I found this book tucked in a corner of Kramer books in Washington DC – an indie book store. The book is called “The Outsiders”, written by William Thorndike, Jr.
A day after I bought it, one of my investors shared he was considering naming his new VC firm after the book so I knew it was a must read.
This is a guide for every entrepreneur, CEO, or person with a big idea on how to fund your ideas by turning $1 into $1000. Keep reading to see how I’m using the strategies in this book to generate those kind of returns at Heyo and in my life.
This book is about the worlds top 8 CEO’s as measured by per share value over their tenure as CEO. Many of these CEO’s you’ve probably never heard of but should absolutely study.
Here they are:
1. Tom Murphy with Capital Cities Broadcasting. If you invested $1 with Tom Murphy in 1966, it was worth $204 by 1995. This was a return of 19.9%/year over 29 years versus +10.1%/year for the S&P 500 index.
2. Henry Singleton with Teledyne. If you invested $1 in 1963 when Singleton became CEO, it was worth $180.94 by 1990. This was a return of 20.3%/year over 27 years versus +8.0%/year for the S&P 500 index.
3. Bill Anders with General Dynamics. $1 invested when Anders started was worth $30 seventeen years later. This was a return of 23.3%/year over 17 years versus +8.9%/year for the S&P 500 index.
4. John Malone with TCI. $1 invested in TCI in 1973 was worth well over $900 by end of 1998. This was a return of 30.3%/year over 25 years (up to ATT acquisition) versus +14.3%/year for the S&P 500 index.
5. Katharine Graham with The Washington Post. $1 invested when Graham became CEO in 1971 was worth $89 by the time she retired. This was a 22.3%/year over 22 years (since IPO) versus 7.4%/year for the S&P 500 index.
6. Bill Stiritz with Ralston Purina. $1 invested with Bill when he became CEO was worth $57 just 19 years later. This was a return of 20.0%/year over 19 years versus +14.7%/year for the S&P 500 index.
7. Dick Smith with General Cinema. $1 invested with Dick at the beginning of 1962 would have been worth $684 at the end of the period in 1991. This was a return of 16.1%/year over 43 years versus +9%/year for the S&P 500 index.
8. Warren Buffett with Berkshire Hathaway. $1 invested at the time of Buffets takeover of BH was worth $6265 45 years later. This was a return of 20.7%/year over 46 years (through 2011) versus 9.3% for the S&P 500 index.
Below are my notes:
Many people think Jack Welch is greatest CEO of all time from his Six Sigma and Total Quality Management (TQM) initiatives along with his intense focus on stock price at General Electric. He was not. The CEO’s in this book were.
Press focuses on increase in companies per share value, this is the wrong focus.
Performance in this book is measured on the compound annual return to shareholders during the CEO’s tenure and the return over the same period for peer companies and for the broader market (usually measured by the S&P 500).
Singleton, CEO of Teledyne, aggressively repurchased stock despite it being unconventional. He avoided dividends and emphasized cash flow over reported earnings and never spoke to journalists or reporters.
Singleton generated a 20.4% return to investors compared to 11% by his comparable peers. If you invested $1 in Singleton in 1963, by 1990 when he retired it was worth $180. Singleton outperformed others by 12x.
The highest performing CEO’s focus on capital allocation: the process of deciding who to deploy the firms resources to earn the best possible return to shareholders. Choices for deploying capital include investing in existing operations, acquiring other companies, issuing dividends, paying down debt, or repurchasing stock. Choices for raising capital include tapping internal cash flow, issuing debt, or raising equity. This is the CEO’s toolkit.
Business schools don’t teach capital allocation Warren buffet has observed very few CEO’s who are good at it (most CEO’s come from product, engineering, or marketing experience).
Singleton focused on selective acquisitions and stock repurchases.
Graham and Dodd advocated investing strategy of buying companies that traded at material discounts to conservative assessments of their net asset values.
The best performing CEO’s understood these 7 things:
1. Capital allocation is the CEO’s most important job
2. What counts in long run is increase in per share value not overall growth or size
3. Cash flow, not reporting earnings, is what determines long term value
4. Decentralized organizations release entrepreneurial energy and keep both costs and rancor down
5. Independent thinking is critical and communication with press is distracting
6. Sometimes best investment is your own stock
7. With acquisitions patience is a virtue as is occasional boldness
These unique CEO’s personalities were typically frugal, humble, analytics, and understated. Family centered, did not attend Davos, did not write books or give advice, did not exude charisma.
