The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success

by William N. Thorndike Jr.

CEOs need to do two things well to be successful: run their operations efficiently and deploy the cash generated by those operations.

Basically, CEOs have five essential choices for deploying capital—investing in existing operations, acquiring other businesses, issuing dividends, paying down debt, or repurchasing stock—and three alternatives for raising it—tapping internal cash flow, issuing debt, or raising equity.

Essentially, capital allocation is investment, and as a result all CEOs are both capital allocators and investors.

Graham and Dodd’s unorthodox investing strategy advocated buying companies that traded at material discounts to conservative assessments of their net asset values.

Doesn’t seem so unorthodox now

the discovery of a mysterious force, the corporate equivalent of teenage peer pressure, that impelled CEOs to imitate the actions of their peers. He dubbed this powerful force the institutional imperative and noted that it was nearly ubiquitous,

Each ran a highly decentralized organization; made at least one very large acquisition; developed unusual, cash flow–based metrics; and bought back a significant amount of stock. None paid meaningful dividends or provided Wall Street guidance. All received the same combination of derision, wonder, and skepticism from their peers and the business press. All also enjoyed eye-popping, credulity-straining performance over very long tenures (twenty-plus years on average).

When their stock was cheap, they bought it (often in large quantities), and when it was expensive, they used it to buy other companies or to raise inexpensive capital to fund future growth. If they couldn’t identify compelling projects, they were comfortable waiting, sometimes for very long periods of time

Under Murphy and his lieutenant, Dan Burke, Capital Cities rejected diversification and instead created an unusually streamlined conglomerate that focused laser-like on the media businesses it knew well. Murphy acquired more radio and TV stations, operated them superbly well, regularly repurchased his shares, and eventually acquired CBS’s rival broadcast network ABC.

focus on industries with attractive economic characteristics, selectively use leverage to buy occasional large properties, improve operations, pay down debt, and repeat.

Murphy’s approach to the roll-up was different. He moved slowly, developed real operational expertise, and focused on a small number of large acquisitions that he knew to be high-probability bets. Under Murphy, Capital Cities combined excellence in both operations and capital allocation to an unusual degree. As Murphy told me, “The business of business is a lot of little decisions every day mixed up with a few big decisions.”

During the extended bear market of the mid-1970s to early 1980s, Murphy became an aggressive purchaser of his own shares, eventually buying in close to 50 percent, most of it at single-digit price-to-earnings (P/E) multiples.

The core economic rationale for the deal was Murphy’s conviction that he could improve the margins for ABC’s TV stations from the low thirties up to Capital Cities’ industry-leading levels (50-plus percent).

In the nine years after the transaction, revenues and cash flows grew significantly in every major ABC business line, including the TV stations, the publishing assets, and ESPN. Even the network, which had been in last place at the time of the acquisition, was ranked number one in prime time ratings and was more profitable than either CBS or NBC.

There are two basic types of resources that any CEO needs to allocate: financial and human.

“Decentralization is the cornerstone of our philosophy. Our goal is to hire the best people we can and give them the responsibility and authority they need to perform their jobs. All decisions are made at the local level. . . . We expect our managers . . . to be forever cost conscious and to recognize and exploit sales potential.”

Headquarters staff was anorexic, and its primary purpose was to support the general managers of operating units.

They believed that the best defense against the revenue lumpiness inherent in advertising-supported businesses was a constant vigilance on costs, which became deeply embedded in the company’s culture.

“The system in place corrupts you with so much autonomy and authority that you can’t imagine leaving.”

Murphy and Burke actively avoided dilution from equity offerings. Other than the sale of stock to Berkshire Hathaway to help finance the ABC acquisition, the company did not issue new stock over the twenty years prior to the Disney sale, and over this period total shares outstanding shrank by 47 percent as a result of repeated repurchases.

When he saw something that he liked, however, Murphy was prepared to make a very large bet, and much of the value created during his nearly thirty-year tenure as CEO was the result of a handful of large acquisition decisions, each of which produced excellent long-terms returns.

