The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success by William N. Thorndike, Jr.
A review and summary of The Outsiders by William Thorndike.
“[The Outsiders] details the extraordinary success of CEOs who took a radically different approach to corporate management.” — Charlie Munger, former Vice-Chairman of Berkshire Hathaway
If you ask most people what defines a great CEO, their answer is usually tied to growth in revenues, profit, or headcount. The Outsiders offers a different answer that comes down to three things:
The compound annual return to shareholders during a CEO’s tenure;
The return over the same period for peer companies; and
The return of the broader market (e.g. the S&P 500) over the same period.
Context matters. It’s one thing to deliver a 20 percent return over a bull market and quite another to deliver it during a bear. In short, relative return matters more than absolute, and it’s the increase in a company’s per share value that matters most.
If a CEO can generate better returns than peers and the market writ large, they’re great. To do that, they need to do two things:
Run their operations efficiently; and
Deploy the cash generated from operations well.
Most CEOs (and most management advice) focus on operations, which are undeniably important. Counterintuitively, many of the best CEOs focus on capital allocation, delegating day to day responsibilities entirely. In other words, capital allocation, not operations, is what often distinguishes good from great.
Great capital allocators master the process of deciding where, and how, to deploy resources to earns the best returns. Capital comes from three places:
Internal cash flow;
Issuing debt; or
Once you have capital, you have five choices:
Invest in existing operations;
Acquire other businesses;
Pay down debts; or
Over the long term, shareholders returns are largely determined by how well you choose between these options. Two companies with identical operating results, but different approaches to capital allocation will have very different outcomes. The issue is most CEOs are not skilled in capital allocation. As Warren Buffett said:
“Most bosses rise to the top because they have excelled in an area such as marketing, production, engineering, administration, or sometimes, institutional politics. Once they become CEOs, they now must make capital allocation decisions, a critical job that they may have never tackled and that is not easily mastered.
To stretch the point, it’s as if the final step for a highly talented musician was not to perform at Carnegie Hall, but instead, to be named Chairman of the Federal Reserve.”
This inexperience has a direct impact on returns because, to borrow from Buffett again, “after ten years on the job, a CEO whose company annually retains earnings equal to 10 percent of net worth will have been responsible for the deployment of more than 60 percent of all the capital at work.”
Thorndike profiles eight CEOs in The Outsiders whose firms’ average returns outperformed the S&P 500 by a factor of twenty. In other words, an investment of $10,000 with each of these CEOs, on average, would have been worth over $1.5 million twenty-five years later.
The eight CEOs in The Outsiders:
Tom Murphy of Capital Cities Broadcasting;
Henry Singleton of Teledyne;
Bill Anders of General Dynamics;
John Malone of TCI;
Katharine Graham of The Washington Post;
Bill Stiritz of Ralston Purina;
Dick Smith of General Cinema; and
Warren Buffett of Berkshire Hathaway.
Despite operating in different industries, all eight:
Saw capital allocation as their most important job
Focused on increasing per share value, not market cap or headcount
Prioritized cash flow, not reported earnings
Ran decentralized organizations that kept costs down
Viewed interactions with Wall Street and the press as distractions
Would buyback their own stock if it was the best opportunity
Were patient, but occasionally bold, with mergers & acquisitions
In short, these CEOs thought more like investors, and often partnered with strong COOs whose close oversight of operations allowed them to focus on longer-term strategic and capital allocation issues.
A perpetual motion machine for returns: Tom Murphy and Capital Cities Broadcasting
“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.” — A bartender
“Tom Murphy and Dan Burke were probably the greatest two-person combination in management that the world has ever seen or maybe ever will see.” — Warren Buffett, Chairman and CEO of Berkshire Hathaway
Buffett often compares Tom Murphy’s Capital Cities Broadcasting to CBS under Bill Paley to illustrate the impact management has on long-term returns. When Murphy became CEO in 1966, Capital Cities had five TV stations and four radio stations that were all in small markets.
At the time, CBS was the dominant media business in the United States, with TV and radios states in the largest markets, the top-rated broadcast network, valuable publishing and music properties, and a market cap 16x larger than Capital Cities.
Thirty years later Capital Cities sold to Disney at a price three times that of CBS.
Every dollar invested with Murphy grew to $204 — a remarkable 19.9% internal rate of return over 29 years, significantly outpacing the 10.1% return of the S&P 500 and 13.2% return of an index of leading media companies over the same period. In words words, Murphy was a phenomenal 16.7x better than the S&P and fourfold his peers.
CBS spent the 1960s and 70s using its enormous cash flow and stock issuance to fund an aggressive acquisition program in new fields, including the purchase of the New York Yankees. Management built a landmark office in midtown Manhattan and developed a corporate structure with forty-two presidents and vice presidents.
CBS’ strategy was consistent with conventional wisdom in the conglomerate era, which espoused diversification and synergies to justify acquisitions of unrelated businesses that, once combined, would magically become more profitable and resilient.
The goal was always to become bigger.
