Book: The Outsiders: Eight Unconventional CEOs & Their Radically Rational Blueprint For Success | Author: William Thorndike
Sponsors: Josh Harris, Katy Hoffman, Glenn Hutchins, William Macaulay, Tom Meurer, Scott Soler, Scott Wallace
Brief Author: Vivek Singh (email@example.com)
If shareholder returns are the ultimate measure of chief executive success, eight CEOs are in a class of their own, with their companies outperforming the S&P by more than twenty times and their peers by over seven times. Investment manager William Thorndike, along with a group of Harvard MBA students, dug deep into the weeds to find these iconoclastic CEOs for The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success. Although their companies spanned industry and time horizons throughout the last 50 years, Thorndike’s research uncovered striking similarities between the approaches of these CEOs.
The wisdom of The Outsiders suggests a new approach to the role of the chief executive, with less emphasis on charismatic leadership and more on careful deployment of firm resources. All of the individuals listed avoided the “institutional imperative,” coined by Warren Buffett, as a nearly ubiquitous phenomenon impelling CEO’s to imitate the actions of their peers. Each also ran a highly decentralized organization, developed unusual cash flow based metrics, and made use of significant share repurchases. They were deeply independent, avoiding Wall Street and outside advisors, focusing on developing a culture for independent thinkers to contribute and thrive.
The business leaders profiled as The Outsiders and their respective companies are as follows: Tom Murphy (Capital Cities Broadcasting), Henry Singleton (Teledyne), Bill Anders (General Dynamics), John Malone (TCI), Katherine Graham (Washington Post Company), Bill Stiritz (Ralston Purina), Dick Smith (General Cinema), and Warren Buffett (Berkshire Hathaway). As a group, these eight CEOs outperformed the S&P 500 by an average of over twenty times and their peers by seven times. They shared old-fashioned values of frugality, humility, independence, and were iconoclasts.
The first deviant decision made by The Outsiders was to embrace capital allocation as the main role of CEO. While CEO’s are traditionally celebrated for their operational excellence and charisma with investors and the media, these CEO’s realized the importance of deciding how to use the money their companies created to beget more money. The Outsiders prided themselves on a focus on the shareholder, and spent most of their waking day focused on answering this question of capital allocation, generally eschewing the media and investor relations.
Although The Outsiders fundamentally ignored the media and Wall Street, operational excellence was still considered a company priority despite their personal decisions to focus on capital allocation as CEO. In fact, each of The Outsiders required operational excellence, as it directly affected the amount of cash they would be able to allocate in their main role. Thus, each of the CEO’s relied heavily on strong management teams (typically COOs, or a like position) who they could trust to create a culture of efficiency in existing operations and potentially, in companies which were acquired. This CEO admittance of reliance was an innately humble trait of all these CEOs, who recognized their subordinate’s ability to do their jobs, and trickled down to make The Outsider companies some of the most decentralized in history.
Within the capital allocation process, the shareholder focus continued as The Outsiders looked for innovative ways to maximize returns for shareholders. One highly unpopular method in public perception, shares repurchases, was utilized by seven of eight Outsiders to an exorbitant degree, from anywhere from 40% - 60% of all total shares outstanding. Although more common in today’s business world, share repurchases were then considered counterintuitive, as most executives looked to avoid shrinking their company. However, The Outsiders relished the opportunity and proactively shrunk themselves when they could buy shares in the open market at prices that they thought were low. This served a double purpose of increasing per share value for the remaining investors and paying larger real returns to their selling investors, at a lower tax rate.
Each of these CEO’s made use of their own financial metrics, which were independently created based on things considered most important, generally focused around available cash (and never the Wall Street darling, EPS). Through EBITDA for John Malone, Cash Earnings for Dick Smith, or Insurance Float for Warren Buffett, The Outsiders got an understanding of their financial situation in a meaningful manner to better consider potential acquisitions. These metrics, along with regular back of the envelope return calculations, helped The Outsiders wait long periods of time in between acquisitions in diligent search for a company which fit well with the metrics provided, and at the right price.
Pat Mulcahy, lieutenant of operations at Outsider Company Ralston Purina said, “We knew what we needed to focus on. Simple as that.” When acquisitions were considered, The Outsiders were excellent at removing ego from the equation and using surgeon-like discipline in vetting through possible targets. Continuing the doctor analogy, the executives in this book erred on the side of caution, viewing acquisitions through avoidance of value-destruction (not killing the patient) first and foremost. This discipline led to typically small value-accretive acquisitions, which steadily compounded upon each other. Eventually, each one made a large well-calculated acquisition that equaled 25% or more of their firm’s enterprise value.
