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December 15, 2023 - February 10, 2024
Malone, ever watchful of unnecessary taxes, structured the transaction as a stock deal, allowing his investors to defer capital gains taxes.
Malone pioneered the active use of debt in the cable industry. He believed financial leverage had two important attributes: it magnified financial returns, and it helped shelter TCI’s cash flow from taxes through the deductibility of interest payments. Malone targeted a ratio of five times debt to EBITDA and maintained it throughout most of the 1980s and 1990s.
“It makes sense to maybe sell off some of our systems . . . at 10 times cash flow to buy back our stock at 7 times.”
“TCI hardly ever disposed of an asset unless there was a tax angle to it.”
In deciding how to deploy TCI’s capital, Malone made choices that were starkly different from those of his peers. He never paid dividends (or even considered them) and rarely paid down debt. He was parsimonious with capital expenditures, aggressive in regard to acquisitions, and opportunistic with stock repurchases.
“We lost no major ground by waiting to invest. Unfortunately, pioneers in cable technology often have arrows in their backs.”
He was also, however, a value buyer, and he quickly developed a simple rule that became the cornerstone of the company’s acquisition program: only purchase companies if the price translated into a maximum multiple of five times cash flow after the easily quantifiable benefits from programming discounts and overhead elimination had been realized.
What mattered was the quality of the assumptions and the ability to achieve the expected synergies, and Malone and Sparkman trained their operations teams to be highly efficient in eliminating unnecessary costs from new acquisitions.
“We are evaluating all alternatives in order to buy our equity at current prices to arbitrage the differential between its current multiple and the private market value.”
Malone realized early on that he could leverage the company’s scale into equity interests in programmers and other cable companies, and that these interests could add significant value for shareholders, with very little incremental investment. At the time of the sale to AT&T, the company had forty-one separate partnership interests, and much of TCI’s long-term return is attributable to these cable and noncable joint ventures.
no one else in the industry used joint ventures to increase system ownership, and only later did other MSOs begin to seek ownership stakes in programmers.
Malone created a model for savvy capital allocation in rapidly growing, capital-intensive businesses that has been followed by executives in industries as diverse as cellular telephony, records management, and communications towers.
For mathematicians, insights often come when variables are taken to extremes, and Malone was no exception.
During the recession of the early 1990s, when her overleveraged peers were forced to the sidelines, the company became uncharacteristically acquisitive, taking advantage of dramatically lower prices to opportunistically purchase cable television systems, underperforming TV stations, and a few education businesses.
Graham raised significant debt only a few times during her tenure, most notably to finance the 1986 purchase of the Capital Cities cable systems. The Post’s strong cash flow, however, allowed the bulk of this debt load to be paid down in less than three years.
Throughout her tenure, she maintained a minimal level of dividends, believing them to be tax inefficient. Again, it’s worth emphasizing the contrarian nature of this approach particularly in the newspaper industry, where founding families, some of whose members typically depended on the dividend income, usually had a high degree of ownership. The Post, under Graham, consistently paid the lowest level of dividends among its peer group and thus had the highest retained earnings.
The key question was, ‘Where’s the next dollar best applied?’ And the company was rigorous and skeptical in answering that question.”
Graham, alone among major newspaper CEOs, held back, eventually becoming the last major publisher to rely on old-fashioned letterpress printing, deferring the expensive investment in a new plant until costs had dropped and the benefits had been definitively proven out by peers.
Last mover advantage
Graham’s approach to acquisitions was characterized by the twin themes of patience and diversification.
With an exceptionally strong balance sheet, she became an active buyer at a time when her overleveraged peers were forced to the sidelines. Taking advantage of dramatically reduced prices, the Post opportunistically purchased a series of rural cable systems, several underperforming television stations in Texas, and a number of education businesses, all of which proved to be extremely accretive to shareholders.
“The Post Company is one of the most decentralized businesses in the country.”
Fortunately, she was also strong willed, independent, and comfortable making controversial, unconventional decisions whether they involved refusing the demands of recalcitrant strikers, not buckling under to repeated threats from the Nixon administration, or ignoring other newspaper executives when they questioned her obsession with buying her own stock and her timidity in making acquisitions.
adhering to the tenets of his mother’s approach: making selected acquisitions, aggressively and opportunistically repurchasing stock (including 20 percent of shares outstanding between 2009 and 2011), and keeping dividend levels relatively low.
In contrast, over the same period, the other well-known, publicly traded, family-owned Northeastern newspaper company—the Sulzbergers’ New York Times Company—overpaid for an Internet portal (Ask.com), built an elaborate new corporate headquarters building in midtown Manhattan . . . and lost almost 90 percent of its value.
Most of them had followed fashion and actively diversified during the 1960s and 1970s in the quixotic pursuit of synergy, and many had ended up in restaurant and agricultural businesses in search of the elusive benefits of “vertical integration.”
He immediately began to remove the underpinnings of his predecessor’s strategy, and his first moves involved actively divesting businesses that did not meet his criteria for profitability and returns.
Stiritz proceeded to sell other noncore businesses, including the company’s soybean operations and miscellaneous restaurant and food service operations, leaving Ralston as a pure branded products company. In this regard, he was not unlike Warren Buffett in the early days at Berkshire Hathaway, extracting capital from the low-return textile business to deploy in much higher-return insurance and media businesses.
