The Last Days of Net Mania

Internet Guru Marc Andreessen is running on adrenaline. It’s the late

afternoon of March 8, and he has just completed a backbreaking, initial public

offering road show that landed him in 70 meetings in 16 days with moneymen

scattered across North America and Europe.

Andreessen has been trying to wow institutional investors with his

18-month-old Internet startup, Loudcloud Now he’s hunkered down with a handful

of Loudcloud associates in a sixth-floor conference room at investment bank

Morgan Stanley Dean Witter’s Manhattan headquarters.

Loudcloud is going public at the worst possible moment. A day earlier, Web

portal Yahoo! sent the market reeling by announcing a massive sales shortfall.

Today, chipmaker Intel warns it will badly miss first-quarter revenues and will

cut 5,000 jobs. When Loudcloud first filed to go public 164 days earlier, it was

valued at $1.15 billion, in spite of losing $107 million on only $6 million in

revenues in the three quarters ended October 31. At the most recent price range

of $6 to $6.50 a share, it would be worth just $440 million. Even at the new

price, the salespeople from Morgan Stanley and co-underwriter Goldman, Sachs

aren’t having an easy time selling all the IPO shares to institutional

investors. Finally, at 5 pm, they finish. The thrift-store price: $6 a share. On

a phone call to a reporter, he sounds chipper in spite of the gloomy outcome.

"We raised the money!" he nearly shouts. "We’ve done it."

Stepping back, this bittersweet moment for Andreessen could mark the end of

an era for Wall Street and for the Internet bonanza. And in one of life’s

little ironies, it’s fitting that Andreessen is the one to witness its

passing. It was his first company, Netscape Communications, with a browser

elegant in its simplicity that opened up the potential of the World Wide Web.

When Netscape went public in 1995—with zero profits, but lots of promise—its

stock rose 107%, whetting appetites for more Net IPOs. Over the next five years,

some 420 Web companies would go public before Net mania turned into Net

aversion.

Racing the clock

In fact, Loudcloud’s drubbing has all but slammed the door for other

Internet offerings. And even when conditions improve again, it’s unlikely

investors will bet their money on long-shot Net companies without a whiff of

profits. Since Loudcloud’s March 9 IPO, no tech firm has filed an application

to go public.

It’s a disappointing turn of events for the 29-year-old Andreessen. The

news for Loudcloud is not good. Goldman Sachs spent at least three days propping

up Loudcloud’s stock price by buying millions of shares, according to Scott

Ryles, CEO of Epoch Partners, a secondary underwriter. Goldman declined to

comment. The stock still sank to a low of $3.88. It has since drifted back to

$4.53.

Now Andreessen’s once-promising startup is in a race to build revenues and

profits before it runs out of money. Loudcloud has about $225 million in the

bank after raising $150 million in its IPO, but it’s burning through about $10

million per month. Although Loudcloud has booked $120 million in contracts for

the next two years and boasts blue-chip customers such as Ford, News, and Nike,

many of its 46 customers are startups and several are in trouble. Even the

analysts for Loudcloud underwriter Goldman Sachs don’t expect Loudcloud to

break even until sometime in early 2003.

Loudcloud’s a brand-new sort of business. Operating out of leased data

centers with leased computers, it provides super-reliable Web sites for

everything from media outfits to e-tailers. And it does it fast. Loudcloud’s

secret sauce is a layer of software, Opsware, which quickly integrates

e-business software programs made by different companies—from Oracle’s

database to Vignette’s software for handling Web pages. That way, Loudcloud

can manage its customers’ Web operations, updating and expanding as needed.

The real threat comes from tech behemoths such as EDS and IBM Global Services

and an up-and-coming powerhouse, Exodus Communications. The bigs offer

corporations the option of handing over the keys to their information systems to

proven and trusted service providers. Companies have been slow to turn over

their Web sites to upstarts like Loudcloud. More than 500 Web hosters have

sprouted up over the last few years, but analysts expect up to 60% of them to

fail by this time next year.

