原子、比特与现金：新经济投资入门

CREDIT SUISSE FIRST BOSTON CORPORATION

Americas

Michael J. Mauboussin 1 212 325 3108 [email protected]

Stephen G. Kawaja 1 212 325 3922 [email protected] Equity Research

U.S. Investment Strategy November 22, 1999

Atoms, Bits, and Cash

The ABCs of Investing in the New Economy

• Detailed analysis of return on invested capital for the S&P 500 shows that the source of value creation is shifting from physical capital to intellectual capital—from atoms to bits.

• Given that our accounting system is poor at capturing intellectual capital, investors must focus on the source of value creation: cash.

• We find that the cash conversion cycle is an excellent measure of how well management is managing its tangible capital base.

• Our data show that new economy industries are improving their capital management better than old economy industries. Further, companies closest to the customer tend to do a better job of managing capital.

• The cash conversion cycle is a great way for growth and value

investors to identify promise or trouble in their stock picks.

Table of Contents

Executive Summary............................................................................................. 3 Introduction .......................................................................................................... 4 The Digital Economy: From Atoms to Bits........................................................ 5 Not Accounting for Bits....................................................................................... 7 Uncovering Tangible Asset Efficiency 9 Capturing Change: The Cash Conversion Cycle............................................ 11 The Mechanics of the Cash Conversion Cycle 11 The Cash Conversion Cycle Applied ............................................................... 13 The Economy 13 Various Sectors 13 Individual Companies 18 Case Study: Dell Computer Corp. 21 Appendix A ......................................................................................................... 24 Appendix B ......................................................................................................... 25

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Executive Summary

• Aggregate return on invested capital data mask some profound trends. Detailed analysis of return on invested capital for the S&P 500 show that the source of value creation is shifting from physical capital to intellectual capital—from atoms to bits. In fact, improved physical capital management has freed roughly $245 billion over the past decade. However, measures of improved physical capital management are offset by a surge in goodwill. Cash is investing’s common denominator. Given that our accounting system is poor at capturing intellectual capital, investors must focus on the source of value creation: cash. There is a substantial and growing chasm between our accounting system and economic reality. Analysis of cash flow shrinks that gap, and allows investors to judge all companies on a universal and proven metric of performance.

• The cash conversion cycle is a powerful tool. We find that the cash conversion cycle is an excellent measure of how well management is employing its tangible capital base. In effect, an improving cash conversion cycle is often a triumph of brains over brawn—intellectual capital over physical capital.

• Cash flow: out with the old, in with the new. Our data show that new economy industries—including technology and communications services—are improving their capital management better than old economy industries such as basic materials and energy. Further, companies closest to the customer tend to do a better job of managing capital than those removed from the end market.

• A stock picker’s delight. The cash conversion cycle is a great tool for growth and value investors to identify promise or trouble in their stock picks. Rising cash conversion cycles often indicate deterioration in cash flows, while declining cash conversion cycles generally signal improving cash flows. Neither rising nor falling cash conversion cycles are readily apparent from the income statement. Thus, changing cash conversion cycles are often a harbinger of stock price performance.

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Introduction

“When I was a kid in the bank, the key economic indicator we looked at was freight car loadings. Who cares about that now? What we need is a way to measure the knowledge we bring to the work we do.”

1 -Walter Wriston Throughout most of history, our economy has centered on the production of tangible goods using physical assets. However, the economy is undergoing a fundamental shift. A new economy is emerging, where reliance on tangible capital is yielding to intellectual capital–from atoms to bits. Intellectual capital is intellectual material—knowledge, information, intellectual property, and experience—that can 2 be put to use to create wealth.

This atoms-to-bits transformation has not only spawned whole new businesses, it is reshaping the competitive landscape of traditional industries. It has also cre-ated significant shareholder value, supporting one of the biggest and longest bull markets in history.

Unfortunately, as ethereal bits eclipse concrete atoms, traditional financial measures become less reliable at capturing value. Our accounting system, designed to track the movement of physical capital, is inelegant in recognizing knowledge capital. The investment rules developed by Graham and Dodd for post-Depression companies have little to say about intangible assets. But none of this matters to the stock market, which clearly has rewarded brains over brawn.