Introduction: The Iconoclasts
The best CEO’s in history were old fashioned, frugal, conservative, and bold. They usually developed their own financial metrics that were unconventional and not accepted by Wall Street.
These CEO’s were exceptional rational. They were not “from industry”, Rather they were diverse and able to make connections across fields to innovate.
Each of these CEO’s 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. They were more like investors than innovators.
When their stock was cheap, they bought it and when it was expensive, they used it to buy other companies or to raise inexpensive capital to fund future growth.
The center of the worldview by these CEO’s was a commitment to rationality, to analyzing data, to thinking for themselves. They had a genius for simplicity.
The simple and single minded cash focus Henry Singleton had led him to buyback 90% of his own stock in the 1970 and 1980’s. For John Malone with TCI, it was the relentless pursuit of cable subscribers, for Bill Anders with General Dynamics it was divesting noncore businesses and for Warren Buffet it was the generation and deployment of insurance float.
Summary: The best CEO’s in the history of business were rational, frugal, conservative, occasionally bold, used out-of-industry information and trends to create breakthroughs, kept their organizations decentralized, and acted more like investors than innovators.
Chapter 1: A perpetual motion machine for returns
Tom Murphy with Capital Cities focused on making his company more valuable, not bigger. The goal is not to have the longest train, but to arrive at the station first using the least fuel.
Murphy’s formula was to focus on industries with attractive economic characteristics, selectively use leverage to buy occasional large properties, improve operations, pay down debt, and repeat.
Murphy executed what we now know as a roll-up. This is where a company acquires a series of businesses, attempts to improve operations, keep acquiring and benefit over time from scale advantages and strong management.
Murphy moved slowly, developed real operational expertise, and focused on a small number of large acquisitions that he knew to be high probability bets.
“The business of business is a lot of little decisions every day mixed up with a few big decisions” – Murphy
Dan Burke was responsible for daily management of operations and Murphy for acquisitions, capital allocation, and occasional interaction with wall street.
Dan Burke believed his job was to create the free cash flow and Murphy’s was to spend it. They were the most potent tag team duo in the history of capitalism when it comes to shareholder returns.
In 1986 Murphy bought the ABC network for $3.5b with financing from Warren Buffet. This represented over 100% of Capital Cities enterprise value at the time – a bold bet.
In summer of 1995 Buffet suggested to Murphy that he meet Michael Eisner, CEO of Disney at the Allen and Company gathering in Sun Valley, Idaho. Murphy and Eisner fleshed out a deal over a weekend where Disney agreed to buy Capital Records for $19b, a 13.5x cash flow multiple on Capital Records and 28 times net income.
If you had invested $1 with Tom Murphy in 1966, it was worth $204 by 1995.
There are two resources CEO’s have to manage: Financial and Human. Hire the best people and leave them alone. Murphy delegated to the point of anarchy and focused on controlling costs, not revenues. Murphy only had three people at corporate and kept headcount low.
Burke kept legendarily detailed annual budgeting process. Outside of these meetings, managers were left alone and sometimes went months without hearing from corporate.
This anarchy set up in place corrupts you with so much freedom that you can’t imagine leaving.
When Murphy knew what he wanted to buy, he spent years developing relationships with the owners. When Murphy approached Goldenson about buying ABC in 1984, he started with: “Leonard, please don’t throw me out the window, but I’d like to buy your company.
Murphy relied on simple rule for evaluating acquisitions: He’d acquire if he could return double digit after tax return over ten years without leverage.
Murphy had an unusual negotiation strategy. He’d ask seller what they thought their property was worth, and if he thought they offer was fair, he’d take it. If the thought proposal was too high, he’d counter with his best price, if seller rejected, he’d walk away. This saved time.
Bartender at Capital Cities party said: “I’ve worked a lot of corporate events over the years. Capital Cities was only one where you couldn’t tell who the bosses were”. This says a lot about how Tom and Dan thought about over excessive spending and the credit they gave out to the individuals they delegated to.