Defying the odds

If Loudcloud fails, the damage to Andreessen’s reputation could be

considerable. In his first business foray out from



under the wings of past mentors, Netscape co-founder James Clark and former
Netscape CEO James Barksdale, Andreessen is determined to build a company that

doesn’t end up like Netscape. Should Loudcloud emerge as a winner, Andreessen

will cement his status as a visionary. If not, the Internet’s wonderkid could

be a has-been at the



tender age of 30.

\What happened? Andreessen and CEO Benjamin Horowitz created a company in one

business environment, and when the world changed, Loudcloud didn’t. The basic

problem is that Loudcloud’s business is so capital intensive. The company

charges customers for three months of service up front and a monthly fee

thereafter, but it has to spend its own money first on engineering the software

and getting customers set up. At the same time, the company decided to delay

reaching profitability, instead spending money aggressively to grow as quickly

as possible. This plan may have seemed smart in earlier Internet days, but in a

world where money is hard to get and dot-com customers are vaporizing, it no

longer looks like a winning formula. Yet they kept plunging ahead as if they

could defy the IPO odds.

Whether Loudcloud succeeds or fails, it will have been a remarkable journey

filled with big money, larger-than-life reputations, a cast of hundreds,

arrogance, pathos, and intrigue. BusinessWeek gained exclusive access to the

company’s odyssey, sitting in on dozens of meetings and conducting 100-plus

interviews in and around the company. Here’s Loudcloud’s tale:

Secret meetings

It’s late in the summer of 1999, six months after AOL

acquired Netscape. Andreessen, Horowitz, and fellow Netscape alums Timothy

Howes and In Sik Rhee are itching to leave their employer and strike out on

their own. The market is booming. The Nasdaq is still six months away from

topping out above 5,000 points, and a stunning 253 Net companies will go

public in the year.



Valuations of dot-coms such as Yahoo! are poised to surpass established
competitors like Walt Disney.

Still employed by AOL, the quartet begins exploring

e-business ideas. To keep the AOL brass from finding out, they all sign up for

non-AOL e-mail. Ducking out for clandestine meals at places near their

offices, they knock around business ideas, but none catch fire. Knowing that

whatever their idea will be they’ll need a Web site, Rhee and Howes set out

to build the software that will assure their site can handle any volume of

visitors without crashing.

Within days, the idea hits them: Building a fail-safe

foundation isn’t a problem they have to overcome on their way to creating

their business. It is their business. They run fail-safe computing systems for

others. By late September, they all quit AOL and are sketching out a business

plan under the towering Redwood trees in the yard of Andreessen’s home. They

are back in the startup business.

• A confident chief

It’s a year later. Loudcloud is up and running, and it

confidently files its paperwork to go public. One blazing hot afternoon,

Andreessen hops into his silver, convertible Mercedes for the four-block jaunt

from his office to a restaurant for a late breakfast. This IPO plan is iffy,

considering that the company has racked up less than $2 million in sales.

Internet stocks are under fire to show profits—money-losers like Amazon.com

and Priceline.com are off 52-week highs by 79% and 95%, respectively.

Why even go public when the market has gone sour? It’s a

no-brainer, says Andreessen. Loudcloud is in a capital-intensive business and

will need the money to stay on its ambitious growth trajectory. Equally

important, Loudcloud wants the credibility of being a public company to help

it win corporate contracts.

What really worries him is not a down market but the

possibility that Loudcloud’s IPO will be too much of a good thing. His fear

is that its stock will rocket and that it will be difficult to meet

expectations.

• Reality bytes

Loudcloud wants to push its IPO out quickly. If the company can start the

road show immediately after Thanksgiving, it could go out by mid-December.

The optimism is fleeting. On November 13, the Loudcloud gang troops into

the posh, dimly lit conference room of Benchmark Capital, its top

venture-capital backer that has put $20 million into the startup. About a

half-dozen of the partners, including Loudcloud director Rachleff, David

Beirne, and Kevin Harvey, drift in to hear the pitch. Andreessen, Horowitz,

and Loudcloud CFO Roderick Sherwood speed through a dry-run presentation of

their company. The goal: to test the seaworthiness of the startup before

embarking on the IPO road show. Less than 15 minutes in, one of Horowitz’

PowerPoint slides sets off alarms. It shows that nearly half of the company’s

revenues come from running the Web sites of the beleaguered dot-com crowd.

