, Discounted Cash Flow with Terminal Earnings Multiples) were being applied to the tried and true cash flowing companies of the S & P 100 index whose values soared with the markets.

It became normal to see a company trading at 25.0x earnings. Or to see a company trading at 3.0x projected revenues. And now today we are left with this legacy. Because who would pay 25.0x (or 25 years times) a company's earnings in order to own a company? The answer unfortunately is today's fund managers. They are caught in a cycle of over valuation that will take many many years to get to equilibrium, and until then, volatility in the markets of the last six months won't be an aberration, it will be the norm.

GE - $11.35, maintain stop loss at $9.90
Dell - 10.37, maintain stop loss at $8.50



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Brad van Siclen