Lastly, Thorndike used a classic comparison of the “fox” and the “hedgehog” to define these CEOs, reproduced from Isaiah Berlin’s famous essay about Leo Tolstoy. The “fox” knows many things, and the “hedgehog” knows one thing, but exceptionally well. Although the traditional CEO is a hedgehog, all of The Outsiders were definitive “foxes”, who used familiarity with different industries to adapt innovative solutions cross functionally. In this brief, I will tell the unique stories of the eight companies of The Outsiders, with attention to detail paid to their backgrounds, and the overlap of their unconventional, yet value-creating decisions.
CLASSIC BRIEF BY: Vivek Singh
Scott Nuttall, KKR | Ron O'Hanley, Fidelity | Alan Dorsey, Neuberger Berman | George Walker, Neuberger Berman | Scott Wallace, Wallace Capital | Christopher Moss, Advanced Financial Group
Tom Murphy (Capital Cities Broadcasting):
“The business of business is a lot of little decisions every day mixed up with a few big decisions.” - Tom Murphy
In 1960, Columbia Broadcasting System (CBS) had a market capitalization sixteen times the size of Tom Murphy’s company, Capital Cities Broadcasting. By the time Capital Cities was sold to Disney 30 years later, it was three times as valuable as CBS. How could such a monumental shift have occurred?
The story begins with Tom Murphy, a man born in 1925 in Brooklyn, NY. After graduating from HBS in 1949, he became a product manager at Lever Brothers, a consumer packaged giant. At a cocktail party in 1954, Murphy was given an offer from family friend Frank Smith to run WTEN, a bankrupt TV station in Albany that Smith had purchased out of bankruptcy. Murphy had no broadcasting experience, no management experience, and accepted the role on the spot.
After initial success with WTEN, Tom Murphy hired Harvard MBA Dan Burke to replace him and moved to Manhattan to help Smith grow the company. After Smith’s death in 1966, Murphy moved into the CEO position, and quickly moved Burke into the role of President & COO. This created the classic dichotomy of capital allocator and operational expert between the two lieutenants of the firm. As Burke said, “(my) job was to create the free cash flow and Murphy’s was to spend it (well).”
Murphy fulfilled his role of master capital allocator from here, starting with a series of acquisitions to build the broadcasting business, before then moving into the related newspaper publishing business with purchases of the Fort Worth Telegram and the Kansas City Star. This “roll-up” model drove slowly towards the $3.5 billion purchase of ABC Network In 1986, yielding the Wall Street Journal headline “Minnow Swallows Whale.” In Murphy’s masterstroke acquisition, he showed massive belief in Burke’s ability to improve the profit margins of ABC from 30% up to the 50% at which Capital Cities operated. The margin gap was closed in just two years. How did they do it?
Operationally, Murphy and Burke created a culture of frugality and autonomy, which lead to a deep trust in the company by their employees. During the ABC integration, Capital Cities quickly implemented their lean approach by cutting unnecessary perks, removing redundant positions, and selling expensive real estate. Murphy instituted his “cab-man” culture by leading through example, and the lean practice quickly rippled through the ranks of the company. This served a double purpose of de-centralizing the organization, where managers were delegated responsibility “to the point of anarchy.” Outside of the annual budgeting meeting, general managers who met Burke’s high margin expectations could go months without hearing from corporate. This autonomy was beloved by employees, who rarely left the company for any competitors.
In typical iconoclast fashion, Murphy’s capital allocation strategy was to streamline Capital Cities around the broadcast business, instead of following the conglomerate trend of the time. As he put it, “The goal is not to have the longest train, but to arrive at the station first using the least fuel.” He did not issue dividends, rarely issued stock, and made active use of leverage. In acquisition, he followed the “crocodile-approach,” choosing to make few acquisitions, with each being at least 25% of the company enterprise value. Lastly, he made active use of share repurchases, buying back $1.8 billion shares over the years at a compound return of 22.4%.
Capital Cities created an esprit de corps through the humility of their leadership and their frugal, and rational allocation strategy that pervades to this day. A bartender at one of their corporate events, when prompted on why he made an investment in Capital Cities stock, had a simple explanation. “I’ve worked at a lot of corporate events over the years, but Capital Cities was the only company where you couldn’t tell who the bosses were.”
