If one aspires to be a Chief Executive Officer (CEO) or
as an investor wishes to identify companies with great prospects, then The Outsiders – Eight unconventional CEOs and their Radical Rational Blueprint for Success
by William N T is a must read.
The book Outsiders is basically a statement on Jack Welch
the Super CEO, who did nothing extraordinary. He was lucky enough to enter the
pond during high tide and handed over to Jeff Immelt prior to Low tide.
Parameters that tie the unconventional CEO’s:
- Stock Repurchase
- Use of Debt
- Strong cash flow
- Avoid issuing equity
- Frugal / Undisturbed living
Why Jack Welch was not the best CEO?
Jack Welch was credited with General Electric’s phenomenal
growth in Market Capitalization. However, William Thorndike brings out a acceptable
statement:
“Context
matters greatly—beginning and ending points can have an enormous impact, and
Welch’s tenure coincided almost exactly with the epic bull market that began in
late 1982 and continued largely uninterrupted until early 2000. During this
remarkable period, the S&P averaged a 14 percent annual return, roughly
double its long-term average. It’s one thing to deliver a 20 percent return
over a period like that and quite another to deliver it during a period that
includes several severe bear markets.
A
baseball analogy helps to make this point. In the steroid-saturated era of the
mid- to late 1990s, twenty-nine home runs was a pretty mediocre level of
offensive output (the leaders consistently hit over sixty). When Babe Ruth did
it in 1919, however, he shattered the prior record (set in 1884) and changed
baseball forever, ushering in the modern power-oriented game. Again, context
matters.”
Henry Singleton
“Known
today only to a small group of investors and cognoscenti, Henry Singleton was a
remarkable man with an unusual background for a CEO. A world-class
mathematician who enjoyed playing chess blindfolded, he had programmed MIT’s
first computer while earning a doctorate in electrical engineering. During
World War II, he developed a “degaussing” technology that allowed Allied ships
to avoid radar detection, and in the 1950s, he created an inertial guidance
system that is still in use in most military and commercial aircraft. All that
before he founded a conglomerate, Teledyne, in the early 1960s and became one
of history’s great CEOs.”
- On CEO’s role and Capital Allocation
“CEOs
need to do two things well to be successful: run their operations efficiently
and deploy the cash generated by those operations. Most CEOs (and the
management books they write or read) focus on managing operations, which is
undeniably important. Singleton, in contrast, gave most of his attention to the
latter task.
Basically,
CEOs have five essential choices for deploying capital—investing in existing
operations, acquiring other businesses, issuing dividends, paying down debt, or
repurchasing stock—and three alternatives for raising it—tapping internal cash
flow, issuing debt, or raising equity. Think of these options collectively as a
tool kit. Over the long term, returns for shareholders will be determined
largely by the decisions a CEO makes in choosing which tools to use (and which
to avoid) among these various options. Stated simply, two companies with
identical operating results and different approaches to allocating capital will
derive two very different long-term outcomes for shareholders.
Essentially,
capital allocation is investment, and as a result all CEOs are both capital
allocators and investors. In fact, this role just might be the most important
responsibility any CEO has, and yet despite its importance, there are no
courses on capital allocation at the top business schools. As Warren Buffett
has observed, very few CEOs come prepared for this critical task:
“The
heads of many companies are not skilled in capital allocation. Their inadequacy
is not surprising. 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.”
What is important to focus on?
- Capital
allocation is a CEO’s most important job.
- What
counts in the long run is the increase in per share value, not overall growth
or size.
- Cash
flow, not reported earnings, is what determines longterm value.
- Decentralized
organizations release entrepreneurial energy and keep both costs and “rancor”
down.
- Independent
thinking is essential to long-term success, and interactions with outside
advisers (Wall Street, the press, etc.) can be distracting and time-consuming.
- Sometimes
the best investment opportunity is your own stock.
- With
acquisitions, patience is a virtue . . . as is occasional boldness.
Tom Murphy (Capital Cities)
“The
goal is not to have the longest train, but to arrive at the station first using
the least fuel.”
“The
business of business is a lot of little decisions every day mixed up with a few
big decisions.”
“This
is the acquisition I’ve been training for my whole life.”
