Third prelude: What is this, really?

When Autodesk was planning their initial public offering, one key question to be decided was ``Is this a CAD company or a software company?''. This was not a matter of publicity nor clear communication: millions of dollars depended on the answer. At the time of our offering, personal computer software companies were out of fashion and each dollar of their earnings was valued at about $6.50 in stock price (in other words, the price/earnings ratio, or P/E, was 6.5). CAD companies, however, were the Going Thing, and commanded P/E's of about 13. So, if you were a CAD company making precisely the same number of dollars on the same volume of sales, your stock would be worth twice as much as a software company reporting identical numbers. How to classify a personal computer software company whose only product was in the CAD industry? Easy: look at the numbers and say, ``Yessiree--we're a CAD company, all right''.

One of the most difficult issues in performing an initial public stock offering is arriving at the valuation of the company--in other words the stock price of the offering. An incorrect valuation can have disastrous consequences: too high and the underwriting syndicate takes a bath on the offering and the lead underwriter may find it hard to fill up the next syndicate; too low and the company selling the stock foregoes millions in proceeds and may take its much more lucrative follow-on offerings somewhere else. For a process that involves more intangible factors than most engineers believe exist in the entire world, it works almost perfectly--if product introduction disasters were as rare as underwriting calamities the world would indeed be ``entrepreneur friendly''. Assigning a valuation to a business is a subjective matter relying on the judgement of individuals who probably could not begin to explain how they arrive at the numbers they do, but the first and most important determining factor comes many months earlier when management answers the question ``what kind of business is this, anyway?''. Their answer is what I refer to as the ``shape of a business''.