The Outsiders


Thorndike profiles eight CEOs who he considers "outsiders" because of the way they make decisions and run their respective companies. The CEOs profiled were Tom Murphy of Capital Cities, Henry Singleton of Teledyne, Bill Anders of General Dynamics, John Malone of TCI, Katharine Graham of The Washington Post Co., Bill Stiritz of Ralston Purina, Dick Smith of General Cinema, and Warren Buffett of Berkshire Hathaway. 

The Rabbit Hole is written by Blas Moros. To support, sign up for the newsletter, become a patron, and/or join The Latticework. Original Design by Thilo Konzok.

Key Takeaways
  1. Most important metric to judge effectiveness of a CEO is the increase of per share value, not growth in sales or earnings
  2. CEOs need to do 2 things to be successful - run their operations efficiently and deploy the cash generated by those operations
  3. Even though the best CEOs came from varied backgrounds and situations, they all tended to:
    • Be iconoclasts - went against the common beliefs of the time
    • Believed capital allocation is a CEO's most important job
    • Increase in per share value is what counts in the long run, not overall growth or size
    • Cash flow, not reported earnings, is what determines long-term value
    • Decentralized organizations release entrepreneurial energy and keep both costs and unhappiness down
    • Independent thinking vital to long-term success and outside interaction with advisers should be minimized
    • Sometimes best investment opportunity is your own stock
    • Believed that with acquisitions, patience is a is occasional boldness\
    • Often frugal, humble, not overly charismatic, analytical and understated people who were devoted to their families
  4. Must study the unusually effective performers (anomalies) to learn from them and improve our own performance
  5. Best capital allocators are practical, opportunistic and flexible. They are not bound by ideology or strategy
  6. Avoiding stupid decisions as, if not more, important than making good decisions. On that same note, avoiding bad industries/businesses just as important as choosing good ones
  7. Provides an incredible checklist in the Epilogue - factors to consider before making a capital allocation decision
What I got out of it
  1. Although these 8 CEOs had varied backgrounds and education, they had many similarities. Namely, they always do the math (which is always straightforward but made with key and conservative assumptions), made strategic share repurchases, were independent thinkers, not concerned about the spotlight or pleasing Wall Street, very patient until the right opportunity appeared and then they pounced, were consistently rational, analytic and pragmatic, had a long-term perspective, and they all felt that their main advantage was not intellect but temperament. 
Preface: Singletonville
  • What matters is not the absolute rate of return but the return relative to peers and the market
  • Compound annual return to shareholders during their tenure, return over the same period for peer companies (make sure you use a broad universe) and for the broader market are extremely important indicators to judge a CEO's effectiveness
  • Context matters greatly - if entire economic environment doing great, it is much different to procure extraordinary returns during this time as opposed to a bear market
  • Henry Singleton - founder of Teledyne and one of the greatest CEOs ever
    • Aggressively repurchased his stock (owned at one point over 90%), avoided dividends and emphasized cash flow over reported earnings, decentralized organization and never split the company's stock
    • Known as the Sphinx for his reluctance to speak to journalists or analysts
    • Annual compounding rate of 20.4% over thirty years!
      • Outperformed his peers by nearly 10% and the overall index by 12x!
    • What set him apart was his skill in capital allocation - how to deploy the firm's resources to earn the best possible return for shareholders
    • CEOs need to do 2 things to be successful - run their operations efficiently and deploy the cash generated by those operations
      • 5 essential choices for deploying capital - investing in existing operations, acquiring other businesses, issuing dividends, paying down debt or repurchasing stock
      • 3 alternatives for raising it - tapping internal cash flow, issuing debt or raising equity
    • Even though the best CEOs came from varied backgrounds and situations, they all tended to:
      • Be iconoclasts - went against the common beliefs of the time
      • Believed capital allocation is a CEO's most important job
      • Increase in per share value is what counts in the long run, not overall growth or size
      • Cash flow, not reported earnings, is what determines long-term value
      • Decentralized organizations release entrepreneurial energy and keep both costs and unhappiness down
      • Independent thinking vital to long-term success and outside interaction with advisers should be minimized
      • Sometimes best investment opportunity is your own stoc
      • Believed that with acquisitions, patience is a is occasional boldness
      • Often frugal, humble, not overly charismatic, analytical and understated people who were devoted to their families
    • The 8 "Outsider" CEOs outperformed the S&P by over 25x and their peers by over 7x
Introduction - An Intelligent Iconoclasm
  • "It is impossible to produce superior performance unless you do something different. - John Templeton
  • The 8 CEOs detailed were not the action-oriented, rock star CEOs that you tend to think of or see on business magazines. Only 2 had MBAs, had very little prior management experience, disdained corporate perks, rarely communicated with Wall Street and avoided the spotlight
  • In the fox (broad set of skills) vs. hedgehog (specialized skill set), these CEOs were foxes
  • "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)."
