THE CAPITAL MARKETS QUARTERLY 13

reduce retail trading interest and underwriting levels in both equities

and fixedincome. However, we believe that any such downdraft would
probably hurt the stocks of retail brokers such as PaineWebber dispro-
portionately to the effect on the carmngs stream, and that as this became
apparent in subsequent quarters, the stocks would reboimd relatively
quickly. Such a market downdraft, therefore, would probably present
an attractive investment opportunity.

Retail Sales & Trading — PaineWebber has quietly shored up its franchise in retail brokerage
Steadily Improving over the last several years, at a time when turmoil in the industry
Distribution brought huge turnover in the broker ranks industrywide. The firm has
continually gained share of industry Registered Representatives (RRs),
and those RRs have matured as a whole, so that the productivity of the
firm's RRs has improved significantly.
Of particular note has been the firm's strong growth in the retail
distribution of asset-management products, which has fueled the
growth of assets under management and the attached stable income
(though this accrues to the Asset Management business, not directly to
Retail). Rapid growth of debt instruments distributed is also a healthy
sign that client relationsliips are being built around a variety of prod-
ucts, rather than just cyclical equities, and that asset allocation princi-
ples are probably being applied to those relationships more than they
were in the past. (See earnings model. Exhibit 5 — Retail and Asset
Management sections and Exhibits 6 and 7).

Coutinueii ou page 17

BERNSTEIN RESEARCH
14 Titr CAPITAL MARKETS QUARTERLY

Exliibit 5 PaineWebber Group inc.: Annuai Income Statement

by Line of Business ($ miiiion)
CAGR CAGR
1993E 1988- 1993-
1988 1989 1990 1991 1992 1993E TrouRh 1997E 1992 1993E 1997E
Institutional Sales & Trading
Listed Commissions
Usted tquitv Commissions $72 $S2 $74 $85 $110 $116 $94 $140 11% 5% 5%
Options and Other 10 12 10 13 18 19 15 25 16 5 7
Total Institutional Commissions $82 $94 $84 $98 $128 5134 SI 09 $165 12% 5% 5%

Principai Transactions
Institutional l.>TC tquities/Arbitrage $10 $10 $20 $100 5109 $114 $50 5200 82% 3% 15%
Corpur.ite Debt 10 10 25 75 95 100 50 146 76 5 10
GovL-rnments and Agencies 76 85 157 177 195 199 150 291 27 2 10
Municipal Debt 60 61 70 78 85 86 68 126 9 1 10
Total Principai Transaclions 5155 $166 $272 $429 $484 $499 $318 $763 33% 3% 11%

Securities Inventory interest Revenue $179 $346 5369 $443 S438 $407 5346 5596 25% (7)% 10%
Securities Inventory Interest Expense (107) (211) (219) (299) (250) (243) (213) (424) 24 (3) 15
Net Di\ idend Income/Stock Borrow Rebate 65 40 25 25 21 20 15 29 (25) (5) 10
Net Carry $137 5174 $176 $170 $209 $185 $148 $202 11% (12)% 2%

Retaii Debt Tnnsaction CroJJts $(90) $( 135) $( 170) $(250) $(275) $(289) S(200) 5(393) 32% 5% 8%
Institutlonai Principal Transactions S202 5205 $278 $349 $418 $395 $266 $572 20% (5)% 10%
L'ndt-nsntip); Concussions 48 30 30 39 49 44 36 60 0 (10) 8
Total Capital Markets Revenues $332 $329 $392 $486 $595 $573 $411 $797 16% (4)% 9%
Brokerage & Clearance (12) (12) (17) (15) (19) (20) (14) (23) 13 5 4
Sales Compensation (30) (23) (32) (47) (58) (58) (39) (89) 18 1 11
Other Compensation and Benefits (204) (190) (173) (215) (252) (260) (200) (380) 5 3 10
Attributable & Allocated Expenses (67) (60) (99) (91) (97) (100) (90) (146) 10 3 10
Capital Markets Transaction Contribution $20 $44 $70 $118 5169 5135 $68 $158 71% (20)% 4%