Henry Singleton (Teledyne):
“I change my mind when the facts change. What do you do?” - John Maynard Keynes
A proclaimed “unconventional conglomerateur”, Henry Singleton’s background does not exactly scream CEO. Born in Haslet, Texas, Singleton studied electrical engineering at MIT for a number of years, earning his bachelors, master’s and PhD degrees. His unique background set the groundwork for a series of contrarian and idiosyncratic practices at Teledyne, a company he founded at 43 in 1960. His shareholders could only smile at his returns, a compounded 20.4% which turned $100 into $18,094 over 27 years.
Singleton began work in the era of the conglomerate, considered the “internet stocks of the 1960s." Darling in the eyes of the public investor, the public hypothesized the conglomerate structure of unrelated companies allowed for synergies for the combined entity. Although conventional wisdom now holds conglomerates as inefficient, Singleton took advantage of the Teledyne stock’s celebrity status during the era, when it ranged from a P/E of 20 to an astronomical 50. He used this overpriced stock as his main vehicle to fund the purchases of 128 companies out of 130 purchases from 1961 to 1969.
Singleton, although busy buying an average of 16 companies a year, was a very disciplined buyer. He never paid more than 12 times earnings for a company, and looked only at growing companies with leading market positions. His mettle was tested as the 1970s approached, when the beginning of the end of the conglomerate era was in sight. With Teledyne’s P/E multiple falling and prices on pure-play companies rising, Singleton abruptly dismissed his acquisition team. From this point on, Teledyne did not make another material purchase or issue any stock.
The next phase in Teledyne’s value-creating process was Singleton’s iconic share repurchases, where he bought back an outlandish 90 percent of Teledyne’s outstanding shares. “No one has ever bought in shares as aggressively,” stated Charlie Munger, which reveals the extent of the contrast between the Teledyne strategy of the 1960s and the 1970s. This showed the flexibility of Singleton to understand the right times to sell his stock (at high valuations) and buy his stock (at low valuations). Singleton executed this remarkably well, issuing shares at an average P/E of 25, and buying back at an average P/E of less than 8.
Next, came the final phase of deconglomeration, where Singleton pioneered the use of spin-offs to unlock shareholder value. After a few spinoffs in the late 1980s, Singleton retired to his ranch in Texas, after leading Teledyne to outperforming the S&P by twelve times during his tenure. It was an amazing 27 years, in which Singleton showed his ability to navigate his company flexibly, simply based on the facts.
“My only plan is to keep coming to work…I like to steer the boat each day rather than plan ahead way into the future,” said Singleton on his strategic vision. To live out this plan, Singleton made sure to avoid reserving any day-to-day responsibilities for himself, and intentionally decided how to spend his time in three essential areas: management of operations, capital allocation, and investor relations. Singleton’s choice was simple; a skeletal investor relations focus (no quarterly earnings or industry conferences), a need-to basis focus on management of operations, and a supreme concentration on capital allocation.
Singleton had many similarities to Warren Buffett (detailed below), although neither of them was particularly similar to anyone else. With CEO’s main role as investor, hey both served decentralized operations, but centralized investment decisions. Both avoided quarterly guidance and were driven off of annual reports, paid no dividends, made ample use of stock-splits, and put their skin in the game through large ownership in their respective companies. Although differences in philosophy existed, there is little to deny their similarities and their value-creating ability.*
Bill Anders (General Dynamics):
“A foolish consistency is the hobgoblin of little minds.” - Ralph Waldo Emerson
When the Berlin Wall crumbled in 1989, the United States defense industry crumbled alongside, with publicly trading defense companies falling 40% within 6 months. General Dynamics was the “lowest of the low,” with negative cash flows and a high debt load that resulted in a market cap of $1 billion on $10 million in revenue in 1991. Enter Bill Anders to orchestrate “The Turnaround.”
Mr. Anders had an unconventional career before joining General Dynamics, graduating with an Electrical Engineering degree from the Naval Academy in 1955. Before his time in the business world, he was best know for being the lunar module pilot on the 1968 Apollo 8 mission. Following his time with General Dynamics, an investor remarked, “After boarding the moon, mundane business problems didn’t faze him.”