  • "...exceptional relative performance demands new thinking, and at the center of the world view shared by these CEOs was a commitment to rational thinking, to analyzing the data and to thinking for themselves."
  • Growth often does not correlate with maximizing shareholder value
Chapter 1 - A Perpetual Motion Machine for Returns: Tom Murphy and Capital Cities Broadcasting
  • Cap Cities outshown CBS due to less diversification, creating a streamlined conglomerate that had a laser-like focus on what it knew well, avoiding excess costs, repurchasing shares
  • Focus on industries that have attractive economic characteristics, selectively use leverage to buy occasional large properties, improve operations, pay down debt, and repeat
  • Make small, everyday decisions good and occasionally large ones and that is a good recipe for success
  • Bought ABC for $3.5B which was the largest non oil and gas transaction in business history and an enormous risk for Cap Cities at that point. The acquisition represented more than 100% of Cap Cities enterprise value
    • Murphy thought he could improve ABC's margins from the low 30's to Cap Cities' 50%+
    • Implemented their lean, decentralized approach and in less than 2 years brought ABC's margins in line with Cap Cities
      • Massive layoffs, consolidated offices and sold unnecessary real estate
    • Soon ABC was the most profitable network
  • Murphy and Burke achieved a 19.9% IRR over 29 years, outdoing the 10.1% of the S&P and the 13.2% of leading media companies over the same time period
  • 2 major allocation jobs for CEO - financial and human
  • Decentralization and autonomy for operating managers was key for Cap Cities. Hire the best people and leave them alone
  • "Murphy delegates to the point of anarchy." - Dan Burke
  • Frugality, keeping headcount low, attention to margins, and improving overall business (getting best news talent and technology) other tenets
  • In hiring process, clearly preferred intelligence, ability and drive over direct industry experience
  • Had extremely low turnover - "The system in place [at Cap Cities] corrupts you with so much autonomy and authority that you can't imagine leaving." - Frank Smith
  • Although 2/3 of acquisitions actually destroy value, Murphy and Burke had such conviction due to Cap Cities operating and integration expertise
  • Worked extremely hard to become the preferred buyer by treating employees fairly and running properties that were consistent leaders in their markets
  • Very strict acquisition rules - double digit after-tax return over 10 years without leverage
  • Transdigm implemented many of these same tenets but in the aviation industry - the parts they provided and serviced are crucial so customers look at performance over price
Chapter 2 - An Unconventional Conglomerateur: Henry Singleton and Teledyne
  • In a time when dividends were all the rage, Singleton ignored the noise as he believed they were inefficient because they were taxed twice
  • Also, ran a very decentralized business, avoided Wall Street analysts, didn't split his stock and repurchased shares as nobody ever has, before or since
  • Never got an MBA but got his bachelor's, master's and phD in electrical engineering from MIT
  • Founded Teledyne in 1960 just as conglomerates (companies with many, unrelated businesses) were becoming vogue. Conglomerates would crash in the lase 60s
    • But, Singleton took advantage of the amazingly high stock prices and P/E ratios of conglomerates and bought 130 companies in 8 years, from aviation electronics to specialty metals and insurance
    • But, his focus on profitable, growing companies in niche markets instead of turnarounds made him successful
    • Very disciplined buyer, never buying more than 12x earnings and purchasing most companies at much lower multiples (all but 2 he bought with Teledyne stock)
  • After acquiring Vasco Metals and promoting George Roberts (his old roommate) he removed himself from operations to focus on strategic and capital allocation issues and stopped acquiring businesses as conglomerate P/Es were decreasing.