Investment Banking
Corporate Undenvriting $163 $103 $123 $194 $280 $252 $168 $343 157o (10)7o 8%
Municipal Undenvriting 34 32 36 36 35 50 39 67 12 (10) 8
Total Underwriting Revenues 5197 S135 SI 58 $230 $335 S302 S207 5410 14% (10)% 8%
rriv.ik' ri.ici.Tnent> 30 38 38 35 25 26 29 36 (4) 5 8
M&A Advisiirj' 55 55 20 15 10 11 12 14 (35) 5 8
All Other Advisory Fees 44 30 15 13 10 11 12 14 (31) 5 8
Total Advisory Revenues $129 $123 $73 563 $45 $47 $52 $64 (23)% 5% 8%
Bridge Loan Net Interest & Fees 26 20 5 0 0 0 0 0 na
1
Merchant Banking St Other Revenues 40 13 7 0 0 0 0 0
Total Banking $392 $291 $243 S293 $380 $349 5258 S474 (1)% (8)% 8%

Less:
Institutionai Underwriting Concessions $(48) $(30) 5(30) $(39) $(49) 5(44) 5(36) 5(60) 0% (10)% 8%
Retail Underwriting Concessions (107) (72) (80) (110) (144) (130) (101) (177) 8 (10) 8
Other Retail Credits (37) (34) (27) (14) (21) (19) (16) (26) (13) (10) 8
Net Banking Revenues $200 5154 $107 SI 24 $166 $156 $105 5213 (5)% (6)% 8%
Compcnsatiiin and Benefits (138) (130) (110) (IN) (146) (139) (117) (196) 1 (5) 9
Attnbulabk' & Alltxated Expenses (58) (30) (20) (15) (10) (10) (8) (35) 3 4
Banking Contribution $5 $(6) 5(23) $(5) $10 $7 $(20) 22% (28)%
S5
Retail Sales & Mariteting
Open Market Securities
Listed HquiU Commissions $233 $293 $268 $301 $355 $376 S284 5512 6% 8%
OTC Equity Commissions 32 37 31 46 65 69 46 121 19 6 15
OTC Equities Trading Income 65 73 95 190 210 223 158 389 34 6 15
Commodities Commissions 54 53 71 67 62 59 71 80 4 (5) 8
Options Commissions 31 38 36 34 40 41 34 56 6 2 8
Debt Principal Transactions 90 135 170 250 275 289 200 393 32 3 8
Undenvriting Credits 107 72 80 no 144 130 101 177 8 (10) 8
Other Retail Transaction Credits 37 34 27 14 21 19 16 26 (13) 8
Total Open-Market Securities $649 $735 $778 $1,014 $1,172 $1,205 5909 $1,753 16% 3% 10%

Packaged Products
Mutual Fund Commissions $46 $66 $67 $104 $122 $128 $98 5224 28% 15%
Direct Investments 39 52 39 25 10 5 7 6 (29) (50) 5
Insurance Commissions 26 45 55 47 40 42 46 57 11 5 8
Other 9 11 20 32 35 35 62 10 15
Packaged Product Revenues $111 $172 $173 $196 $204 $210 5186 $287 3%
Total Retail Production $760 $907 $951 $1,210 $U76 $1,415 $1,095 $2,040 16% 3% 10%

BERNSTEtN RE5EAttCH
 THE CAPITAL MARKETS QUARTERLY

Exhibit 5 PaineWebber Group Inc.: Annual Income Statement

by Line of Business ($ million) (cont'd)
1993E CACR CAGR
1988 1989 1990 iq«l 1492 Trough 1997E 1988-iy92 1993E 1993-199711
Customer Financing
Customer Margin Interest $125 $130 $110 $90 $90 590 $88 $122 (8)% 0%
Interest Evpenso (82) (91) (95) (60) (51) (55) (52) (80) (11) 7 10
Stock Borrow Rebate 25 25 15 15 15 15 15 20 (12) 0 8
Cusiomer Rnancing Contribution $68 564 S30 $45 $54 $50 $51 5(.3 (6) (7) 6
Other Retail Ri-venues 3 20 40 76 84 78 114 26 10 8
Tolal Retali Sales Revenues S858 $991 $1,021 $1,319 $1,506 $1,549 $1,224 $2,217 15% 3%