Mr. Anders shifted to private sector training under contemporary Jack Welch in his mid-forties for around ten years, learning his management philosophies. Bill’s modest tenure of private sector experience at General Electric is important to note because although he was the oldest incoming CEO in The Outsiders, he still maintained a set of fresh eyes. GE was followed by a brief stint with Textron and before a transition to Vice Chairman of General Dynamics to familiarize with the defense industry. Shortly thereafter, he took over as CEO.
Anders’s first order of business was to refocus the company on the shareholders. Over the years, General Dynamics had become cash flow negative due to a focus on creating the most innovative, new, weaponry instead of making expenditures to develop the best returns. To begin the turnaround, Anders brought his own team to replace 21 of 25 top executives, to completely reshape the culture of the company. The newcomers were led by Jim Mellor, COO, “the type of person who would look for the last nickel and hold people responsible.”
After setting up the team, Bill Anders and Jim Mellor set up a three pronged strategy for the turnaround: Only be in businesses where General Dynamics had the number one or number two market positions, exit commodity businesses with low returns, and stick to business it knew very well. Because the company was burning cash upon Ander’s arrival, the strategy would be implemented in two phases: first, the generation of cash, and second, the deployment process.
The generation of cash was done primarily through divesting non-core businesses, and tightening the business operations in existing business. As the defense industry shrunk, Anders was able to take advantage of the buyers who looked to expand their market share, who were surprisingly willing to pay premium dollar for many of General Dynamic’s non-core operations. Then, when shifting focus to building upon his core business, the military aircraft unit, he was faced with a pivotal decision after receiveing a hefty $1.5 billion counter-offer from Lockheed Martin. Anders made the rational business decision and sold the unit, showing again the rationality of nature of an outsider CEO.
With prices remaining high in the market, Anders centered his deployment strategy on returning capital to shareholders, through three special dividends and a $1 billion share repurchase tender. Because Anders had sold so much of General Dynamics, the dividends were considered “return of capital” and were not taxed, making it the most efficient way to return capital. The next most tax efficient return was through share repurchases, which was used to the tune of another $1 billion, and concluded an unprecedented value creating exercise for his shareholders. By the end, the company had systematically shrunk itself to about half its original equity value, and entered a new phase of development under Nick Chabraja.
Heir apparent to Bill Anders and Jim Mellor, Nick Chabraja was once called “the most business-like lawyer (Anders had) ever seen.” Chabraja came into CEO with a distinctly different framework to value creation, with a goal of growth through acquisition. While Chabraja’s framework differed from Anders both made decisions with a rational, shareholder-oriented mindset. This showed the ability of The Outsiders to shift based on circumstances in their respective time periods. Chabraja set ambitious targets to quadruple the company’s stock price in ten years and before stepping down in 2008, he exceeded his initial objectives.
Chabraja focused initially “broadening the product line into adjacent spaces” with a series of smaller acquisition before catching a big fish in 1999, Gulfstream. A $5 billion purchase, the commercial aviation leader represented 56% of General Dynamics new enterprise value. Although widely criticized originally, Chabraja was able to tap into latent knowledge within General Dynamics to properly integrate Gulfstream, leading to above average returns. In total, the 17-½ years lead by Anders and Chabraja were an exercise in practicality, opportunistic buying and selling, and a flexibility to accept changes as they came.
John Malone (TCI):
“Chance favors the prepared mind.” - Louis Pasteur
A Yale double major in economics and electrical engineering with master’s & PhD degrees in operations research, John Malone was built for value creation. He held laser focus output maximization, first during his time at Bell Labs with AT&T and next with a variety of Fortune 500 companies during his time with McKinsey & Co. Then, at 29, one of his clients, General Instrument, offered him the chance to run its rapidly growing cable television equipment division, Jerrold. This began his introduction into the cable television business, and he was courted in two years by two of the industry’s largest operators. He chose TCI for their larger equity opportunity and because his wife preferred Denver to a more high sprung alternative, Manhattan.
During his career, with large exposure to numerous industries, Malone had never seen anything like the cable television business in 1970. The business model was built on highly predictable revenues from cable subscribers, utility-like revenues, extremely favorable tax characteristics, and it was growing wildly. The tax characteristics proved especially interesting to Malone, who noticed how high depreciation on cable systems lead to little net income shown, even with healthy cash flows. This depreciation, along with similarly tax-deductible interest (from debt), could shelter a company completely from taxes.