Happily, there is a common denominator for valuing atoms and bits: cash. In fact, Graham and Dodd were right all along: the value of a business is the present value of future free cash flows. Debates about purchase versus pooling, expens-ing versus capitalizing, and income statement versus balance sheet all overlook a basic verity: the stock market follows cash. Increasingly, intellectual capital is replacing physical capital—freeing huge sums of cash and confounding traditional analysis.

This report is broken into four parts. First, we explore the shift from atoms to bits. Our analysis reveals clear evidence of a surge in intellectual capital that is not well captured in aggregate data. Second, we highlight the cash conversion cycle as a useful starting point in identifying companies that are successfully replacing tangible assets with intellectual capital. Third, we apply the cash conversion cycle to various sectors and companies. This analysis highlights shifts in the economy and provides critical insights about valuation. Finally, we show how the cash conversion cycle can be a great tool for stock picking.

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The Digital Economy: From Atoms to Bits

“While the weight of current economic output is probably only modestly higher than it was a half century ago, value added, adjusted for price change, has risen well over threefold.”

3 -Alan Greenspan The Information Age is supplanting the Industrial Age. Knowledge is replacing physical things as both the primary input and the final output of the production process. The proof is everywhere, from radical new production processes to the 4 booming software industry.

Consider a beverage can. In 1958, Reynolds Metals developed a seven-ounce 5 aluminum can to compete with the standard steel can. The new container weighed a relatively hefty two-thirds of an ounce, and required costly chemicals or massive amounts of expensive electric power to produce.

This all changed when aluminum producers and can manufacturers figured out how to make the aluminum can into a viable alternative to the steel can. Improved manufacturing know-how reduced the weight of the can to less than half an ounce. The creation of an expansive recycling network—recycled aluminum uses about 5% of the electricity needed to make ingot out of scratch—circumvented the massive power cost disadvantage. The technology took off.

By 1967, the year Coke and Pepsi started using the aluminum can, engineers had figured out how to reduce the material used by more than 25%. Yet another triumph of knowledge over nature.

Aluminum can production is a microcosm. For example, U.S. exports lost 50% of 6 their physical weight per dollar of value from 1990 to 1996.

The trend away from manufacturing and toward services and other nonphysical output has become pronounced. In 1800, only 3% of the domestic workforce held service jobs. By 1950, that number had jumped to 45%. We expect 70% of the domestic workforce to hold service jobs by the turn of the millennium (see 7 Figure 1).

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Figure 1 The Changing Economy as a percentage of the domestic workforce

100% 90% 80%

Source: Myths of Rich and Poor, by W. Michael Cox and Richard Alm, and CSFB estimates.

All industries are affected by this shift. Moore’s Law predicts the doubling of com- 8 puting power every 18-24 months. Gilder’s Law foretells the tripling of bandwidth 9 every year in the foreseeable future. The continual shedding of mass and improvement in quality has spawned a generation of consumers that expects more and more for less and less. And they are getting it.

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Not Accounting for Bits

“The good news is that there’s a new item in the asset column, one you’re probably not even accounting for: your information assets.”

10 -Downes and Mui Replacing capital with knowledge should manifest itself in a reduced asset base, boosting commonly used return metrics such as return on operating assets. But, as Figure 3 shows, this does not appear to be the case. A detailed analysis of the S&P Industrials suggests that the world has not changed much in the past dec-

ade. Total operating return on assets is essentially the same as it was ten years ago.

Figure 2 The Pretax Value Equation: Return on Operating Assets "Operating Margin" "Asset Turns"

Operating Profit Return on Operating Assets = Sales

• TotalSales Assets Source: CSFB.

Figure 3 Operating Return on Assets Unchanged since the End of the 1980s

Source: CSFB estimates, company financials, and FactSet.

In fact, if we dissect operating return on assets into its components—operating margins and total asset turns—we still fail to find proof that bits have replaced atoms. Actually, we see just the opposite: overall asset efficiency appears to have deteriorated, with asset turns (sales/average total assets) falling from 1.04 in 11 1987 to 0.86 in 1998. The apparent conclusion is that more assets are needed to generate the same amount of revenue. So what gives?

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Figure 4 Asset Turns Fall over the 1990s S&P Industrials; in percent and turns

Total Asset Turns Operating Margin

Source: CSFB estimates, company financials, and FactSet.