Brokerage & Clearance $(40) S(41) $(46) $(48) 5(57) $(60) $(47) $(67) 9% 5% 3"/..
Sales Compens.ition (316) (355) (382) (489) (561) (578) (444) (851) 15 3 10
Othur Compensation and Benefits (180) (205) (200) (247) (296) (305) (22U) (447) 13 3 10
Attributable & Allocated Expenses (220) (235) (230) (250) (268) (276) (250) (403) 5 3 10
Other Expenses (169) (120) (131) (144) (162) (167) (140) (244) 0) 3 10
Total Expenses S(925) S(956) ${989) $(1.179) $(1344) S(2,012) 10% 10%
Retail Sales Contribution $(67) $35 S31 $140 $163 $164 $124 S204 1% 6%

Asset Management
Mutu.ll Fund A.sset M g t . / A d m i n . Fees $84 S104 $126 SI 52 S191 $220 $214 $384 23% 15% 15%
Man.ifie<j Accounts and Other 50 46 44 43 44 45 49 61 (3) 2 8
Total Asset Management Revenues $134 $150 S170 $195 $235 S265 $263 S445 15% 13% 14%
Compensation and Benefits (60) (70) (79) (90) (104) (115) (115) (20t) 15 10 15
Attnbutable & A][oca^ed Expenses (34) (45) (45) (45) (60) (63) (66) (122) 15 5 18
Asset Management Contribution $40 $35 $46 $60 $71 $87 $82 $122 15% 237o 9%

Risk Arbitrage. Discontinued Businesses, and Other

Net Re\ fnue> S2M 5149 $105 535 $30 50 yi
Compensation & Benefits (92) (59) (56) (17) (15) 0 0
Attnbutable & Allocated Expenses (48) (40) (35) (14) (5) 0 0
Contribution SI 24 $50 $14 $4 510 $0 SO $0
Depreciation and Amortization Expense S(24) S(29) $(33) $(33) $(35) $(36) $(35) $(49) 9% 3% 8%
Interest Expense on Term Debt (34) (47) (59) (56) (48) (82) (85) (35) 9 71 (10)
Earnings Belore tncome Taxes & Restructuring S63 S83 547 $226 S339 $275 $134 $385 52% (19)% 9%
Restructuring Charjio 0 0 (149) 0 0 0 0 0
Provision For Income Taxes (21) (31) 45 (76) (126) (96) (47) (154) 57"/o (24)% 12%
Extraordinar\- Charge 0 0 0 0 0 0 0 0 na
Net Income $42 S52 $(57) $151 $213 $179 $87 S23I 50% (16)% 7%
Source: Regulatory filings, corporate reports, and Bemstein estimates.

Exhibit 6 PaineWebber Group Inc.: Annual Functional Income Statement ($ million)

CAGR CACR
1988 1989 1990 1991 1992 1993E TrouRh 1997E 1988-1992 1993E 1993-1997E
Reventies
Commissions 5543 $677 $652 $723 $822 S854 S694 51,221 11% 4% 9%
Net Interest Income 212 212 152 15S 215 153 114 209 0 (29) 8
Principal Transactions 484 388 472 654 724 722 476 1,152 11 0 12
Investment Banking 326 258 231 293 380 349 258 474 4 (8) 8
Asset Management 134 159 181 215 267 300 298 445 19 12 10
Other 55 33 47 64 76 U 78 114 S 10 8
Total Revenues 51,755 $1,727 $1,736 $2,108 $2,484 52.461 $1,919 $3,616 9% (1)% 10%

Expenses
Compensation and Benefits S( 1,020) $(1,032) 5(1.033) 5(1,224) 5(1,433) 5(1.455) 5(1,135) 5(2,164) 9% 2% 10%
Other Attributable and Allocated
Expenses (427) (410) (429) (415) (440) (449) (414) (684) 1 2 11
Brokerage, Commissions and
Clearance Fees (52) (53) (63) (63) (76) (80) (61) (91) 10 5 3
Other (193) (149) (164) (178) (197) (203) (175) (293) 0 3 10
Totai Expenses $(1,692) $(1,644) 5(1,689) 5(1,881) 5(2,145) $(2,186) 5(1,785) $(3,231) 6% 2% 10%
Pretax Income $63 583 $47 $226 $339 $275 $134 5385 52% (19)% 9%
Restructuring & Merchant
Banking Charge 0 0 (149) 0 0 0 0 0 na
Provision for Income Taxes (21) (31) 45 (76) (126) (96) (47) (154) 57 (24) 12
Rvtraordinarv Charge 0 0 0 0 0 0 0 0 na
Net Income $42 $52 $(57) 5151 $213 $179 587 $231 50% (16)% 7%