    • Dismissed acquisition team and never made another material purchase or issued another share of stock
    • Strategy hard to question - EPS grew 64x in 10 years while shares outstanding grew less than 14x
  • Teledyne return - average cash flow and net income for each business unit - emphasized cash generation and was the basis for bonuses for all business unit managers
    • Wanted to maximize cash flow, not reported earnings which is what Wall Street eats up. Very unusual for a Fortune 500 CEO
  • In 1972, Singleton believed his stock was the best place to allocate money and started repurchasing shares at rates never before seen. This was controversial and at this scale unseen in history. Over 12 years, bought back 90% of Teledyne's outstanding shares. Lead to a 40-fold increase in EPS
  • Invested insurance assets in high concentrations, with equity allocation ranging from 10 to 77%
  • In 1986, began spinning off parts of the company and soon after declared a dividend
  • Over 27 years, delivered a 20.4% compound annual returns, compared to 8% of S&P and 11.6% for other major conglomerates
  • Management's use of time in operations, capital allocation and investor relations is vital
    • Singleton not rigid with his time, preferring to have a flexible schedule so he can take care of whatever is in the best interest of the company at any given time
    • Did not court Wall Street or spend much time worrying about investor relations
  • Buffett and Singleton similarities - CEO as investor, decentralized operations but centralized investment decisions, focused investments in industries they understood, no courting of Wall Street, few/no dividends, no stock splits, significant insider ownership, insurance subsidiaries, attracted like-minded clients and employees
Chapter 3 - The Turnaround: Bill Anders and General Dynamics
  • Fall of Berlin Wall forced defense-industry companies to redefine themselves
  • Bill Anders took over as CEO of General Dynamics who was in terrible shape when he first came in. Anders was an astronaut before joining GD and took the Earthrise photo
    • Believed that due to excess capacity of defense industry companies, either needed to consolidate or be acquired
    • Believed that GD should only be in businesses where it had the top or second spot in the market, exit commodity businesses where returns were unsatisfactory, stick to businesses it knew well. Exit everything else
    • Changed GD culture from engineering and fully tech focused to shareholder friendly
    • Also needed to revamp the operations team and replaced 21/25 top executives
    • 2 phases during his tenure - generation of cash and its deployment
    • Reduced headcount by 60% and corporate staff by 80%
    • Competitors at that time wanted to buy so GD sold off a lot of noncore businesses at premium prices
    • Most CEOs in this book avoided detailed strategic plans, preferring to stay flexible and opportunistic (Antifragile!). These CEOs were always "rational and pragmatic, agnostic and clear-eyed. They did not have ideology"
      • He sold off the F-16 business, his favorite by far, because he was offered such an attractive price. Left with 2 business units with top market positions - tanks and submarines
    • After selling off businesses, turned to returning money to shareholders - special dividends and repurchases (30% of shares outstanding). Both of these were virtually unheard of at the time
      • "Most CEOs grade themselves on size and growth...very few really focus on shareholder returns." - Anders
    • Believed in the naval succession model in which retiring captains avoid returning to their ships so as not to interfere with their successor's authority
    • It's important to acknowledge the more general point that circumstances vary and it's how you play the hand you're dealt that ultimately determines your success as an executive
  • Achieved 23.3% compound annual returns over 17 years, 8.9% S&P and 17.6% for company peers
  • Focused on decentralizing the organization and aligning management compensation with shareholders' interests
  • Chabraja, a later CEO of GD, made a risky but strategic acquisition of Gulfstream jets - helped with the cyclicality found in the defense industry
  • Best capital allocators are practical, opportunistic and flexible. They are not bound by ideology or strategy
Chapter 4 - Value Creation in a Fast-Moving Stream: John Malone and TCI
  • Malone immediately recognized the benefits of the cable industry - predictability and tax efficiencies.
    • Good cable companies rarely show Net Income and therefore pay little, if any taxes, despite healthy cash flows since they can use debt  to build new systems and depreciating the costs of construction
  • TCI's headquarters did not look like the HQ of the largest company in an industry that was redefining the American media landscape. The company's offices were spartan, with few executives at corporate, fewer secretaries and peeling metal desks on Formica floors
    • Beware of companies that build expensive and lavish HQ's as this is often a misalignment of management and shareholder priorities
  • Came to the conclusion that size was of utmost importance as this helped with programming costs and increase cash flow
    • Over a 16 year period, made 482 acquisitions - on average, one every other week
    • By 1987, it was twice the size of its next largest competitor, Time Inc.'s ATC
    • Also provided funding for cable programs such as BET, Starz, Encore and Turner channels (CNN and Cartoon Network)
  • Focus on cash flow as opposed to EPS was very unconventional and he popularized EBITDA
  • Would later focus on telephone services and cellular franchises
  • Used spin-offs to his advantage and spun off TCI's minority interests into a new entity, Liberty Media
    • Spin-offs include Teleport (sold to AT&T for $11B - a 28x ROI), Sprint and General Instrument. Helped make the different TCI businesses transparent to shareholders
  • Got funding from 3 sources - debt (great for tax efficiencies), issuing equity (sparingly) and selling assets (opportunistically and only if it came with tax advantages)
    • Never paid out dividends and rarely paid down debt (although leverage was substantial for tax reasons), cheap with capex, aggressive with acquisitions and opportunistic with stock repurchases
  • Often find that the most technically savvy CEOs typically are some of the last to implement new technology, preferring the role of technological "settler" as opposed to "pioneer."