Murphy’s approach was different to his peers. He avoided diversification, paid minimal dividends, rarely issued stock, regularly repurchased shares, and between long periods of inactivity, made the occasional very large acquisition funded by debt that would be paid down aggressively. His goal was always to make Capital Cities more valuable. “The goal is not to have the longest train, but to arrive at the station first using the least fuel.”
Under Murphy and his lieutenant, Dan Burke, Capital Cities grew into a streamlined conglomerate that focused on media businesses within its circle of competence. Burke was responsible for daily operations and Murphy for acquisitions, capital allocation, and occasional interaction with Wall Street.
Burke believed his job “was to create the free cash flow and Murphy’s was to spend it.”
Their formula was simple: focus on industries with attractive economic characteristics that they knew well, selectively use leverage to buy large properties, improve operations, pay down debt, and repeat.
Acquisitions were far and away the largest outlet for the company’s capital and Murphy was a master at prospecting. He knew what he wanted and spent years developing relationships with owners of desirable properties. Every major transaction was sourced via direct contact with sellers, he never participated in a hostile takeover. Much like Buffett, Murphy worked hard to become a preferred buyer by treating employees fairly, running acquired properties well, and leaving something on the table so sellers came away happy.
Capital Cities is what we now call a roll-up, a company that acquires a series of businesses, attempts to improve operations, and keeps acquiring, benefiting from scale and shared best practices. Roll-ups peaked in the mid- to late 1990s before flaming out in the early 2000s because many companies acquired too quickly, underestimated the difficulty (and importance) of improving operations, and collapsed under the burden of too much debt.
Capital Cities was different. Murphy moved slowly, relying on simple but powerful rules for evaluating potential acquisitions: a benchmark of a double-digit after-tax return over ten years without leverage. This meant focusing on a small number of large acquisitions that they knew were high-probability bets, and under Burke acquired properties became beacons of operational excellence.
In other words, Murphy and Burke combined excellence in capital allocation and operations. And while they frequently used debt to fund acquisitions, they never borrowed money to fund share repurchases, avoided dilution from equity offerings, and aggressively paid down the debt they had.
Financial resources are one of the two basic types of resources a CEO needs to allocate. The other, equally important part, is human. Murphy and Burke emphasized flat organizations, dehydrated corporate staff, and autonomy. The extraordinary autonomy Murphy and Burke gave to their operating managers is summarized inside the cover of every Capital Cities annual report:
“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 only existed to support the general managers of operating units. There were no vice presidents in functional areas, no corporate counsel, and no PR department. Murphy’s own secretary fielded all media calls. Publishers and station managers had the power and prestige internally, and almost never heard from New York if they hit their numbers.
The guiding human resources philosophy was to “hire the best people you can and leave them alone.” Burke himself was the guinea pig of this philosophy. When he became general manager of WTEN in 1961, he began sending weekly memos to Murphy. After months of receiving no response, he stopped sending them and spent his time on improving operations. Burke said, “Murphy delegates to the point of anarchy.”
Decentralization gave Capital Cities another gift, frugality.
You can’t control your revenue, but you can control your costs and the best defense against the revenue lumpiness inherent to advertising-support businesses is cost control. One of the earliest and most often told corporate legends was that Murphy scrutinized costs as small as the cost to paint an office’s exterior. He believed the smallest operating expenditures, particularly those related to head count could have unforeseen long-term costs and needed to be monitored.
To run the company’s dispersed operations, Burke developed a legendarily detailed annual budgeting process. Each year, every general manager came to New York to present operating and capital budgets for the coming year. Burke and his CFO, Ron Doerfler, went through them line-by-line and there were almost always material changes, with particular focus on capital expenditure and expenses.
While managers were expected to outperform peers and great attention was paid to margins, Burke was as tough on under-resourcing as excessive costs. Outside of these meetings, managers were left alone and sometimes went months without hearing from corporate.
The combination of extreme delegation and cost consciousness is what gave Murphy his edge. He could buy properties and know that under Burke, they would become more profitable, lowering the effective price paid.
That’s not to say they cut their way to high margins. The key drivers of profitability in most media businesses is revenue growth and advertising market share, so they invested heavily to ensure local leadership in talent and technology.
Capital Cities’ hiring practices were equally unconventional. Murphy and Burke had no broadcasting experience and had a clear preference for intelligence, ability, and drive over industry experience. When they made an acquisition or entered a new industry, they inevitably designated a top Capital Cities executives, often from an unrelated division, to oversee the property. And they were equally comfortable giving responsibility to promising young talent which likely helped their exceptionally low turnover.
As Robert Price, a rival broadcaster, once remarked, “We always see lots of resumes but we never see any from Capital Cities.” The system in place corrupted talent with autonomy and authority and they couldn’t imagine working anywhere else.
