Learning - The Outsiders (William N T)

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)

• On Focus

“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.”

• On hiring and retaining

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.”

• On focus

“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.”

• On Repurchase of shares

“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)

• On McKinsey Consulting

“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)

• On Mindset

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.”

• On Clarity

“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.”

• On Economic reality

“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.”

• On analytical thinking

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)

• On issue of equity

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)

• On Float

“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