Eamings Applicable to Common and

Common Equivalent Shares 517 526 $(83) S127 5196 5173 S81 5231 $1 SO $0
Primary Shares Outstanding (mil.) 43.3 40.3 37.4 40.5 46.3 52.0 52.0 52,0 21'.. 12% 0%
Fully-Diluted Shares Outstanding (mil.) 43.3 40.3 37.4 63.5 61.6 57.0 57.0 52.0 9 (7) (2)
Eamings Per Primary Share- $0.39 $0.65 $(2.23) $3.15 $424 $3.33 $1.56 $4.44 82':'o (22)% 7%
Fully-Diluted Eamings Per Share 0.98 1.30 (1.54) 2.49 3.55 3.14 1.53 4.44 38 (12) 9

Source: Corporate reports and Bemstein estimates.

V BERNSTEIN RESEARCH
16 Tin; CAi'iiAi. MAHKns QUAUTUKLY

Exhibit 7 PaineWebber Group Inc.: Line of Business Profitability ($ miiiion)

1993E
1988 1989 l'^-L. 1491 1992 1993E TrouRh 1997E
Retail Sales & Markeling
$856 $991 $1,021 $1,319 $1,506 $1349 $1,224 $2,217
Pretax E j m i n g s (67) 35 31 140 163 164 124 204
Pretax M a r g i n (8)% 4'Ji, 3% 117« 11% 10% 9%

AsselMansgement
SI 34 $150 $170 $195 $235 $265 $263 $445
Pretax E.imings 40 35 46 60 71 84 82 116
Pretax M a r g i n 30% 23'%. 17% 31% 30% 32% 31% 26%

Institutional Sales.&JfadiDg
N f t Revenue $332 $329 $392 $486 $595 $579 $411 $805
Pretax Earnings 20 44 70 118 169 140 68 165
Pretax M a r g i n 6% 13% 18% 24% 28% 24% 16% 20%

Inveslmenl Banking
Net Revenue S200 SI 54 SI 07 SI 29 S166 $156 $105 $213
Pretax Earnings 5 (6) (23) (5) 10 7 (20) 5
Pretav M a r g i n 2% (4)% (22)% (4)% 6% 5% (19)% 2%

Risk Arbitrage & Discontinued Lioes

Net Revenue S2M $149 $105 $35 $30 -
Pretax Earnings 124 50 14 4 10 - -
Pretax M a r g i n 47% 34% 13% 11% 33%

Tolal P3ineWebber_Groim
Net Revt-nue S1.755 SI .727 $1,736 $2,108 S2,484 $2,467 $1,919 $3,624
Pretax E.imings 63 83 47 226 339 177 134 386
Pretax M a r g i n 4% 5% 3% 11% 14% 11% 7% 11%

Memo: Corporate Expenses

Interest i.in T i r m Debt $34 S47 $59 S56 $48 $82 S85 $55
Depreciation & A m o r t i z a t i o n 24 29 33 33 35 36 35 49

Source: Corporate reports and Bemstein estimates.

* • BERNSTEIN RESEARCH
 THE CAPITAL MARKETS QUARTERLY 77

Coulinuciifiotti pfage 13

Exhibit 8 Key Securities industry Drivers: Historical Growth Patterns

1985-92b I992E
NYSE Trading Value 14% 9% 15%
NYSE Retail Trading Value 11 13 17
NASDAQ Trading Value 21 21 27

Equity Ownership
Households 7% 7% 1%
Institutions 15 17 6

Nel Equity Purchases

Households 8% {24)% (74)%
[nstituhons lun 12 (24)

Listed Commissions
Investmont Banks 57.. 0% 3%
National Full-Line Firms 3 6 0
Regional Firms 2 3 01)
Discount BroWiTs 24 18 14
All Firms 4% 4% (2)%

OTC Trading Prolits

Investment Banks 3% 47o 53%
National Full-Line Firms 9 9 3
Regional Firms 4 11 20
All Firms 10% 8%

Industry Equity Revenues 5% 5% 0%

Margin Debt 8% 5% 24%

Credit Balances 13 10 4

Government Debt Trading

(CustunuT Tr.idi-^) 16% 7% 18%
Corporate Debt Trading na 18% 43%

Undenvriting Revenues
N.itK'iial I uil-1 me Firms
- Debl (3)% 47o
- Equities 11 17 44
All Firms
- Debt 37o 6% 25%
- Equities 8 16 12

Source: NYSE, SIA, Federal Reserve, and NASDAQ.