As it turns out, significant improvements in physical asset efficiency have been masked by a substantial increase in goodwill. Goodwill is the residual between the acquisition cost of a company and the sum of the fair values of all its identifi- 12 able assets and liabilities. Our analysis of the S&P Industrials found that goodwill as a percentage of total assets jumped nearly 77% in the last eight years, from 3.4% in 1990 to 6.0% in 1998. Goodwill as a percentage of sales rose from 3.6% in 1990 to 6.3% in 1998. The very existence of goodwill is recognition that much of a company’s assets are knowledge-based.

Further, these goodwill data are understated by the sizable write-offs taken in recent years. R.G. Associates estimates that 1,369 special charges were taken or announced during 1998 (charges for restructuring, in-process R&D, merger- 13 related items, and write-downs), representing $72.1 billion.

Figure 5 Goodwill Grows on Balance Sheets

As a % of Total Assets As a % of Sales

Source: CSFB estimates, company financials, and FactSet.

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Moreover, the surge in goodwill, while impressive, actually understates the rise in 14 intangible assets. Reported goodwill results only from a merger or acquisition.

However, acquirors can choose to record transactions as either a “purchase” or a “pooling,” with radically different accounting consequences. 15 Purchase account- 

ing results in goodwill that is amortized, or expensed, against earnings for a period of up to 40 years. In contrast, there is no goodwill entry for pooling deals. As a result, a “pooling” deal leaves a company with a smaller asset base than a 16 “purchase” deal, even though the economics are identical.

So while an active market for corporate control has forced goodwill onto balance sheets, goodwill is in no way a systematic or complete measure of intellectual capital. In 1998 alone, 45.3% of the total domestic deal value was treated as a pooling, leaving massive amounts of goodwill unreported.

Table 1 Chosen Accounting Convention for M&A Deals Announced in 1998 Total Value Number of Deals (in millions) (in units)

Accounting Convention:

Domestic $1,996,279.9 14,801.0 Pooling 45.3% 3.8% Purchase 54.7% 96.2% Source: Security Data Corp.

Figure 6 Operating Return on Assets Does Not Explain Value S&P Industrials; in percent and turns

S&P Industrials ROA S&P Industrials Price

Source: CSFB estimates, company financials, and FactSet.

Uncovering Tangible Asset Efficiency Removing goodwill from the equation, we see that tangible asset efficiency is actually soaring. Economy-wide productivity gains have reduced tangible asset needs by more than $245 billion in the 1990s. 17 For the S&P Industrials, we see that:

• Net working capital as a percentage of sales fell, in aggregate, from 14.5% in 1990 to 11.4% in 1998. Had working capital efficiency remained at 1990 levels, an additional $124 billion would be tied up in net working capital alone.

• Net plant, property, and equipment enjoyed a similar, albeit more modest, improvement over the decade. Net PPE as a percentage of sales fell from

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37.1% in 1990 to 35.4% in 1998. Without improved efficiency, managers would have been forced to inject an additional $121 billion into fixed assets.

Several catalysts have triggered this improvement.

• Advances in technology. From software to computers to communications, technology has provided the tools to better manage physical capital. Bar codes allow close tracking of products at all stages, from inception to sale.

Point-of-sale scanners transmit up-to-the minute data to all participants in the 18 supply chain. Enterprise and manufacturing resource-planning software provides managers with unprecedented information about their businesses. A myriad of management techniques have followed: just-in-time, total quality management, quick response, efficient consumer response, demand flow, and accurate response. As a result, supply chains have compressed to unprecedented levels.

• A shift in compensation systems. The adoption of value-based management systems and compensation schemes has shifted management’s focus to the balance sheet. Compensation directly tied to asset efficiency provides a significant incentive to improve performance.

• Active market for corporate control. The robust M&A market has provided further impetus for tighter corporate control. Investors look for opportunities to exploit asset inefficiency. Managers who do not use their assets optimally risk losing their company to a third party.

Figure 7 Fewer Tangible Assets Generated More Sales in the 1990s S&P Industrials; as a percentage of sales

Net PPE Net Working Capital

Source: CSFB estimates, company financials, and FactSet.

Capturing Change: The Cash Conversion Cycle

The cash conversion cycle is a powerful tool for assessing how well a company is managing capital. It not only highlights the drivers of working capital, but also sheds light on the dynamics of a supply chain. Interestingly, many industry supply chains are being altered by information technology. These supply chains are evolving from a system where goods are “pushed” from the vendor to the customer to one where goods are “pulled” by the consumer through a responsive chain. The result is reduced inventories, faster receivables collection, and extended payment terms with suppliers.