  • Actively used joint ventures and created great returns. Added layers of complexity but was worth it
  • Created 30.3% annual compound return over 15 years, compared to 20.4% for public cable companies and 14.3% for S&P
    • $1 turned to over $900 vs $180 in other public cable companies and $22 in the S&P
  • Eventually was acquired by AT&T
Chapter 5 - The Widow Takes the Helm: Katharine Graham and the Washington Post Company
  • Katherine Graham came into CEO position after husband who was the CEO committed suicide
  • Over 22 years, she returned 22.3% per year vs. 7.4% for the S&P and 12.4% of her peers
  • Owned the Post, Newsweek and 3 TV stations in FL and TX when Katherine took over
  • Won 18 Pulitzer Prizes during her tenure
  • Took Buffett on as a board member and mentor. She excellently handled a strike, only missing 1 day and printing 139 consecutive days with only a skeleton crew
  • Aggressively repurchased shares, nearly 40% of outstanding shares
    • Closing of Washington Star, their closest competitor, left them with a lot of room to grow
  • Strict rule around acquisitions - 11% cash return without leverage over a 10 year period
    • Led to fewer deals but "the deals not done were very important."
    • Most acquisitions under Graham would be in businesses outside of print/broadcasting
  • Amazing at recruiting top talent to the company and to the board
  • Buffett in the 1970s acquired a lot of WPO stock and instead of being afraid of him like her board, she welcomed him and gave him a seat on the board. Recognizing his genius at a time when he was basically unknown, was one of her best decisions
Chapter 6 - A Public LBO: Bill Stiritz and Ralston Purina
  • Bill Stiritz was not even the leading internal candidate but submitted a memo with his strategy if he were to become CEO - days later he got the job
  • Quickly divested businesses that did not meet his criteria for profitability and high returns
    • Purina owned random things like Jack in the Box fast food, the St. Louis Blues hockey team, etc.
    • Bought 2 large companies - Continental Baking (twinkies and wonder bread) and the Energizer Battery division from Carbide
    • Batteries and pet food brands became Purina's main cash cows
    • Used a lot of debt in his purchases but used it wisely through share repurchases (60% of shares outstanding) and acquisitions
      • If the potential acquisition didn't beat the return they thought they could get through repurchasing, they wouldn't do it
    • With acquisitions, tried to do it by direct contact with the seller and avoided auctions
      • Would use basic, key assumptions when deciding how much to bid - no massive, technical models or anything like that
  • Over 19 years, had returns of 20% compared to 17.7% of his peers and 14.7% of the S&P
  • Believed that "leadership is analysis" as without this critical component you have to rely on others, like bankers
  • Was a fox-like sponge when it came to new thinking/ideas, regardless of its source
Chapter 7 - Optimizing the Family Firm: Dick Smith and General Cinema
  • Dick Smith took over as CEO from his dad after he passed away. He was 37 years old when he became of these movie theater and drive-in franchises
  • Outside of movie theaters, ventured into shopping mall theaters, American Beverage (largest, independent Pepsi bottler), retailing (Carter Hawley - Neiman Marcus was part of this group) and publishing (Harcourt Brace Jovanovich) Going into such diversified business is very risky and there are more failures than successes but Smith was able to time the acquisitions well and was very analytical and patient in doing so
    • After ABC, realized the potential of these franchises and started buying more throughout the US
  • Was the first to lease the land the theater was on instead of buying it (lower up front investment) and added more screens per theater to attract larger audiences and buy more high margin snacks and food
  • Started looking into different businesses in the late 60's when he realized movie theater growth was limited
  • Investment with involvement - smaller investments into public companies where he could take a board seat and help improve operations
  • In the late 80's, as Coke was making big moves, he sold his bottling franchises back to Pepsi for over $1B cash and used that money to buy HBJ - an educational and scientific publisher. Bought it for $1.5B, equal to 60% of General Cinema's EV
  • Over 43 years, Smith achieved 16.1% annual returns, compared to 9.8% of his peers and 9% of the S&P
Chapter 8 - The Investor as CEO: Warren Buffett and Berkshire Hathaway
  • Made a radical shift in his investment beliefs going from the traditional Ben Graham thinking to focusing more on companies that had strong franchises/competitive barriers (moats), along with having a margin of safety
  • Insurance is the backbone of Berkshire's growth. Buffett uses the float (money held but not owned) produced by these insurers and invests them at great returns