Retail margins have expanded; while in large measLire this is due,

of course, to the current boom, the 2% margins of 1989-90 are Lmlikely
to be repeated because of price increases put into effect in 1991, higher
fee revenues from evergreen products such as the RMA (similar to
Merrill's CMA accoLint) and the Wrap accounts, and a generally much
higher figure for total assets under custody. Though this figure can be
misleading as a measure of activity since the assets may indeed just sit,
it is a reasonable indication of potential trading activity. Also of poten-
tial benefit in case of a slowing in the equities business is lessened
dependence on equities, with the sales force more knowledgeable about

Retail Sales and Marketing: Key Indicators

1987 1990 1992E
RMA Accounts (000) 79 196 238
Wrap Accounts (S bil.) $\2 $4.2,
Client Assets Under Control ($ bil.) $42.0 74.0 107.0
11.7 16.2 22.0
Client Assets Under Control Per Broker ($ mil.)

1 Under company's new definition, this figure is 118.0.

Source: Bemstein estimates. ^^_

BERN5TE1N RESEARCH
16 Tiih CAI'HAL MARKGTS QUARTBRLY

mutunl funds and bonds. We believe trough margins in retail would

approximate 6%, with 107n the forecast for 1993. We estimate 11%
margins were recorded in 1992.
In distribution, the firm has clearly done a better job than its peers
of attracting and retaining producers (see Exhibit 10), registering 4%
growth in the broker census over the last five years versus flat to
negative growth elsewhere. This is probably due to the perception
among brokers of PaineWebber as a relatively pleasant place to work,
not least because of higher payouts than Merrill and some other firms
but also because of the relative lack of ttirmoil in the late '80s and 1990.

Exhibit 10 Registered Representative Count: Major Brokerage Firms (thousand)

CAGR
1987 1988 1989 1990 1991 1992 1987-1992
PaineWebber 4.2 4.4 4.5 4.6 4.7 5.1 5%
Share' 9.3% 10.0% 10.1% 10,6% 11.6% 12.07o 6
Merrill Lynch 11.7 12.0 11.7 11.7 11.6 11.8 0%
Sh.ire' 25.9% 27.1% 26.0% 17.T/» 28.57o 28.0% 1
Shearson 11.5 10.9 10.4 8.7 8.6 8.8 1%
Share' 25.5% 24.6% 23.17o 20.2% 21.1% 20.97o 2
Prudential 5.8 5.6 7.0 6.8 5.7 5.8 (8)%
Share' 12.97o 12,6% 15.6% 15.8% 14.07,. 13.87o (7)
Smith Barney 2,3 2.1 2.5 2.4 2.4 2.4 (1)%
Share' 5.1% 4.7% 5.6% 5.6% 5.8% 5.6% 0
Kidder Peabody 1.9 1.6 13 1.3 1.1 1.2 (4)%
Share 4.2% 3.6% 2.9% 3.0% 2.77o 2.8% (3)
Total — Major National Firms 45.1 44.3 44.9 43.0 40.6 42.1 (1)%
1 Denok's sh.irf ot Major National Firm Total (7 national full-service firms).
2 Includes f-l- Button.
Source: Corporate reports. Securities Industry Association, Bernstein estimates.

Clearly, the productivity increase (see Exliibit 11) has been driven
in large measure by the improving capital markets environment and
consequent trading demand; however, on average, the firm has retained
or acquired more experienced and successful representatives than it
has lost. In 1991, the average experienced broker joining the firm had
average production of $300,000, whereas the average departing broker
produced $108,000. Furthermore, the firm uses its fLxed-cost invest-
ment in the retail network more efficiently than before, but is still not
capacity-constrained in this regard and could add substantially more
sales people and volume without major new fixed investment. Capac-
ity utilization in retail (i.e., seats filled) hovered around 80% in 1988-
1991, and is only up to 86% as of the latter part of 1992.