As he had at Continental, Stiritz moved immediately to improve Energizer’s products and marketing (including the creation of the famous ad campaign featuring the eponymous bunny), enhance distribution, and eliminate excess costs.
Throughout the 1990s, Stiritz focused on continued opportunistic stock buybacks, occasional acquisitions, and, significantly, the use of a relatively new structuring device, the spin-off, to rationalize Ralston’s brand portfolio.
In a spin-off, a business unit is transferred from the parent company into a new corporate entity. Shareholders in the parent company are given equivalent pro rata ownership in the new company and can make their own decisions about whether to hold or sell these shares. Importantly, spin-offs highlight the value of smaller business units, allow for better alignment of management incentives, and, critically, defer capital gains taxes.
This series of moves left Ralston at the dawn of the new millennium as a pure play pet food company, the dominant player by far in the US market. It did not escape Stiritz’s attention that pruning unrelated businesses might make the company’s core pet food brands more attractive to a strategic acquirer, and in 2001 the company was approached by Nestlé. After extensive negotiations (which Stiritz characteristically handled himself), the Swiss giant agreed to pay a record price for Ralston: $10.4 billion, equal to an extraordinary multiple of fourteen times cash flow.
“Effective capital allocation . . . requires a certain temperament. To be successful you have to think like an investor, dispassionately and probabilistically, with a certain coolness.
Stiritz, however, saw that the prudent use of leverage could enhance shareholders’ returns significantly. He believed that businesses with predictable cash flows should employ debt to enhance shareholder returns, and he made active use of leverage to finance stock repurchases and acquisitions, including his two largest, Energizer and Continental. Ralston consistently maintained an industry-high average debt–to–cash flow ratio during his tenure,
While Stiritz acknowledges today that the price was very attractive, he regrets not taking stock, given the strength of Nestlé’s business and the capital gains tax incurred by his shareholders.
Outside of the steady, year-in, year-out pattern of debt service, internal capital expenditures, and (minimal) dividends, Stiritz’s two primary uses of cash were share repurchases and acquisitions.
Stiritz believed buyback returns represented a handy benchmark for other internal capital investment decisions, particularly acquisitions. As his longtime lieutenant, Pat Mulcahy, said, “The hurdle we always used for investment decisions was the share repurchase return. If an acquisition, with some certainty, could beat that return, it was worth doing.”3 Conversely, if a potential acquisition’s returns didn’t meaningfully exceed the buyback return, Stiritz passed.
Stiritz focused on sourcing acquisitions through direct contact with sellers, avoiding competitive auctions whenever possible.
Stiritz believed that Ralston should only pursue opportunities that presented compelling returns under conservative assumptions, and he disdained the false precision of detailed financial models, focusing instead on a handful of key variables: market growth, competition, potential operating improvements, and, always, cash generation. As he told me, “I really only cared about the key assumptions going into the model. First, I wanted to know about the underlying trends in the market: its growth and competitive dynamics.”
He made a point of using different bankers for various transactions so that none felt overly secure about his business.
The business world is strewn with the wreckage of companies that tried unsuccessfully to purchase businesses outside of their industry. Such diversifying acquisitions are notoriously difficult to execute (think Time Warner and AOL),
His second innovation was to add more screens per theater to attract larger audiences and to optimize high-margin concession sales. As a result of these dual innovations, General Cinema enjoyed exceptional returns on its investments in new theaters
As time went on, Smith’s approach to acquisitions evolved. From the early 1980s on, Smith and his team focused on the occasional, large opportunistic acquisition and on a series of minority investments in public companies that he believed to be undervalued. These investments were attempts at diversification through a strategy of what Smith termed investment with involvement, the idea being to make a sizable minority investment, take a seat on the board, and work with management to improve operations and increase value.
“He gave me permission to publicly disagree with him in front of the Board. Very few CEOs would have done that.”
Smith’s capital allocation record was excellent. The three primary sources of cash during Smith’s long tenure were operating cash flow, long-term debt, and proceeds from the occasional large asset sale.
The company did, however, make strategic use of debt to fund acquisitions. Its two largest purchases, Carter Hawley Hale and Harcourt Brace Jovanovich, were entirely debt financed. As a result, from the mid-1980s on, the company consistently maintained debt-to-cash flow ratios of at least three times, leveraging equity returns and helping minimize taxes.
when he saw a combination of dimming growth prospects and high valuations, he moved aggressively to sell, even if it meant substantially shrinking his company.
General Cinema maintained a disciplined approach to capital expenditures, with all capital requests requiring attractive cash returns on invested capital. The company’s early suburban theaters generated exceptional returns, and the beverage division also had attractive internal investment options. General Cinema’s other businesses were held to these high standards.
Although the retail business was more capital intensive than General Cinema’s other businesses, Smith saw in Neiman Marcus a unique brand that had been poorly run by its prior owners. Smith was willing to make the occasional large investment to open new Neiman stores because he believed that demonstrating growth potential would allow the company to realize a premium price on exit (in its twenty years of ownership, General Cinema opened just twelve stores; the new buyer would plan to open many times that number). This logic was amply justified by Neiman’s stratospheric exit price.
You shape your houses and then your houses shape you. —Winston Churchill The most powerful force in the universe is compound interest. —Albert Einstein Being a CEO has made me a better investor, and vice versa. —Warren Buffett
Fear of inflation was a constant theme in Berkshire’s annual reports throughout the 1970s and into the early 1980s.