"Investors are going to throw up when they see that," pipes up one

VC.

Still, they don’t discourage the IPO. Instead, they explore ways to

downplay Loudcloud’s vulnerability.

Later in the week, the company’s lead bankers, Morgan Stanley and Goldman

Sachs, call to say they’re lukewarm on an IPO before Christmas. With

momentum quickly turning against an IPO, Andreessen and Horowitz decide to

postpone their run for the money.

• No go, again

It’s January 8, time for another go/no-go decision. Before 9 am, CFO

Sherwood and Horowitz are working the phones, powwowing with bankers and

advisers for hours. Benchmark Capital and most of Loudcloud’s executive

staff are itching to pull the trigger. The bankers are dead-set against going

out. Their reason: Loudcloud’s comparables—the stock prices of other

similar companies—are down another 40% to 50% since early December.

That afternoon, at the company’s executive-staff meeting, Horowitz and

Sherwood break the news. "The bankers’ economists are telling us there’s

a 45% chance of a global recession," explains the gravelly voiced

Sherwood. Unlike two months ago, this IPO delay will have far greater

implications. Despite the crumbling market, Loudcloud has quadrupled its staff

in the past nine months, to 586 people. Now, Horowitz is considering

postponing a move into some new office space.

• They’ve got cojones

Cash has become a worry. Loudcloud puts out feelers for a third round of

venture backing, but offers trickle in at about two-thirds of what the bankers

believe they can fetch with an IPO. That would put their valuation roughly in

the neighborhood of $375 million. It’s a slap in the face, considering that

the second round Loudcloud attracted last summer put the company’s worth

north of $700 million. With bankers still confident that Loudcloud could be

valued between $550 million and $650 million on the open market; a third push

for an IPO begins in early February.

The biggest question: How do they price the deal? Most public competitors

are down more than 50% since Loudcloud first set its pricing last Halloween.

That would put its asking price between $5 and $6 per share. Worried about the

psychological impact of having a low, single-digit stock price, the company

works a reverse stock split, essentially turning every two shares of stock

into a single share. On February 16, Loudcloud files its final IPO paperwork.

The reverse stock split has allowed it to price between $8 to $10 a share—a

valuation 47% lower than it had hoped for just months earlier.

It ends up a ragged day for the Loudcloud team. They pile into the

35th-floor office of an Internet analyst. After posting back-to-back solid

days, the Nasdaq is down a freaky 120 points. "We’ve got cojones. That

should be our slogan," bellows the analyst.

Taking a bloodbath

On a warm New York City afternoon on February 20th, a black limousine pulls

up in front of Morgan Stanley’s world headquarters in bustling Times Square.

Andreessen, wearing an elegant black coat, is the first of five Loudcloud

execs to step onto the curb. They’re there to give a 4 pm pitch to the

Morgan Stanley sales crew. They can’t miss the giant electronic ticker, 40

feet above street level, reeling off one stock disaster after another. Nasdaq

is down 106 points for the day.

Over the next 16 days, they will notch 70 meetings in 26 cities. The

audience is tough. At every stop, money managers are shell-shocked—some

sitting on portfolios that are down well over 50% in a year. They ask why the

Loudcloud team is there and why now? Many fund managers turn out for meetings

because of Andreessen’s pedigree. But that’s not enough to convince them

to invest.

• Anticlimax

It’s IPO day. Loudcloud staffers don’t pop any champagne. The only

celebration is an impromptu gathering of about 40 employees eating doughnuts

and watching their CEO on TV. There are a few laughs and cheers, then it’s

back to business. Loudcloud got its money. But that’s all.

Today, Loudcloud looks a lot like any other post-meltdown Internet company.

It has a low-single-digit stock price, some employee stock options are

under water, and most of its investors are in the red. The company is

conserving cash. It has delayed a costly TV ad campaign, it’s hiring more

slowly, and has eased up international expansion. "It was a whole

different set of rules when we started," concedes Horowitz.

"Everything about our business has changed. Now we’re optimized for

profits, not growth." With luck, Horowitz and Andreessen will one day

look back on Loudcloud’s early miscalculations as a bullet dodged, not one

taken to the heart.

Ben Elgin with Steve Hamm in New York–BusinessWeek