Murphy
and Burke believed that even the smallest operating decisions, particularly
those relating to head count, could have unforeseen long-term costs and needed
to be watched constantly.
Burke
recalls Smith saying, “The system in place corrupts you with so much autonomy
and authority that you can’t imagine leaving.”
Henry Singleton (Teledyne)
- On lack of politics at Teledyne one of the managers
stated:
“No
one worried who Henry was having lunch with.”
“If
anyone wants to follow Teledyne, they should get used to the fact that our quarterly
earnings will jiggle. Our accounting is set to maximize cash flow, not reported
earnings.”
“Singleton
believed repurchases were a far more tax-efficient method for returning capital
to shareholders than dividends, which for most of his tenure were taxed at very
high rates. Singleton believed buying stock at attractive prices was
selfcatalyzing, analogous to coiling a spring that at some future point would
surge forward to realize full value, generating exceptional returns in the
process. These repurchases provided a useful capital allocation benchmark, and
whenever the return from purchasing his stock looked attractive relative to
other investment opportunities, Singleton tendered for his shares.”
Bill Anders (General Dynamics)
- The commendable part of Bill Anders:
Divesting business
Generating Cash pile
Repurchase of share
Succession planning (CEO’s)
- Advise for Company with High PE Ratio:
As
Chabraja described it to me, “What drove me was the realization that the stock
was trading at a significant premium to our historic norm: twenty-three times
next year’s projected earnings versus an historic average of sixteen times. So
what do you do with a high-priced stock? Use it to acquire a premium asset in a
related field at a lower multiple and benefit from the arbitrage.”
John Malone (TCI)
EBITDA was first introduced by John Malone in Business
world.
Applying
his engineering mind-set, Malone looked for nobrainers, focusing only on
projects that had compelling returns. Interestingly, he didn’t use
spreadsheets, preferring instead projects where returns could be justified by
simple math. As he once said, “Computers require an immense amount of detail. .
. I’m a mathematician, not a programmer. I may be accurate, but I’m not
precise.”
Katharine Graham (Washington Post)
“Ironically,
in the early 1980s, the management consulting firm McKinsey advised the company
to halt its buyback program. Graham followed McKinsey’s advice for a little
over two years, before, with Buffett’s help, coming to her senses and resuming
the repurchase program in 1984. Donald Graham reckons this high-priced McKinsey
wisdom cost Post shareholders hundreds of millions of dollars of value, calling
it the “most expensive consulting assignment ever!”
Bill Stiritz (Ralston Purina)
When
asked to summarize what made Stiritz different, Mauboussin told me, “Effective
capital allocation . . . requires a certain temperament. To be successful you
have to think like an investor, dispassionately and probabilistically, with a
certain coolness. Stiritz had that mindset.”
“His
protégé, Pat Mulcahy, who would later run the business, described Stiritz’s
approach to the seminal Energizer acquisition: “When the opportunity to buy
Energizer came up, a small group of us met at 1:00 PM and got the seller’s
books. We performed a back of the envelope LBO model, met again at 4:00 PM and
decided to bid $1.4 billion. Simple as that. We knew what we needed to focus
on. No massive studies and no bankers.”Again, Stiritz’s approach (similar to
those of Tom Murphy, John Malone, Katharine Graham, and others) featured a
single sheet of paper and an intense focus on key assumptions, not a forty-page
set of projections.”
“He
focused on newfangled metrics, like EBITDA and internal rate of return (IRR),
that were becoming the lingua franca of the nascent private equity industry,
and he eschewed more traditional accounting measures, such as reported earnings
and book value, that were Wall Street’s preferred financial metrics at the
time. He had particular disdain for book value, once declaring during a rare
appearance at an industry conference that “book equity has no meaning in our
business,” a statement that was greeted with stunned silence by the audience,
according to longtime analyst John Bierbusse. Mauboussin added, “You have to
have fortitude to look past book value, EPS, and other standard accounting
metrics which don’t always correlate with economic reality.”