However, TCI had been very aggressive with debt before Malone’s entrance and he would face tough waters entering his role as CEO in 1972. Malone entered hoping to reduce the exorbitant debt load through an equity offering, but regulations blindsided the cable industry and left stock prices too low to use to pay down debt. Shortly thereafter, the 1973-1974 Arab oil embargo dried up liquidity in the debt capital markets, leaving TCI on the cusp of bankruptcy with no refinancing options.
Malone and Bob Magness, TCI founder, went through the next years re-negotiating terms with bankers and holding them at bay while restructuring the operations of the company. In the meantime, they created a decentralized and frugal culture, by telling his managers if they could grow subscribers at 10% a year while maintaining margins, he would allow them to remain absolutely independent. TCI also held “Spartan” corporate offices, with very few executives there, rather preferring to stay at motels on the road. COO J.C. Sparkman remarked, “Holiday Inn’s were a rare luxury for us in those days.”
As noted as a trend amongst The Outsiders, Malone delegated most of the day-to-day operations to his COO Sparkman, who set cash flow budget targets and enforced them with a military like discipline. Autonomy was granted freely to all, as long as they hit their numbers. Underperformers were quickly weeded out of the company. This turnaround enhanced an entrepreneurial culture and allowed Malone’s TCI to get back into the good books of lenders and investors alike. By 1977, TCI’s growth convinced a host of insurance companies to come in and replace the bank debt at a lower price, giving way to Malone to finally unveil his new capital allocation strategy.
Malone looked to maximize value in an unconventional fashion by focusing on two key areas: leverage with suppliers and financial leverage. The largest cost for cable television systems is paying the programmers (HBO, MTV, ESPN, etc.), amounting to about 40% of total operating expenses. The larger companies were able to create leverage with these programmers and lower costs on a per subscriber basis. In the same breadth, cable companies must be comfortable with high degrees of leverage to amplify the ability to grow quickly and to minimize taxes. This low tax rate allowed cash created by TCI to be directly utilized to scale the business. This required Malone to disregard EPS, the preferred metric for public companies, in order to fund internal growth and acquisitions.
Malone moved swiftly and aggressively to execute his strategy, closing an astonishing 482 acquisitions between 1973 and 1989, an average of one every other week. Although the frenetic pace may make it seem likely he did not always consider price, he refrained from franchise wars common in the larger metropolitan areas and instead focused on less expensive rural and suburban subscribers. He also coined a new term, EBITDA, (Earnings Before Interest, Taxes, Depreciation, and Amortization), now widely used in the business world, to help determine the cash generating ability of an acquisition. By 1982, TCI had 2.5 million subscribers and was the largest company in the industry. The train continued even further as Malone opportunistically acquired control in many of the urban areas at low rates, where he had refrained from the initial bidding wars.
Malone then began serving as a quasi-venture capitalist within the TCI umbrella. He begun by taking minority stakes in the businesses of cable entrepreneurs, and in turn offering them access to TCI’s scale and programming discounts. This led to his introduction into the cable programming market, where his portfolio including channels such as CNN, Cartoon Network, Discovery, Encore, and BET. This eventually concluded in a series of spin-offs, to increase transparency and dissuade regulatory scrutiny. Aside from the cable-programming spin-off, Malone created two new entities, Teleport (telephone services) and Sprint/PCS (a JV to bid on cellular franchises).
After finding homes for several of the successful spinoffs (Sprint/PCS, Teleport and General Instrument sold for $9-$11 billion each), Malone turned to finding a suitor for TCI. At the glorious end of the road, he found one in AT&T, who purchased the company for $48 billion in 1998. This included a huge premium of $8.5 billion and showed Malone to be as adept at selling his business as he had been at acquiring over the years.
Over the years, John Malone pioneered the role of active debt in the cable industry, avoided taxes at all costs, only offered stock when it was overpriced (where he repurchased 40% of his shares), issued no dividends, stuck to an EBITDA based M&A criteria, and entrusted his COO with the operations of the company. In a similar tale to his fellow Outsiders, Malone unlocked a remarkable amount of value, with $100 invested in TCI in 1973 worth $90,000 by 1998. TCI outperformed the S&P by over forty times during this time horizon, and helped make many shareholders happy.