The Mechanics of the Cash Conversion Cycle The cash conversion cycle quantifies the time between cash payment to suppliers and cash receipt from customers.

19 The three components of the cash conversion cycle are:

• Days sales outstanding (DSO).20 The number of days between the sale of a product and the receipt of a cash payment.

• Days in inventory (DII).21 The speed with which the stock of raw materials, work in progress and finished goods of a company are converted into product sales.

• Days payables outstanding (DPO).22 The number of days between the purchase of an input from a vendor and cash payment to that vendor.

Figure 8 Components of the Cash Conversion Cycle Cash Conversion Cycle

Days Payables Outstanding

Inventory Purchased Supplier Paid Customer Purchase Payment Received

Days in Inventory Days Sales Outstanding Source: CSFB.

Investors should look for a pattern of short or shortening DSO and DII. Both inventories and receivables tie up cash—every dollar freed from inventories or receivables translates into a one-time contribution to cash flow and a reduced need 23 for product financing through the supply chain.

Investors should look for a lengthening of days payables outstanding. The attrac-tion of an account payable is similar to that of a charge card: enjoy the merchandise now, pay later. Payables are a flexible and cheap form of financing, with implicit sensitivity to product demand and order patterns.

Although payables lack explicit financing charges, the financing costs associated with them are passed along in the cost of goods sold. Earlier payment is usually rewarded with a discount that translates into higher margins. Thus, while late payment is better on a cash basis, investors must monitor the movement in margins that accompanies extended terms.

Some businesses lengthen days payables outstanding beyond the days in inventory and days sales outstanding combined, resulting in a negative cash conversion cycle. This strategy turns working capital into a source of cash as 24 suppliers finance sales growth. Increasingly, managements in both new and old economy businesses are looking at lengthening payables as a way of boosting the return on invested capital in their businesses.

In fact, Wal-Mart recently announced its objective: “to sell merchandise before we 25 pay for it.” Currently, 63% of Wal-Mart’s inventory is sold before the bills are paid, up from 55% in 1998. Wal-Mart expects its entire inventory to be financed by suppliers within three years.

The Cash Conversion Cycle Applied

The Economy 26 As Figure 9 shows, the cash conversion cycle for the S&P 500 fell from 101.6 days in 1990 to 71.3 days in 1998, a 29.8% drop. This change suggests an aggregate improvement in supply chain management. But, as we explain below, the spoils have not accrued to all industries evenly.

S&P 500 CCC S&P 500 Price

Source: CSFB estimates, company financials, and FactSet.

Various Sectors Two key trends emerge when we examine the sectors that compose the index.

First, within and across industries, position in the supply chain is critical in deter-mining a firm’s cash conversion cycle. Companies closest to the consumer generally enjoy better cash economics. Many consumer businesses are cash and carry, meaning that the typical 30- to 45-day terms extended in business-tobusiness transactions are not required. Furthermore, an abundance of real-time purchase information often gives these companies the ability to carry optimal levels of inventory.

Figure 10 Sectors Closer to the Consumer Enjoy Better Cash Conversion Cycles S&P 500; in days

Shortening Communication Services

Consumer Health Cyclicals Care

Technology Capital

Cash Conversion Cycle Goods Consumer Staples Far Near Closeness to Customer Basic Materials Energy

Lengthening

Source: CSFB.

Second, companies that deal primarily with tangible output produced by physical assets have been unable to enjoy the same improvements in cash conversion cycles as those that deal in bits. For example, as Figure 10 highlights, the foun-dation of the new economy, health care and technology, both posted impressive improvements in their cash conversion cycles.

Specifics for each sector are as follows:

• Communication services. Communication services companies posted the largest decline in cash conversion cycles, from an average of 24.6 days in 1991 to an average of 8.9 days in the first two quarters of 1999. Days in inventory were cut in half, falling from an average of 17.2 days in 1991 to an average of 7.8 days in the first half of 1999.

• Health care. Companies within the health care sector managed to reduce their cash conversion cycle by 27.7% in the 1990s, from an average of 112.4 days in 1991 to an average of 81.2 days in the first half of 1999. A 19.6% reduction in days in inventory, from an average of 121.4 days in 1991 to an average of 97.7 days in the first two quarters of 1999, drove this reduction.