  • Buffett believes the key trait for long-term success is temperament - willingness to be "greedy when others are fearful"
  • Operations highly decentralized but capital allocation decisions extremely centralized
  • Buffett has never issued a dividend or issued significant amounts of stock
  • Avoiding stupid decisions as, if not more, important than making good decisions. On that same note, avoiding bad industries/businesses just as important as choosing good ones
  • Portfolio management - how many, and how long, an investor holds his stocks
    • Buffett has differed in that he has had a very concentrated portfolio and a very long holding period
      • Top 5 investments typically hold between 60-80% of the total value
  • However, Buffett hasn't repurchased significant amounts of his own stock
  • Buffett has created a niche for owners who need liquidity but don't want to have to IPO and deal with Wall Street
    • Can often give owners an answer in 5 minutes or less if they approach him
  • With acquisitions, does very quick due diligence, never visits operating facilities and rarely meets with management. Never participates in auctions
  • Designed Berkshire so that he could spend the maximum amount of time on capital allocation (where he feels nobody can beat what he does, and he's probably right) versus meddling with management (where he feels he can add little value)
    • Hire well, manage little
  • His calendar is mostly unscheduled and spends the vast majority of his time reading and thinking - not in meetings or traveling. He does not have a computer in his office and has never had a stock ticker. Reads countless annual reports per day as well as 5+ newspapers
  • How Buffett thinks goes beyond an investment strategy, it is a worldview. He emphasizes long-term relationships with excellent people and avoids turnover at all costs.
  • Over a 45 year period, achieved 20.7% compound annual returns vs 9.3% of the S&P
Chapter 9 - Radical Rationality: The Outsider's Mindset
  • Always do the math
    • The Outsider CEO always started out by asking what the return was. Usually only requires elementary arithmetic, but these CEOs did it consistently, used conservative assumptions and only went forward if the investment surpassed their hurdle
  • The denominator matters
    • Made strategic share repurchases
  • A feisty independence
    • Master delegators but not of capital allocation
    • Independent thinking and limited interaction with outside advisers/Wall Street
  • Charisma is overrated
    • Unpromotional CEOs, no guidance for Wall Street, did not seek the spotlight
  • A crocodile-like temperament that mixes patience...
    • Avoided overpriced acquisitions
  • ...with occasional boldness
    • But, when the right opportunity arouse, they pounced
  • The consistent application of a rational, analytical approach to decisions large and small
  • Allowed them to sift through the noise and come to their own conclusions
  • A long-term perspective
  • Many other very similar tactics - disdained dividends, made disciplined (occasionally large) acquisitions, used leverage selectively, bought back a lot of stock, minimized taxes, ran decentralized organizations and focused on cash flow over reported net income
  • What matters is how you play the hand you're dealt. The key is optimizing within given circumstances
  • Their advantage compared to peers was not intellect but temperament
Epilogue: An Example and a Checklist
  • Checklist
    1. Allocation process should be CEO-led, not delegated to finance or business development personnel
    2. Start by determining the hurdle rate, the minimum acceptable return for investment projects
      • This is one of the most important decisions any CEO makes
      • Should be made in reference to the set of opportunities available to the company and should generally exceed the blended cost of equity and debt capital (mid teens or higher usually)
    3. Calculate returns for all internal and external investment alternatives and rank them by return and risk. Use conservative assumptions and calculations do not need to be perfectly precise
    4. Calculate the return for stock repurchases. Require that acquisition returns meaningfully exceed this benchmark
    5. Focus on after-tax returns and run all transactions by a tax counsel
    6. Determine acceptable, conservative cash and debt levels and run the company to stay within them
    7. Consider a decentralized organizational model. Ratio of people at HQ to total employees?
    8. Retain capital in the business only if you have confidence you can generate returns over time that are above your hurdle rate
    9. If you do not have potential high-return investment projects, consider paying a dividend. Be cautious - difficult to reverse and are tax inefficient
    10. When prices are extremely high, consider selling businesses or stock and close under performing business units if no longer capable of generating acceptable returns

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