Katherine Graham (Washington Post Company):
“Establishing and maintaining an unconventional (approach) requires…frequently appearing downright imprudent in the eyes of conventional wisdom.” - David Swensen
Katherine Graham was the daughter of Eugene Meyer, founder of The Washington Post who passed down the reigns to Philip Graham, Katherine’s husband and his son-in-law. Philip Graham ran Meyer’s company with intermittent brilliance until his suicide left the role to Katherine, who was a full time mother of four and hadn’t been regularly employed for 20 years. The widow took the helm with a penchant for cool pragmatism, and created a compounded return to shareholders of 22.3% over 21 years.
After a few years familiarizing herself with her diversified business, Graham made her first large decision. She put 44 year old Ben Bradlee, a former assistant editor at Newsweek, in charge of her paper. Shortly thereafter in 1971, the “Pentagon Papers Crisis” began. Bradlee and the Post investigated the Republican campaign amidst threats from the White House, but held their ground in what eventually lead to the Watergate scandal. The Post’s coverage forced President Nixon’s resignation, achieved a Pulitzer for Bradlee, and cemented the paper’s position as a national powerhouse.
In 1975, Graham navigated the company through a 139-day strike by personally (alongside Bradlee and her son, Donald) printing the paper until the pressman accepted significant concessions. This was one of the first times a major metropolitan newspaper successfully navigated a strike. Afterwards, Graham bought back almost 40% of her shares at their lowest price in years, an unconventional play urged by chairman Warren Buffet (outside of The Outsiders), with no other major newspapers following her lead.
Shortly thereafter, the Post became the only newspaper in the nation’s capital, with The Washington Star ceasing publication. Perhaps more significantly, Graham pegged Dick Simmons as the new COO of the Post, whose focus on margins led to a surge in profitability over the next several years. The theme continued for The Outsiders, with Stockton’s focus on bringing in executive talent and implementing a bonus compensation structure allowing Graham to focus on capital allocation.
Katherine Graham of the 1980s taught us a CEO’s job of capital allocation does not always require allocation to be made. During the “feeding frenzy” of the decade, Graham made the prudent decision to enjoy the sidelines as deal making in the industry reached a peak, and prices skyrocketed. Her restraint proved vital, although not considered correct by the press, and she was rewarded through a purchase of Capital Cities in 1986 and many underpriced companies during the recession of the early 1990s. As she said later, “The deals not done were very important. Another large newspaper would have been a boat anchor around our necks today.”
Katherine Graham’s term as CEO was characterized by her rational approach to both human and capital allocation, with a decided aloofness to popular opinion in exchange for rationality. This led her to maintain industry low dividends, repurchase large portions of stock, remain patient in acquisitions, and conservative in capital expenditures. As she transitioned from CEO of the Post Company, she left behind a company with talented younger managers ready to assume leadership roles and continue focus on the shareholder.
Bill Stiritz (Ralston Purina):
“Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.” - Warren Buffett
Ralston Purina was a company with a long history in agricultural feed products, which fell victim to the conglomerate era of the 1970s by using enormous loads of cash flow to diversify into many industries. By 1980, the company’s stock price had not moved in a decade, and varied operating divisions included the Jack and the Box chain, the St. Louis Blues hockey team, and the Keystone ski resort in Colorado. This strategy changed drastically when Bill Stiritz surprisingly came to power after 17 years within the first. During his time at the helm, he used his background as a poker player to “calculate odds, read personalities, and make large bets when the odds were overwhelmingly in (his) favor.”
Stiritz spent little time waiting to implement the strategy he detailed in a memo to the board to steal the CEO spot from other top, national candidates. He began by selling all of the non-core businesses to leave Ralston as a pure branded products company, and re-organized around the valuable economics of the consumer brands segment. The reorganization served to collect all capital used in lower return areas so they could eventually be redeployed around their highest return business. This was followed by the initiation of an aggressive stock repurchase program, which would become a central figure in his allocation strategy throughout the years.
After initial divestures, two large acquisitions worth 30% of Ralston’s enterprise value brought Twinkies, Wonder Bread, and Continental under Ralston’s management. Then, in 1986, Ralston pounced on the Energizer Battery division, a neglected division of the struggling Union Carbide, for $1.5 billion (20% of Ralston’s enterprise value). In all these acquisitions, Stiritz looked for a “motivated seller,” whom he would be able to negotiate more favorable terms to retain most value for his own shareholders.
As Ralston moved into a pure-play consumer packaged goods company, Stiritz remained very comfortable divesting assets he perceived as underperforming, rather than holding on to a company whose growth prospects were low. All decisions were guided by a focus on potential shareholder returns, which eventually led Stiritz to the spin-off, as a way to realize value on brands in Ralston’s portfolio he believed to be undervalued.