Stiritz
was fiercely independent, and actively disdained the advice of outside
advisers. He believed that charisma was overrated as a managerial attribute and
that analytical skill was a critical prerequisite for a CEO and the key to
independent thinking: “Without it, chief executives are at the mercy of their
bankers and CFOs.” Stiritz observed that many CEOs came from functional areas
(legal, marketing, manufacturing, sales) where this sort of analytical ability
was not required. Without it, he believed they were severely handicapped. His
counsel was simple: “Leadership is analysis.”
Dick Smith (General Cinema)
Smith
disdained equity offerings. In fact, he almost entirely avoided issuing equity
from the time of the company’s IPO until issuing a microscopic number of shares
in 1991 to facilitate favorable tax treatment for the HBJ transaction. As he
said to me, “We never issued any stock. I was like a feudal lord, holding onto
the ancestral land!”
Warren Buffet (Berkshire Hathway)
“Float
is money we hold but don’t own. In an insurance operation, float arises because
premiums are received before losses are paid, an interval that sometimes
extends over many years. During that time, the insurer invests the money.” This
is another example of a powerful iconoclastic metric, one that the rest of the
industry largely ignored at the time.
- Focus on acquired company is on
As
Charlie Munger points out, “Unlike operations (which are very decentralized),
capital allocation at Berkshire is highly centralized.”
- On benefits of associated with Berkshire Hathway
“Buffett
has created an attractive, highly differentiated option for sellers of large
private businesses, one that falls somewhere between an IPO and a private
equity sale. A sale to Berkshire is unique in allowing an owner/operator to
achieve liquidity while continuing to run the company without interference or
Wall Street scrutiny. Buffett offers an environment that is completely free of
corporate bureaucracy, with unlimited access to capital for worthwhile
projects. This package is highly differentiated from the private equity
alternative, which promises a high level of investor involvement and a typical
five-year holding period before the next exit event.”
- Final nail in the Welch coffin
|
Comparison of Welch’s
and Buffett’s approaches to management
|
|
Parameters
|
Welch
|
Buffet
|
|
Earnings pattern
|
Smooth
|
Lumpy
|
|
Employees
|
400,000
|
270,000
|
|
Headquarters staff
|
Thousands
|
23
|
|
Travels
|
Lot
|
Little
|
|
Primary Activity
|
Meetings
|
Reading
|
|
Investor Relations
Time
|
A
Lot
|
None
|
|
Tone of workday
|
Frentic/
Busy
|
Quite/Unscheduled
|
|
Change Managers
|
A
Lot
|
Almost
Never
|
|
Off-site meetings
|
Frequently
|
Never
|
|
Strategic Planning
|
Regularly
|
Never
|
|
Stock Splits
|
Yes
|
No
|
Overall
“The
outsider CEOs were master delegators, running highly decentralized
organizations and pushing operating decisions down to the lowest, most local
levels in their organizations. They did not, however, delegate capital
allocation decisions. As Charlie Munger described it to me, their companies
were “an odd blend of decentralized operations and highly centralized capital
allocation,” and this mix of loose and tight, of delegation and hierarchy,
proved to be a very powerful counter to the institutional imperative. In
addition to thinking independently, they were comfortable acting with a minimum
of input from outside advisers. There is something out of High Noon in John
Malone showing up solo to face a phalanx of AT&T corporate development
staff, lawyers, and accountants; or Bill Stiritz showing up alone with a yellow
legal pad for due diligence on a potential multibillion-dollar transaction; or
Warren Buffett making a decision on a potential acquisition for Berkshire in a
single day without ever visiting the company.”
“.....a
virtually identical blueprint: they 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.”
Conclusion
Learning from the Singleton is that Repurchase of Stocks
with consistent growth in earnings , profits and a strong cash flow is a sure
fire way of increasing share value. Indeed a powerful mechanism.
Agreed in
better times instead of declaring high dividends indulge in share repurchase, especially when the stock price is beaten up due to Global / Trade / International factors.
Benefits:
- Tax efficient methodology
- Reduction of Outstanding Share Capital
- Increase in Share value
Corporate Head quarters
If you are a conglomerate make sure you do not have more
than handful of employees sitting at Head quarters.
Book:
The Outsiders : Eight Unconventional CEOs And Their Radically Rational Blueprint for Success.
Author:
William N Thorndike