BERNSTEIN RESEARCH
 Tilt- CAPITAL MAKKETS QUAHTEKLY 19

Exhibit 11 Retail Broker Productivity: Industry and Selected Firms

It 000)
$300 ,

aso

S200

SlOO

sso

so
1989
PaineWebb«(-12%

1 Percentages reflect compound annual growth rate from 1988-1992E

Source: Corporale reports and Bemstein estimates.

The thrust among many of the retail-oriented firms in recent years

has been to counteract cyclicality in the basic business with a steady
stream of money-management revenue. To measure success in this
endeavor, it is appropriate to examine both the absolute size and growth
of assets under management, and the same measure on a per-broker
basis. This analysis indicates that, while PaineWebber has had asset
growth only slightly below the industry average, the average per broker
has not kept pace with the industry per group (see Exhibits 12 and 13).
Nonetheless, as noted above, the growth in assets has driven substantial
improvement in the coverage of the firm's fixed costs by recurring fees,
the bulk of which are generated by revenues from mutual-fund man-
agement (see Exhibits 23 and 24; see also discussion oi Asset Manage-
ment business, below). Of course, the shortfall relative to peers can be
viewed as an opportunity and the firm is increasii^igly founded on
maxintizing recurring fees.

Exhibit 12 Proprietary Mutual-Fund Assets Under Management:

Major Brokerage Firms ($ billion)
CACR
1987 1988 1989 1990 1991 1992E 1987-1992E
PaineWebber $13 $14 $16 $18 $19 $21 10%
Merrill Lynch 66 65 82 86 100 112 11
Shearson 35 33 38 35 61 65 13
Prudential 17 23 29 29 37 40 19
Snfiith Bamey 4 4 6 6 17
Kidder Peabody 4 4 4 5 5
Total $170 $179 $215 S218 S275 $301 12%

1 Includes EF Hutton.
Source: Lipper Analytical Services, Investment Company Institute, and Bemstein estimates.

V BERNSTFIN RosEARCir
20 T i l l CAI'ITAI. MAHKETS QUARTERLY

Exhibit 13 Proprietary Mutual-Fund Assets Under Management Per Retail Broker:

Major Brokerage Firms ($ million)
CAGR
1987 1988 1989 1990 1991 1992E 1987-1992E
PaineWebber $3.1 $3.2 $3.5 $3.9 $4.1 $4.1 6%
Merrill Lynch 5.6 5.4 7.0 7.4 8.6 9.5 11
Shearsun 3.0 3.0 M 4.0 7.1 7.4 20
Prudential 2.9 4.1 4.1 4.2 6.5 7.0 19
Kidder Peabody 2.1 2.5 3.4 3.7 4.7 4.2 15
Smith liamey 1.7 1.9 2.2 2.6 3.3 3.6 16
Average $3.8 $4.0 $4.8 $5.1 $6.8 $7.2 147o
1 Includes EF Hutton.
Source: Lipper Analytical Services, Investment Company Institute, and corporate reports

It should be noted, however, tliat, for purposes of the line-of-busi-

ness accounting we present here, the mutual-fund management reve-
nues are included iii the Asset Management business line. Because of
this, retail eamings will continue to be relatively volatile, dependent
upon the swings in retail-investor interest; as indicated in our model
(see Exliibit 5), net revenues in 1993 could vary from the $1.5 billion or
so recorded in 1992 down to as low as $1.2 billion, with margins from
ir*/o or so down to 6%, for pretax earnings therefore possibly as low as
$70-$80 million versus 1992's approximately $165 million.

Asset Management — PaineWebber has three parts to its asset-management business: the
Growing The Mutual-Fund mutual-fund business discussed above; a business focused on high-
Business net-worth individuals (MHIA and PWAM); and an institutional money-
management division. The institutional component, known as Mitchell
Hutchins Institutional In\'estors (MHII) was acquired in early 1988 and
at that time had assets under management of $22 billion. It was known
then, however, that a large but not particularly profitable account of
the State of California would be withdrawn in stages over the next three
years; tliis drove MHII's assets down to $9.9 billion by December 1990.
Since that time, however, the assets managed have shown some growth
and "pruning" of less-profitable accounts has improved realizations.
MHIA has grown more rapidly (see Exhibit 14).

BERNSTEIN RESEARCH