The spin-off, transferring a business unit from the parent company to it’s own business entity, serves to highlight value of a specific business unit while also deferring capital gains taxes. He first spun-off Ralcorp, a collection of smaller brands including Chex, before his last hurrah spin-off of Energizer Holdings, worth 15% of the Ralston’s enterprise value at the time. Pruning off well-performing businesses served a double purpose of making the company’s core pet food brands more attractive to a strategic buyer. In 2001, the sale of the pure play Ralston came to fruition for an amazing $10.4 billion to Nestlé, a record large acquisition and capstone for Stiritz’s extraordinary run as CEO. In a deeper dive into Stiritz’s run, he proved to be iconoclastic from a few angles.
Stiritz shared many characteristics with all of The Outsiders, with high margins, an active share repurchasing program, and a focus on capital allocation. Within his industry, he was a pioneer in the use of debt to fund transactions, and made use of his internal sales price for all of his assets to decide on whether to sell. Stiritz said, “Leadership is analysis,” and lived by his word by guarding his time to address key issues in his business and the industry as a whole, and removing interactions with Wall Street from his day to day. By the time Stiritz sold Ralston, his unorthodox strategy had been implemented in some fashion by all of his peers.*
Dick Smith (General Cinema): “Optimizing the Family Firm”
“You shape your houses and then your houses shape you.” - Winston Churchill
After the death of his father in 1962, a 37-year-old Dick Smith took over as CEO of General Drive-In, a pioneering movie theater chain and the family business. A graduate of both Cambridge and Harvard College as an engineer, Smith worked as a naval engineer during World War II before coming to back to work in the family business. He was full partner at 32 and, although thrust into a role of CEO unexpectedly, proved himself to be more than capable in leading his father’s company.
In his first acts as CEO, Smith showed how his youth would encourage an independence from industry norms, freeing him to make two innovations that would shape the future of the company. First, while looking to expand General Drive-In’s theater circuit into the growing suburban area, Smith established the use of lease financing to build the theaters. This minimized the up front capital investment necessary to build a theater, and therefore rapidly increased the company’s ability to grow its theater fleet. Second, Smith introduced the idea of larger movie theaters, which served to attract more viewers and increase efficiency of the fast growing concessions market. Both of these innovations reeked of avoidance of the “institutional imperative”.
Then came a shift in General Cinema, with the transformational purchase of American Beverage Company (ABC), the largest Pepsi bottler in the country. ABC served as a “platform company,” where other companies could be added on efficiently, and gave a second arm to the already thriving theater business. Acting on this insight, Smith added several franchises over the years (including the rights to 7 Up and Dr. Pepper) and unveiled their own sodas (Sunkist). Smith then turned focus on a potential “third leg” which he found through his well-refined acquisition criteria.
When investment banker Eric Gleacher called regarding Carter Hawley Hale (CHH), a retail conglomerate, Smith did not initially see it as his optimal “third leg.” However, it became clear CHH was on a ridiculous time crunch to avoid a hostile takeover, and Smith jumped at the opportunity. After a weekend of intense due diligence, Smith emerged with CHH as his “third leg”, purchased for over 40% of his enterprise value. This decision, made on an impossibly short timetable, showed General Cinema’s propensity to act quickly, and the company eventually realized an amazing 51.2% return on their CHH transaction.
As to the question of how, Smith answered very similarly to others among The Outsiders. He ran a company in collaboration with his “Office of the Chairman”, referring to his COO and CFO. He encouraged dissention amongst the management team, “conducting wrestling matches in a constructive, collegial way.” He was open to being overruled, an aspect of humility not overlooked by his employees, who appreciated his infectious enthusiasm and trust in their ability. Smith also aligned compensation with his workers performance, to further prove their efforts would be rewarded.
Smith focused on cash from existing operations to fund, eschewing equity as a capital raising option and acted as “a feudal lord, holding onto the ancestral land” when it came to stock offerings. He was very frugal using his money, deciding on potential investments based on his unique metrics, Cash Earnings and Return On Invested Capital (ROIC). Together, the General Cinema executives made rational decisions and successfully led the company into new businesses, through operating excellence and exceptional allocation disciple.