• Technology. Technology companies’ cash conversion cycle fell from an average of 89.5 days in 1991 to an average of 67.6 days in the first two quarters of 1999. Like the health care and communication services sectors, a 37.8% decline in inventory, from an average of 82.0 days in 1991 to an average of 51.0 days in the first two quarters of 1999, fueled the decline.

• Consumer cyclicals. Through aggressive management of terms, consumer cyclicals companies’ cash conversion cycle fell 43.9%, from an average of 175.7 days in 1991 to an average of 98.5 days in the first half of 1999. While days in inventory were actually slightly higher over the period, days sales

outstanding were halved, from an average of 177.4 in 1991 to an average of 88.7 in the first half of 1999.

• Capital goods. Like consumer cyclicals, capital goods companies were able to improve their cash conversion cycle primarily by better managing receivables. The sector’s cash conversion cycle fell 23.2%, from an average of 118.0 days in 1991 to an average of 90.7 in the first two quarters of 1999.

• Consumer staples. While the average cash conversion cycle in the sector dropped a mere 12.6%, from an average of 48.3 in 1991 to 42.3 days in the first two quarters of 1999, the absolute level is still less than half of its cyclical counterpart.

• Basic materials. The basic materials sector usually sits at the beginning of the supply chain and deals in physical goods. Consequently, it is one of only two sectors that actually showed a lengthening cash conversion cycle over the 1990s. Both DSOs and DIIs lengthened, driving the cash conversion cycle from an average of 73.7 days in 1991 to an average of 80.9 days in the first half of 1999.

• Energy. The energy sector posted the greatest lengthening in its cash conversion cycle, jumping 34.9% in the 1990s—from an average of 17.5 days in 1991 to an average of 23.6 days in the first two quarters of 1999.

Table 2 Cash Conversion Cycle by Sector S&P 500 sector definitions; in days; percentage change

Improved Lagged Average Average Average 1991 year-to-date 1999 Change Average 1991 year-to-date 1999 Change Communication Services Basic Materials

Consumer Cyclicals Energy

Source: CSFB estimates, company financials, and FactSet.

Table 3 Longest and Shortest Cash Conversions by Sector S&P 500 sector definitions; in days; percentage change

Sector Cash Conversion Cycle (in days) Shortest Longest

Source: CSFB estimates, company financials, and FactSet.

Individual Companies The cash conversion cycle is a robust tool when applied to individual companies. Overall, there is a remarkable correspondence between capital market valuation and a short cash conversion cycle.

First, the difference between individual companies across sectors is striking. For example, Microsoft, an icon of the Information Age, had a negative 83.0-day cash conversion cycle and traded at 83.1 times noncash assets at its 1999 fiscal year-

end. On the same day, Exxon, the world’s largest oil company, had a negative 0.7 day cash conversion cycle and traded at 2.1 times its noncash assets.

Figure 11 Asset Values and Market Values Diverge in the New Economy in millions; ratios in units

Exxon Corp. Microsoft Corp.

For the quarter ended 6/30/99 For the quarter ended 6/30/99 Days In: Days In:

Partial Balance Sheet - excluding cash & investments Partial Balance Sheet - excluding cash & investments in millions in millions

Assets 6/30/99 Assets 6/30/99 Current Assets Current Assets

Market Capitalization Market Capitalization

Note: annualized quarterly data.

Source: Company financials.

Second, even within a traditional industry such as steel, we see serious valuation mismatches based on different cash conversion cycles. Steel was the quintes-sential manufactured product of the early Twentieth Century. Once, sheer brawn added most of the value in the production of steel—extracting the ore, shipping it to the mills, and the like. Now, the revolutionary application of intellectual capital to the production process makes brains more important than brawn. Bethlehem Steel once required three to four man-hours of labor to make a ton of steel. Today, Nucor Steel can process the same ton in 45 minutes. This substitution of bits 27 for atoms is immediately apparent in the cash conversion cycle.

Figure 12 The Market Values Intellectual Capital in millions; ratios in units

Bethlehem Steel Corp. Nucor Corp.

