Story Behind the LoudCloud IPO

From: Jeff Barr (
Date: Fri Apr 06 2001 - 09:32:46 PDT

>From the Wall St. Journal - Note that insiders had to buy shares at the IPO
to prop up the deal. Not a good sign.


Doing an Internet IPO Now
Takes Grit, Loudcloud Finds

One morning a few weeks ago, money manager Jeff Matthews picked up the phone
to hear a surprising plea from Morgan Stanley Dean Witter & Co.: Would he
please consider buying shares in the initial public offering of Loudcloud
Inc.? It had exciting technology, it was led by Netscape co-founder Marc
Andreessen, and it was a bargain: The underwriters had just slashed the

Mr. Matthews doesn't buy initial offerings and told the salesman so. But as
manager of a modest $60 million at Ram Partners LP in Greenwich, Conn., he
was amused to get the call. "It cracked me up, because I'm at the bottom of
the barrel when it comes to buying IPOs," he says. "My reaction was, 'Wow,
they were desperate.' "

A little more than a year ago, newborn technology firms with no pedigree and
scant revenue were setting off feeding frenzies in the IPO market -- message
boards abuzz, investors clamoring to buy and often being turned away. Then
the stock would open for trading, soar, and hand a windfall to the
ground-floor investors. In 1999, nearly a quarter of IPOs doubled or better
on their first day. A few rose six- and sevenfold.

See information on the performance of recent initial public offerings.

Banks, Investors Adjust to Chill in IPO Market

Loudcloud IPO Soaks Latecomers as It Manages Only a Meager Gain (March 12)

Loudcloud Raises Eyebrows With Pre-IPO News Release (March 10)

Loudcloud IPO Is Priced at $6, Down From Earlier Estimates (March 9)

Andreessen's Presence in IPO Might Not Help Loudcloud (March 7)

Now, as stocks struggle and Internet highfliers fade, the IPO market is a
cold place. Only 21 companies went public in the first quarter, compared
with 123 a year earlier. At least 80 firms canceled or postponed.
Underwriters are reduced to wooing customers they once ignored. And it's
payback time in the eyes of some investors who resented having to grovel --
and now won't even go to the roadshows.

Loudcloud knew the barriers but thought it could clear them. It had
blue-chip backers such as Benchmark Capital and even bluer-chip
underwriters: Morgan Stanley and Goldman Sachs Group, which last June wanted
in so badly they waived their informal bans on sharing a lead role.
Loudcloud's customer list was impressive and growing. Above all, it had Mr.
Andreessen. Not only did his Netscape revolutionize the Internet with the
first easy-to-use browser, it had launched the go-go IPO era when it went
public in 1995 and doubled the first day.

But Loudcloud's March 8 IPO met such resistance that insiders bought 15% of
the shares to keep the offer from fizzling, say people familiar with the
deal. Underwriters had to cut the price twice, finally to just $6 a share.
The stock ended its first day up a mere 16 cents and has since fallen to

Most astonishingly, the venture capitalists -- the firms that seed new
businesses and had grown accustomed to making huge scores at the IPO -- are
in some cases showing 75% paper losses on the deal.

For investors who bought giddily in the euphoria of a year ago, "the
laughing-gas tank is empty," says Storm Boswick, a managing director at J&W
Seligman & Co. in New York.

The Loudcloud story began after Netscape was sold to America Online in late
1998 and its founders went looking for a new challenge. Mr. Andreessen and
three other alumni decided to tackle a new problem: managing Internet-site
infrastructure. Their idea was to monitor corporate customers' software and
hardware, helping set up and maintain Web sites so they wouldn't crash when
thousands of people visited them. They would automate this process, so their
cost of adding customers would be small.

The Loudcloud name? "Cloud" is tech-speak for hard-to-fathom Internet
infrastructure. They added "loud" for pizzazz.

At first, raising money was easy. Mr. Andreessen, who is 29, contributed $2
million in seed capital. Benchmark quickly put in $15 million in November
1999. This first round of private financing closed so fast that some who
wanted in, such as Redpoint Ventures in Menlo Park, Calif., missed out
because they didn't act fast enough. The business moved from Mr.
Andreessen's living room to pricey office space in Menlo Park, which was
soon overflowing. It has since moved to Sunnyvale.