Like others in this book, he relied on simple but powerful rules in evaluating transactions. For Murphy, that benchmark was a double-digit after-tax return over ten years without leverage.

He believed in “leaving something on the table” for the seller and said that in the best transactions, everyone came away happy. He would often ask the seller what they thought their property was worth, and if he thought their offer was fair he’d take it (as he did when Annenberg told him the Triangle stations were worth ten times pretax profits). If he thought their proposal was high, he would counter with his best price, and if the seller rejected his offer, Murphy would walk away.

When the company’s multiple was low relative to private market comparables, Murphy bought back stock. Over the years, Murphy devoted over $1.8 billion to buybacks, mostly at single-digit multiples of cash flow.

Murphy and Burke’s unique blend of operating and capital allocation skills created a “perpetual motion machine for returns.”

Conglomerates, companies with many, unrelated business units, were the Internet stocks of their day. Taking advantage of their stratospheric stock prices, they grew by voraciously and often indiscriminately acquiring businesses in a wide range of industries. These purchases initially brought higher profits, which led to still higher stock prices that were then used to buy more companies.

During this heady period, there was significantly less competition for acquisitions than today (private equity firms did not yet exist), and the price to buy control of an operating company (measured by its P/E ratio) was often materially less than the multiple the acquirer traded for in the stock market, providing a compelling logic for acquisitions.

In mid-1969, with the multiple on his stock falling and acquisition prices rising, he abruptly dismissed his acquisition team. Singleton, as a disciplined buyer, realized that with a lower P/E ratio, the currency of his stock was no longer attractive for acquisitions. From this point on, the company never made another material purchase and never issued another share of stock.

His top holdings were invariably companies he knew well (including smaller conglomerates like Curtiss-Wright and large energy and insurance companies like Texaco and Aetna), whose P/E ratios were at or near record lows at the time of his investment. As Charlie Munger said of Singleton’s investment approach, “Like Warren and me, he was comfortable with concentration and bought only a few things that he understood well.”

A dollar invested with Henry Singleton in 1963 would have been worth $180.94 by 1990, an almost ninefold outperformance versus his peers and a more than twelvefold outperformance versus the S&P 500, leaving Jack Welch a distant speck in his rearview mirror.

One of the most important decisions any CEO makes is how he spends his time—specifically, how much time he spends in three essential areas: management of operations, capital allocation, and investor relations.

with Teledyne’s P/E multiple near an all-time low, Singleton initiated the company’s largest tender yet, which was oversubscribed by threefold. Singleton decided to buy all the tendered shares (over 20 percent of shares outstanding), and given the company’s strong free cash flow and a recent drop in interest rates, financed the entire repurchase with fixed-rate debt.

As a result of this complex series of transactions, Teledyne successfully financed a large stock repurchase with inexpensive debt, the pension fund realized sizable tax-free gains on its bond purchase when interest rates subsequently fell, and, oh yes . . . the stock appreciated enormously (a ten-year compound return of over 40 percent).

In 1989, he met a senior General Dynamics executive at a trade association meeting, and when offered the chance to join the company as vice-chairman for a year and then move into the CEO slot, he leapt at the opportunity. He spent that interim period getting to know the company’s businesses and culture and studying, with the assistance of Bain & Company, the massive changes roiling the industry as the era of lofty defense spending came to a seemingly abrupt halt. This year of study enabled him to hit the ground running when he was formally named CEO.

His turnaround strategy for General Dynamics was rooted in a central strategic insight: the defense industry had significant excess capacity following the end of the Cold War. As a result, Anders believed industry players needed to move aggressively to either shrink their businesses or grow through acquisition.

There were two basic sources of this astonishing influx: a remarkable tightening of operations and the sale of businesses deemed noncore by Anders’s strategic framework.