For the quarter ended 6/30/99 For the quarter ended 7/3/99 Days In: Days In:

Partial balance Sheet - excluding cash, investments and discontinued operations Partial Balance Sheet - excluding cash & investments in millions in millions

Assets 6/30/99 Assets 7/3/99 Current Assets Current Assets

Other assets 1,284 4,032 2,093

Total Operating Assets 5,309 Total Operating Assets 2,907

Market Capitalization Market Capitalization

Note: annualized quarterly data.

Source: Company financials.

Third, different cash conversion cycles are apparent between the old and new economy business model within particular industries.

Figure 13 Companies with Negative Cash Conversion Cycles are Rewarded in millions; ratios in units

Compaq Computer Corp. Dell Computer Corp.

For the quarter ended 6/30/99 For the quarter ended 7/30/99 Days In: Days In:

Partial Balance Sheet - excluding cash & investments Partial Balance Sheet - excluding cash & investments in millions in millions

Assets 6/30/99 Assets 7/30/99 Current Assets Current Assets

Market Capitalization Market Capitalization

Note: annualized quarterly data.

Source: Company financials.

Finally, tracking a company’s cash conversion cycle gives the best assessment of the dynamic capital needs of a business, making the measure a useful in antici-pating stock price performance. The following case study illustrates this point.

Dell Computer Corp.

“The balance between profitable growth and liquidity management is all about velocity.”

28 Thomas Meredith, Chief Financial Officer, Dell Computer Corp.

On January 3, 1995, Dell’s stock fetched $0.623 per (split-adjusted) share. By June 30, 1999, Dell stock traded at $37.00 per share, almost sixty times the earlier value.

Over the period, Dell management made a deliberate effort to break out all inter-nal activities into their operational components, isolating the essential drivers of return on invested capital. This process highlighted the importance of working capital requirements on invested capital totals.

Through the implementation of the direct model (build to order) and fast receivables collection, the company actually turned working capital into a source of cash. Dell’s return on invested capital went from 37% in 1995 to 195% in 1998.

Because so much of Dell’s invested capital was tied up in working capital, we estimate that without the improvements in the cash conversion cycle, Dell’s return on investment would be roughly two-thirds its current level.

The effective management of these assets over the period led to a dramatic rise in market value.

Figure 14 Dell’s Shortening CCC Translates into Market Value

Relative Price 50 20 40 In days

Cash Conversion Cycle Relative Price Source: Company financials, disclosure, and FactSet.

Conclusion The economy is in transition. As intellectual capital sucks tangible capital from businesses, cash is freed. We believe the cash conversion cycle allows investors to better pick winners in this New Economy.

N.B.CREDIT SUISSE FIRST BOSTON CORPORATION may have, within the last three years, served as a manager or co-manager of a public offering of securities for or makes a primary market in issues of any or all of the companies mentioned. Closing prices are as of November 18, 1999.

Appendix A

Operating return on assets is skewed by numerous other accounting distortions. The most relevant are listed below.

• Restructurings occur when a company makes a fundamental change in its business strategy, operations, or structure, resulting in provisions for ex- 29 pected losses. This provisional charge has three effects. First, it reduces depreciation and/or amortization expense, helping operating margins. Second, it boosts future reported earnings by recognizing future expenses in the current period. Finally, it shrinks the asset base, enhancing returns. Restructuring charges have become more and more prevalent. Warren Buffett recently said, “I believe that the behavior of managements has been...worse when it comes to restructurings and merger accounting...many CEOs think 30 this kind of manipulation is not only okay, but actually their duty.”

• As the source of value has shifted, employees have become more and more valuable. Increasingly, the way to attract and motivate employees is through 31 employee stock options (giving them “a piece of the action”) . Although cash compensation is expensed, most employee stock options are not. Recognizing employee stock options as an expense serves to reduce operating profits and depress computed returns.

Current accounting convention views research, development, software, and information technology spending as costs—which are expensed on the income statement—rather than as investments in future growth—which are capitalized on the balance sheet. This convention has caused a material understatement both of the reported asset base and earnings. The impact is significant. To put it in per-spective, consider that U.S. companies spent $212 billion on information technol- 32 ogy in 1996 alone.

Appendix B

Calculation of the S&P 500 Cash Conversion Cycle Unless otherwise indicated, cash conversion cycles were calculated using the last twelve months sales, last twelve months cost of goods sold, and average accounts receivable, inventories, and payables over the prior four quarters.