How I’m applying this chapter to my life and Heyo:
– I used to feel good about the fact that I could answer “20+” when someone asked me how many jobs Heyo has created at a cocktail party or startup event. What’s more important is revenue per employee. Murphy said in this chapter: “The goal is not to have the longest train but to arrive at the station first using the least fuel”.
– One of Heyo’s strengths is storytelling and marketing. We build great relationships and then figure out value added ways to introduce the Heyo product to consumers via those relationships. This strength could be maximized if I had more high quality products to introduce via webinar to each influencers different audience.
A roll-up strategy makes sense here. I’m going to spend time evaluating if I can buy 2-3 companies for under $1m each, introduce their product to the distribution channels we’ve built at Heyo and increase their value. I may also look to invest $50k in 3-4 different social media startups and then help them drive revenue growth. Either way, Heyo spreads it’s wings. Capital Cities under Murphy, as described in this chapter was an extremely successful example of a roll-up that leveraged Capital Cities scale advantages. I’ll follow his playbook.
Chapter 2: An Unconventional Conglomerator: Henry Singleton, Teledyne
Warren Buffet believes Henry Singleton has the best operating and capital deployment record in American business.
In 1960, Teledyne refused to pay dividends despite everyone else doing so, believing they were tax inefficient.
Teledyne started by acquiring 3 small electronics companies. Using this base, they successfully bid for a large naval contract.
Conglomerates, companies with many, unrelated business units, were the internet stocks of their day in the 1960’s.
Conventional wisdom today is that conglomerates are inefficient when compared to their “pure play” competitors (Rackspace is pure play hosting versus Amazon which competes directly with Rackspace but also has other business units)
Most conglomerates in 1960 had high PE ratios which they used to acquire like crazy. (Stock was easier to use as effective bargaining chip)
During this period, there was less competition for deals (private equity didn’t exist yet), and the price to buy control of an operating company was often materially less than the multiple the acquirer traded for in the stock market providing a compelling logic for acquisition.
Singleton used his high PE ratio (arbitrage) to his advantage and between 1961 and 1969 acquired 130 companies. All but two acquisitions were entirely stock based.
Singleton emphasized decentralization. Hire smart people and let them build business units. Those business units would make money, sent back to Singleton who would then decide how to allocate capital.
In 1972, Singleton proposed stock buyback because he felt there was no hire return way to spend capital than on his own stock.
Singleton believes buying stocks at attractive prices was self-catalyzing, analogous to coiling a spring that at some future point would surge forward to realize full value, generating exceptional returns in the process.
Charlie Munger said of Singleton: Like Warren and me, he was comfortable with concentration and bought only a few things that he understood well.
In 1986, Singleton begun to de-conglomerate (starting spinning off business units due to attractive prices).
Most important decision CEO makes is how he spends his time between management of operations, capital allocation, and investor relations. Singleton reserved no day to day operations for himself.
“I do not define my job in any rigid terms but in terms of having the freedom to do whatever seems to be in the best interests of the company at any time. I know people who have specific schedules, but we’re subject to tremendous number of outside influences and the vast majority of them cannot be predicted. So my idea is to stay flexible. 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.” – Singleton
Buffet and Singleton: Separated at birth?
– Both CEO as investor
– Decentralized operations, centralized investment decisions
– Concentrated investments in areas they knew well
– Neither spend meaningful time with analysts
– Don’t pay dividends
– Don’t split stock
– Both had huge insurance businesses and used float to re-invest
How I’m applying this chapter to my life and Heyo:
– This chapter described how conglomerates in the 1960’s enjoyed lofty PE ratios and used the currency of their stock to engage in acquisitions. I’m going to research the PE ratios of publicly traded companies who I believe could be great partners to Heyo. Click here to see my handwritten notes when I got this idea in the book. I’ll then convince them using rational logic to issue stock to Heyo (so we get a piece of their business) in exchange for a partnership with Heyo responsible for delivering revenue growth to the public company leveraging the technology Heyo has already built.
– For example, Hubspot just went public and is trading at a P/E ratio of 0 because they have no earnings. They are losing money but the market is valuing them on top line revenue. Ideally, if we help them drive additional top line revenue, the market values them more. If I can quantify the revenue we could deliver them, it becomes a simple math equation about how much HubSpot stock that revenue growth is worth. This strategy should work well with most SaaS companies who have no earnings and are valued primarily on top line revenue.
Click here to continue reading part 2 of the notes