While Mellor was wringing excess cash from the operations, Anders set out to divest noncore businesses and grow his largest business units through acquisition. Interestingly, as Anders met with his industry peers, he found that, as a group, they were more interested in buying than selling. He also found that they were often willing to pay premium prices. The result was a dramatic shrinking of the company through a series of highly accretive divestitures.

This single decision underscores a key point across the CEOs in this book: as a group, they were, at their core, rational and pragmatic, agnostic and clear-eyed. They did not have ideology.

“What drove me was the realization that the stock was trading at a significant premium to our historic norm: twenty-three times next year’s projected earnings versus an historic average of sixteen times. So what do you do with a high-priced stock? Use it to acquire a premium asset in a related field at a lower multiple and benefit from the arbitrage.”11 As Ray Lewis summarized, “Nick sold shares equaling one-third of the company to acquire a business that provided half of our consolidated operating cash flow.”

Prudent cable operators could successfully shelter their cash flow from taxes by using debt to build new systems and by aggressively depreciating the costs of construction. These substantial depreciation charges reduced taxable income as did the interest expense on the debt, with the result that well-run cable companies rarely showed net income, and as a result, rarely paid taxes, despite very healthy cash flows. If an operator then used debt to buy or build additional systems and depreciated the newly acquired assets, he could continue to shelter his cash flow indefinitely.

There is an apparent inverse correlation between the construction of elaborate new headquarters buildings and investor returns.

As a result of this frugality, TCI, for a long time, had the highest margins in the industry and gained a reputation with its investors and lenders as a company that consistently underpromised and overdelivered.

Malone, the engineer and optimizer, realized early on that the key to creating value in the cable television business was to maximize both financial leverage and leverage with suppliers, particularly programmers, and that the key to both kinds of leverage was size.

“The key to future profitability and success in the cable business will be the ability to control programming costs through the leverage of size.”

In a cable television system, the largest category of cost (40 percent of total operating expenses) is the fees paid to programmers (HBO, MTV, ESPN, etc.). Larger cable operators are able to negotiate lower programming costs per subscriber, and the more subscribers a cable company has, the lower its programming cost (and the higher its cash flow) per subscriber. These discounts continue to grow with size, providing powerful scale advantages for the largest players.

Terms and concepts such as EBITDA (earnings before interest, taxes, depreciation, and amortization) were first introduced into the business lexicon by Malone. EBITDA in particular was a radically new concept, going further up the income statement than anyone had gone before to arrive at a pure definition of the cash-generating ability of a business before interest payments, taxes, and depreciation or amortization charges.

The market for cable stocks remained volatile throughout the 1970s and into the early 1980s. Malone and Magness, concerned about the potential for a hostile takeover, took advantage of occasional market downturns to opportunistically repurchase stock, thereby increasing their combined stake.

Malone, however, unlike his peers, was uncomfortable with the extraordinary economic terms that municipalities were extracting from pliant cable operators, and alone among the larger cable companies, he refrained from these franchise wars, focusing instead on acquiring less expensive rural and suburban subscribers. By 1982, TCI was the largest company in the industry, with 2.5 million subscribers.

When many of the early urban franchises collapsed under a combination of too much debt and uneconomic terms, Malone stepped forward and acquired control at a fraction of the original cost. In this manner, the company gained control of the cable franchises for Pittsburgh, Chicago, Washington, St. Louis, and Buffalo.

In putting these partnerships together, Malone was in effect an extremely creative venture capitalist who actively sought young, talented entrepreneurs and provided them with access to TCI’s scale advantages (its subscribers and programming discounts) in return for minority stakes in their businesses. In this way, he generated enormous returns for his shareholders.

Malone was a pioneer in the use of spin-offs and tracking stocks, which he believed accomplished two important objectives: (1) increased transparency, allowing investors to value parts of the company that had previously been obscured by TCI’s byzantine structure, and (2) increased separation between TCI’s core cable business and other related interests (particularly programming) that might attract regulatory scrutiny.