Companies in the financial, transportation, and utilities sectors were removed from the calculation because of the absence of a defined product cycle. In addi-tion, the companies listed below were excluded for one or more of the following reasons: (1) accounts payable is not reported as a separate line; item, (2) quarterly data is missing; or (3) financing is a core business.

Figure 15 Companies Excluded in Calculation of the S&P 500 Cash Conversion Cycle

FDC FIRST DATA CORP.

UN UNILEVER N V -NY SHARES VO SEAGRAM CO LTD

Because the aggregated calculations are sales weighted, large companies may have undue influence on the entire sector’s cash conversion cycle. Figure 16 shows the five largest companies, by sales, included in the calculations.

Figure 16 Largest Companies by Sales and Sector S&P 500 sector definitions; in days; percentage change Revenue Largest by Sector Ticker Name Jun-99

1 Interview with Walter Wriston, quoted in Thomas A. Stewart, “Brainpower,” Fortune, June 3, 1991. 2 See Intellectual Capital by Thomas A. Stewart, Doubleday, 1997.

3 http://www.bog.frb.fed.us/BOARDDOCS/SPEECHES/19961016.htm.

4 See The Weightless World by Diane Coyle, Capstone Publishing, 1997.

5 This example is taken from Intellectual Capital by Thomas A. Stewart, Doubleday, 1997. 6 See New Rules for the New Economy by Kevin Kelly, Penguin Books, 1998.

7 See Myths of Rich and Poor by W. Michael Cox and Richard Alm.

8 http://www.intel.com/intel/museum/25anniv/hof/moore.htm.

9 http://www.seas.upenn.edu/~gaj1/wireless.html.

10 See Unleashing the Killer App by Larry Downes and Chunka Mui, Harvard Business School Press, 1998. 11 This is a commonly used measure of the productivity of assets.

12 See Financial Statement Analysis by Leopold Bernstein and John Wild, McGraw-Hill, 1998.

13 Warren Buffett, Berkshire Hathaway Annual Report 1998.

14 See Appendix A.

15 Purchase accounting assumes that one company uses its economic resources to acquire another, and thus net assets acquired are recorded at their fair value purchase price. In a purchase of net assets, this is exactly what happens: the net assets purchased from the selling entity are recorded on the acquirer’s books at fair value. Any premium over and above fair value is goodwill. While part of the gap between book value and price is allocated to the target’s identifiable net assets to bring them up to fair value, the largest portion (up to 90% in some acquisitions) is assigned to goodwill.

Pooling accounting merges two firms using the existing recorded book values of their net assets. There is no adjustment to fair value because the underlying assumption is that there has not been an exchange of economic resources, but rather a combining of equity interests.

16 See “Let’s Make a Deal” by Michael Mauboussin and Bob Hiler, Credit Suisse First Boston, April 27, 1998.

17 Assumes net working capital and net PPE remained at the same percentage of sales as in 1990 in each subsequent year. This figure is the nominal sum of the incremental difference between implied and actual net working capital and net PPE.

18 See “What Is the Right Supply Chain for Your Product?” by Marshall Fisher, Harvard Business Review, March-April 1997. 19 See “A Cash Conversion Cycle Approach to Liquidity Analysis” by Verylyn D. Richards and Eugen J. Laughlin, Financial Management, Spring 1980, 32-38.

20 DSO = Days in the year (360) / (Sales / Average accounts receivable).

21 DII = Days in the year (360) / (Cost of goods sold / Average inventory).

22 DPO = Days in the year (360) / (Cost of goods sold / Average accounts payables).

23 Product financing costs amounted to more than 4% of GDP in 1998. See “Combining Logistics with Financing for Enhanced Profitability” by Richard Palmieri and Jon Africk, Credit Suisse First Boston at http://palmieri.ascet.com. 24 See Essentials of Managerial Finance, 5th ed. by J. Fred Weston and Eugene F. Brigham, The Dryden Press, 1979. 25 Jay Fitzsimmons, Wal-mart senior vice-president, quoted in The Wall Street Journal, November 10, 1999. 26 See Appendix B for methodology.

27 See Intellectual Capital by Thomas A. Stewart, Doubleday, 1997.

28 See “Thomas Meredith” by Stephen Barr, CFO Magazine, September 1998.

29 There are two main types of restructuring charges:

1. Costs associated with terminated employees or assets no longer being used—termination benefits, facility closure costs, operating leases, lease termination costs, excess lease costs, losses on planned disposals of assets, and certain contractual obligations.