An unconventional conglomerateur: Henry Singleton and Teledyne
“Henry Singleton has the best operating and capital deployment record in American business… if one took the 100 top business school graduates and made a composite of their triumphs, their record would not be as good as Singleton’s.” — Warren Buffett
“Henry Singleton was this very brilliant, intellectual type who could foresee all these problems that no one else could see, and he saw opportunities. Henry was as intellectual as anyone I had come across.” — Arthur Rock, one of the first venture capitalists and investor in Fairchild Semiconductor, Intel, Apple, and Teledyne.
Henry Singleton had an unusual background for a CEO, he programmed MIT’s first computer while earning his doctorate in electrical engineering and was a world-class mathematician. During World War II, he developed technology to help Allied ships evade radar, and in the 1950s, he created an inertial guidance system still in use in most military and commercial aircraft.
This was all before starting Teledyne in the early 1960s. Known as “the Sphinx” due to his reluctance to engage with analysts or the press, he was truly iconoclastic. Unlike most conglomerateurs, Singleton ran a famously decentralization organization with less than fifty people at headquarters, despite employing more than forty thousand.
A dollar invested with Singleton in 1963 would have been worth $180 in 1990 when he retired as chairman during a severe bear market—an extraordinary 20.4 percent return for almost three decades. That same dollar invested in a broad group of conglomerates would have been worth $27, or $15 if invested in the S&P 500.
Singleton achieved these results by constantly reinventing himself based on market conditions. He acquired aggressively when P/E ratios were high, bought back nearly 90 percent of Teledyne’s stock when P/E ratios fell, and used dividends as a last resort. He even went on to disassemble the company when he believed it was in the best interest of shareholders.
In the 1960s, conglomerates were the technology stocks of their day. They enjoyed high valuations due to lofty P/E ratios. Singleton took full advantage of this, acquiring a diversified set of 130 profitable, growing businesses with leading market positions in niche markets between 1961 and 1969. All but two were acquired using Teledyne’s stock. Singleton avoided turnarounds, never payed more than 12x earnings, and most purchases were at significantly lower multiples than that. For context, Teledyne’s P/E ratio ranged from 20 to 50 over the period.
In 1967, Singleton made his largest acquisition to date, acquiring Vasco Metals for $43 million. After the acquisition, George Roberts, Vasco Metals' president, became president of Teledyne. Once Roberts joined the company, Singleton removed himself from operations to focus on strategy and capital allocation. Shortly after, Singleton dismantled his acquisition team as the multiple on his stock fell, and acquisition prices rose. The lower P/E ratio of Teledyne, the primary currency for acquisitions was no longer attractive. Singleton would never make another material purchase nor issue another share of stock.
Once the acquisition engine stopped, Roberts and Singleton focused on the company’s existing operations: improving margins, reducing working capital, and optimizing for free cash flow. Cash generation became the basis for bonus compensation for all business unit managers. From 1970, the company generated remarkably consistent profits across a range of market conditions. Cash was sent to Singleton to be allocated.
Starting in 1972, Singleton embarked on an unprecedented share repurchasing spree, buying back 90 percent of outstanding shares over the next 12 years. This obsession with repurchases represented a change in thinking for Singleton, who had been an active and highly effective issuer of stock. These tender offers were almost always oversubscribed, and he always bought all shares offered.
Singleton believed that repurchases were a better method of returning capital to shareholders than dividends, and he effectively used them as a capital allocation benchmark, repurchasing his stock when it looked attractive relative to other opportunities. But repurchases only add value for shareholders if they are made at attractive prices and Singleton’s repurchases were very large bets for Teledyne, ranging from 4 percent to 66 percent of the company’s book value at they time they were announced. All in all, he spent $2.5 billion on buybacks, resulting in a fortyfold increase in earnings per share between 1961 and 1984. Not surprisingly, he bought extremely well, generating a 42 percent compound annual return for shareholders across tenders.
In the mid-1970s, Singleton took direct responsibility for investing the stock portfolios at Teledyne’s insurance subsidiaries when P/E ratios were at their lowest since the Great Depression. He increased the equity allocation from ten percent in 1975 to 77 percent in 1981, investing over 70 percent of the portfolio in five companies, and 25 percent in one (his former employer, Litton Industries). As with his repurchases of Teledyne stock, Singleton’s returns in these insurance portfolios were excellent, approximately an eightfold growth in book value from 1975 to 1985.
Between 1984 and 1996, Singleton’s thinking evolved again. He began dismantling the company, believing spin-offs reduced the company’s complexity, simplified successions issues, and unlocked the full value of their large insurance operations. In 1987, when acquisition and stock prices (including his own) were at historic highs, he concluded that the best option for deploying the company’s cash flow was to issue a dividend, the company’s first in its 26 years as a public company.
After a few successful spin-offs, Singleton retired as chairman in 1991 to focus on his cattle ranching operations, becoming one of the largest holders of ranchland in the United States. He returned in 1996 to personally negotiate the merger of Teledyne’s remaining manufacturing operations with Allegheny Industries and to fend off a hostile takeover by Bennett LeBow. During these negotiations, Singleton focused exclusively on getting the best possible price, netting shareholders a 30 percent premium to the company’s prior trading price.