Selling shares privately means assigning a value to the business, a matter
that often sparks a tug of war. Founders typically want to push the
valuation up. Venture capitalists try to keep a lid on it so they can get a
larger stake for less money. This time, there was an added element: shifting
perceptions of worth after tech stocks started falling last spring.

The founders got their first whiff of the new climate in May and June. Jay
Hoag of Technology Crossover Ventures in Palo Alto says he told them he'd
consider investing if Loudcloud valued itself at $300 million to $400
million, less than half of what the founders had in mind. Another
venture-capitalist who met with them recalls hazarding a guess that, based
on its skimpy revenue, Loudcloud would be looking for investments that gave
it an implied value of $100 million. Loudcloud executives reacted with
silence, then laughter, he says, adding that one replied, "We were thinking
more like a billion." Ben Horowitz, Loudcloud's 34-year-old president and
chief executive, agrees some investors tried to get sharply lower valuations
but says he doesn't recall this incident or any valuations that low.

For every cautious venture capitalist, many others were enthusiastic.
Despite dot-com troubles, they were high on "Internet infrastructure" plays
and clamoring to get in at a price that valued Loudcloud at $700 million.
"We all had stars in our eyes," says Steven Bird of Charter Growth Capital
in Palo Alto. "We were very anxious to get into the deal."

Loudcloud officials debated how much of this eager capital to accept. Some
favored selling a smaller stake for less money, Mr. Horowitz says, but
others implored him to build a war chest in case of bad times. Ultimately,
Loudcloud accepted $120 million in this third round of private financing in
June. Mr. Bird's firm put in $20 million for a 2.5% stake.

Looking to the IPO, the firm tapped Netscape underwriter Morgan Stanley plus
Goldman Sachs. The bankers finished a registration statement in September.
Loudcloud anticipated going public in December, raising $100 million to $120
million by selling 9.5% of itself, say people familiar with the deal. The
whole company would have a value of up to $1.25 billion.

But the market was shifting fast. Internet infrastructure stocks like Akamai
Technologies and Exodus Communications, still strong in the summer, now were
sliding. When an auto-company executive warned that a recession was
possible, it started to sink in that raising public money wasn't going to be
easy. "Look, the weather's about to change," Mr. Horowitz told employees in
an e-mail. "It's been raining and it's going to snow. We've got to put our
coat on right now." Loudcloud began to watch its costs.

The underwriters needed the market to stay calm for an extended period, to
permit presentations to investors. But each time they thought things had
stabilized, the market stumbled again. In December, they put the IPO on hold
until the new year. And Loudcloud, having done three rounds of private
money-raising, now thought about a fourth. That would enable it to wait
longer for a decent market in which to go public.

Burn Rate

There was some urgency to this. Loudcloud didn't anticipate break-even
operations for many more months. And though it had some $88 million in cash,
it was burning it at a rate of $12 million a month.

In early February, Loudcloud on its own circulated a proposal. It would sell
securities convertible into common stock at a discount of 25% or more to the
price at which it eventually went public. Investors were dubious. If
Loudcloud didn't go public now, when could it, some wondered. Others had
trouble valuing the deal. The company dropped the idea, and -- encouraged by
interest-rate cuts and hints of money flowing back into stocks -- went back
to plan A: an IPO.

But bankers tweaked the price and structure of the deal. On the surface, the
price range didn't appear to drop that much -- to $8-$10 from $10-$12 -- but
Loudcloud also did a reverse stock split to try to make the per-share
pricing look more appetizing. Loudcloud now would be selling 27% of its
stock at a company valuation of up to $732 million, compared with its
original plan of selling 10% at a valuation of as much as $1.25 billion.

The upshot: Buyers at the IPO would be paying less for their shares than did
venture capitalists who got in at the last round eight months earlier.

Venture capitalists had no power to block such a deal. In any case, says
Roger McNamee of Integral Capital Partners in Menlo Park, they faced the
choice of this, a private financing that might be on onerous terms, or
seeing the unprofitable company eventually run out of money. "From where we
sat ... this seemed like the best option among a particularly ugly set of
options," he says. Integral had paid $10 million for a stake that at $6 a
share would be worth about $3.5 million.

Integral not only approved of the lower-price IPO but agreed to buy about a
million shares at the offering. Partners debated intensely whether this was
throwing good money after bad and decided it wasn't. "As painful as the
paper losses are in the short term, the IPO prepares the company to lead a
category that will support several players," Mr. McNamee says.