2. Costs associated with retained employees or assets—employee relocation, temporarily idled facilities, equipment relocation, training and retraining, business re-engineering, information systems enhancements, inventory write-downs, and asset impairments.

Source: Financial Accounting Standards Board, Emerging Issues Task Force No. 94-3, February 21, 1994.

30 Warren Buffett, Berkshire Hathaway Annual Report 1998.

31 See “A Piece of the Action” by Michael Mauboussin and Bob Hiler, Credit Suisse First Boston, November 2, 1998. 32 See New Rules for the New Economy by Kevin Kelly, Penguin Books, 1998.

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Copyright 1999 Credit Suisse First Boston Corporation 1999. All rights reserved This report is provided to you solely for informational purposes and does not constitute an offer or solicitation of an offer, or any advice or recommendation, to purchase any securities or other financial instruments and may not be construed as such. This report may not be reproduced or redistributed to any other person, in whole or in part, without the prior written consent of the distributor listed below. The information set forth herein has been obtained or derived from sources believed by Credit Suisse First Boston Corporation and its affiliates (“CSFB” or “the firm”) to be reliable, but CSFB does not make any representation or warranty, express or implied, as to its accuracy or complete-ness.

Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied is made regarding future performance. Opinions and estimates may be changed without notice. The firm, or one or more of its partners or employees, from time to time may have long or short posi-tions in, or buy and sell and make markets in, any of the securities discussed herein. The firm may underwrite or provide investment banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein. If CSFB makes a market in any security, there can be no assurance that CSFB will continue to do so. Additional information is available upon request.

CSFB may have issued other reports that are inconsistent with, and reach different conclusions from, the information presented herein. Those reports reflect the different assumptions, views and analytical methods of the analysts who prepared them.

This report is being distributed in the United States by CSFB, and in Canada by Credit Suisse First Boston Securities Canada, Inc. (“CSFBSC”) with CSFB as mailing/delivery agent. In jurisdictions where CSFB is not registered or licensed to trade in securities, any trade will be made only in accordance with applicable securities legislation which will vary from jurisdiction to jurisdiction and may require that the trade be made in accordance with applicable exemptions from registration or licensing requirements. CSFBSC has approved the distribution of this memorandum. Any U.S. customer wishing to effect a transaction in any security should do so only by contacting a representative at Credit Suisse First Boston Corporation, Eleven Madison Avenue, New York, NY 10010 (212) 325-2000. ni4127.doc

Copyright 1999 Credit Suisse First Boston Corporation 1999. All rights reserved This report is provided to you solely for informational purposes and does not constitute an offer or solicitation of an offer, or any advice or recommendation, to purchase any securities or other financial instruments and may not be construed as such. This report may not be reproduced or redistributed to any other person, in whole or in part, without the prior written consent of the distributor listed below. The information set forth herein has been obtained or derived from sources believed by Credit Suisse First Boston Corporation and its affiliates (“CSFB” or “the firm”) to be reliable, but CSFB does not make any representation or warranty, express or implied, as to its accuracy or complete-ness.

Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied is made regarding future performance. Opinions and estimates may be changed without notice. The firm, or one or more of its partners or employees, from time to time may have long or short posi-tions in, or buy and sell and make markets in, any of the securities discussed herein. The firm may underwrite or provide investment banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein. If CSFB makes a market in any security, there can be no assurance that CSFB will continue to do so. Additional information is available upon request.

CSFB may have issued other reports that are inconsistent with, and reach different conclusions from, the information presented herein. Those reports reflect the different assumptions, views and analytical methods of the analysts who prepared them.

This report is being distributed in the United States by CSFB, and in Canada by Credit Suisse First Boston Securities Canada, Inc. (“CSFBSC”) with CSFB as mailing/delivery agent. In jurisdictions where CSFB is not registered or licensed to trade in securities, any trade will be made only in accordance with applicable securities legislation which will vary from jurisdiction to jurisdiction and may require that the trade be made in accordance with applicable exemptions from registration or licensing requirements. CSFBSC has approved the distribution of this memorandum. Any U.S. customer wishing to effect a transaction in any security should do so only by contacting a representative at Credit Suisse First Boston Corporation, Eleven Madison Avenue, New York, NY 10010 (212) 325-2000. ni4127.doc