Warren Buffett (Berkshire Hathaway):
“The most powerful force in the universe is compound interest.” - Albert Einstein
Although Warren Buffet’s successful history career with Berkshire Hathaway is far too detailed to briefly summarize, it is important to note the three areas that drive Warren Buffett, coined “the capital flywheel.” Capital generation, capital allocation, and management of operations all serve an interrelated purpose in the value-creation process, one Warren Buffett and his legendary team has paved like no other team in history. $100 invested with Berkshire Hathaway in 1965 was worth $626,500 as of 2011, as compared to $6,200 if invested in the S&P.
As quoted by Charlie Munger, iconic lieutenant at Berkshire, the secret to their long-term success has been the ability to “generate funds at 3 percent and invest them at 13 percent.” For capital generation, the amazing truth is Berkshire has generated a grand majority of it’s investment capital from internal sources – primarily, it’s insurance float. Insurance companies, the groundwork of Berkshire Hathaway, require premiums to be paid to the insurer before anything bad happens to enact payment. The insurer holds the money until something goes wrong but does not own it, rather referring to it as the company float. During the time the insurer holds the float it is invested, similarly to debt but generally at a much lower implied interest rate. Float has grown enormously for Berkshire over the years, from $237 million in 1970 to $70 billion in 2011, fueling the investment returns found all around their business.
However, it is important to note that Mr. Buffett did not lose focus on profitability when deciding how many insurance premiums to underwrite to fuel his business. When pricing was low, Buffett did not sell, even when short-term profitability suffered. When prices were attractive, he sold large amounts of insurance. This led to uneven revenue for his insurance businesses, with National Indemnity writing $98.4 million or less in premiums for 13 years before writing over $600 million in 2004 alone. The lumpy revenue stream, although harder to explain as an independent insurer, was Mr. Buffett’s preferred stream, simply because it was the most profitable option.
When it comes to capital allocation, Berkshire levies the most central approach in the world. Mr. Buffett insists on all extra cash being sent to Omaha for allocation, from where he uses his wide variety of industry expertise to choose the next high-return investment. More so than any other CEO, Mr. Buffet has a wide palate of expertise areas that serves as a possible investment zones, creating a competitive advantage to Berkshire’s shareholders.
Berkshire and Mr. Buffett also spent time analyzing both the public and private markets for potential investments. Perhaps better known for his stock market prowess, some key notes of his public portfolio is 1) the high concentration of the top five positions (60-80% of the portfolio) and 2) the extremely long holding periods on his top five stocks. These both go contrarian to the typical mutual fund, and gives indication to the highly selective filter it takes to get into the top five investments at Berkshire. On the private side, Berkshire is a highly differentiated option, where private company CEOs can go public through Buffett’s entity, and still maintain most of the perks of low interference from corporate or from Wall Street. Because of this advantage, Buffett has been placing a larger emphasis on the private market in recent years.
As far as Berkshire goes to control cash for allocation, the company may go even further in their efforts to decentralize their operations. In a company with over 270,000 employees, Berkshire employs a grand total of 23 individuals at the corporate headquarters. The companies hold no regular budget meetings with Berkshire, and simply never hear from Buffet unless they themselves seek him out for advice. His approach to “hire well, manage little” has shown to be successful over the years.
Warren Buffett may also be understood through his worldview. At his core, he believes in the power of long-term relationships with great people, and in the compounding effect those relationships can create. He has shown through his numerous long-term holdings the significant benefits of consistency, and has avoided unnecessary change with a passion. Through his Zen-like logic and emphasis on people, Warren Buffett may be able to teach us as much about life as he teaches us about investing.
A Radical Rationality
“If you can keep your head when all about you are losing theirs…” - Rudyard Kipling, “If”
After reading the similarities between of the approaches of all of the Outsiders, a few questions remain: How could the next realm of CEOs apply and use these? Although as we have seen, successful operations have been executed using eerily similar methods, what do we have to do to truly follow their footsteps?
The parallel between The Outsiders seems to be a learned ability to perform unadulterated, rational thought. Through all the noise of Wall Street, the industry leaders, and the crowds of investors, these CEO’s leaned on their ability to think for themselves. As simple a maxim as they come, it seems their ability to execute on this task was honed through their background experiences and pushed further through their discipline in avoiding the unwanted opinions of the masses.
A quote by Benjamin Graham would be considered a maxim of these eight iconoclasts, and perhaps should be considered as such for all students looking to join the business world as well. He says, “You are right not because others agree with you, but because your facts and reasoning are sound.”