Show Opens

On Feb. 20, Loudcloud executives and bankers began two weeks of
presentations to pension, mutual and hedge funds and wealthy individuals.
They were optimistic, given the strengths they could point to, such as deep
management. And although Loudcloud had a mere $6.5 million in revenue
through the nine months ended Oct. 31 -- along with $107.6 million in
losses -- its new orders totaled more than $100 million.

Executives compiled customer references, a step that once was routine but
had lapsed during the go-go days of IPOs. Loudcloud had lots of name
clients, among them Ford and Nike. Famed Hollywood agent Michael Ovitz was
on its board.

Traveling on a Gulfstream G4 chartered by the underwriters, the team began
with a 7 a.m. meeting in Detroit, then one four hours later in Chicago.
There, as investors munched steak sandwiches with fried onions, Messrs.
Andreessen and Horowitz saw firsthand how hard the sale would be. Investors
wanted something that no one had missed during the hot Internet market of a
year earlier: profits.

"This probably isn't the right time to bring this company public," one money
manager says he told them in Chicago. "It needs to be more mature."

And to some investors, the company was hard to understand. In the elevator
taking them to the street from the fourth-floor meeting room, one piped up,
"So, what exactly is it that they do?" Everyone laughed. No one volunteered
an answer.

Each day the market seemed to get worse. When greeting investors, Mr.
Horowitz recalls, "We'd say, 'How are you doing?' They'd say, 'How do you
think I'm doing? I'm hiding under my bed.' "

A little over a year ago, IPO underwriters often lined up buyers for 75% of
the shares in the first week of a roadshow. With Loudcloud, it was only 40%
or 50%.

No Thanks

Some invitees wouldn't even listen. Paul Meeks of Merrill Lynch Asset
Management in Princeton, N.J., says, "This is not an environment for doing a
technology IPO. I'm shocked that Goldman and Morgan are trying to get these
deals off in this environment." He skipped the pitch: "I didn't want the
management to come to our office when I knew I wasn't going to buy a share."

Brad Koenig, a managing director at Goldman Sachs, says, "We knew there was
a core of really interested" investors. The question, he says, wasn't
whether the deal would get done but what price those investors would be
willing to pay.

In the second week, bankers began wooing smaller money managers. Darren
Chervitz of Jacob Asset Management in New York, which controls just $30
million, says he sometimes has trouble getting people at top firms to take a
call. This time, they called him. "Evidently, no investor was too small to
be offered a chance to get into this deal," he says. He didn't buy.

Right before the IPO, the climate turned even more sour when Yahoo! warned
of worsening results. In a last-ditch bid, the team did what would have been
unthinkable 18 months earlier: They cut the price a second time, to just $6.
They also boosted the number of shares to 25 million. Loudcloud wouldn't
sell 10% of itself but more than a third. The company's implied value
wouldn't be $1.25 billion but $440 million.

Salesmen began follow-up calls to hesitant investors. Besides telling them
of the price cut they said some executives, directors and early-stage
investors would be buying up to 500,000 shares each -- a total of 3.75
million shares -- say people familiar with the matter. One of these was Mike
Homer, a former Netscape executive who had bought pre-IPO shares. "I voted
with my wallet," he says. "I think it's . . . a great long-term business."

The price cut and insider buying made customers out of some fence-sitters.
Robert Turner of Turner Investment Partners in Berwyn, Pa., says he has a
long-term view, and "at $6 a share, I can live with the risk." The insider
buying helped win over Seligman's Mr. Boswick: "When management is eating
their own cooking, that's a good sign," he says.

They have a little more information to go on now. Loudcloud Thursday night
reported that its revenue grew to nearly $9 million in the fourth quarter,
bringing the total for the year ended Jan. 31 to $15.5 million. The year's
operating loss was $94.7 million. Proceeds of the IPO mean that Loudcloud
now has about $243 million in cash.

The insiders maintain the IPO was a triumph of sorts. They got the deal done
in a terrible time for the markets. "I truly believe that the IPO was an
excellent decision and a fabulous accomplishment," Mr. Horowitz says.

And thinking of would-be rivals, he spots a silver lining: "I think it will
be extremely challenging to raise money to compete with us."

Jeff Barr - Vertex Development - (
  Address: 4610 191st Place NE. Redmond, WA 98074;
  Phone: Office: 425-868-4919 - Home: 425-836-5624
  IM: MSN:; AIM: jeffscottbarr

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