Many people would say that it was Jack Welch, who achieved a 20.9% annual compounded shareholder return during his 20 years as CEO of General Electric from 1981-2001. However, during this period, the S&P 500 grew at an annualized rate of 14%, which is almost twice its long-term return. In other words, Welch achieved a 20% return in a bull market and only outperformed the market by 6%. On the other hand, Henry Singleton achieved an annualized return of 20.4% for Teledyne shareholders during his 27-year tenure from 1963-1990, while the S&P 500 returned 10% during the same period. Singleton outperformed the market by 10% over a longer period of time, including several long bear markets. Singleton's success was not due to a unique or rapidly growing business, but rather his unparalleled capital allocation ability.
The CEO's main responsibilities are only two: managing operations and allocating cash flow generated from the business. Most CEOs focus on the former, while Singleton focuses on the latter. Capital allocation skills can be divided into two categories: fundraising and allocation. The three tools for fundraising are: business profitability, debt issuance, and new stock issuance. The five options for asset allocation are: investing in existing businesses, mergers and acquisitions, dividends, debt repayment, and stock buybacks. Singleton used Teledyne's funds for large-scale share buybacks and selective M&A. He rarely issued new shares, frequently used debt (which can reduce taxes through the debt shield), and did not pay dividends until the late 1980s (dividends are taxed twice). His peers, on the other hand, issued new shares for company acquisitions, paid dividends, avoided stock buybacks, and rarely borrowed money. Different asset management methods have resulted in vastly different outcomes, with Singleton's annualized return being 20% and his peers' being 11%. If human resource management is also viewed as a form of asset allocation, Singleton's approach is completely different from that of others. He advocated for a decentralized organizational structure, with only a small number of employees at the headquarters and decision-making power given to the general managers of each business unit. Other CEOs hired large numbers of vice presidents and MBAs at headquarters to manage business in various regions.
Singleton is not alone in his views, and there are some other CEOs who share similar opinions: 1. Capital allocation is the most important job for a CEO; 2. In the long run, what is important is the growth of earnings per share, not the overall size of the company; 3. Cash flow determines long-term value, not reported profits; 4. Decentralized organizational structures release corporate profits, reduce costs and friction; 5. Independent thinking is crucial for long-term success, and dealing with outside advisors (Wall Street, business media, etc.) can be distracting and wasteful of time; 6. Sometimes the best investment opportunity is one's own stock; 7. In terms of acquisitions, patience is a virtue, but occasionally bold action is necessary. Outsider CEOs are rare, with only seven besides Singleton.
Holding similar views to Singleton, they all agree that the value of a company lies in its cash flow, and that the CEO's responsibility is to maximize the long-term value of earnings per share. These CEOs actively buy back stock when their company's shares are undervalued and use stock to acquire other companies when their shares are overvalued. They also cut off poorly performing businesses rather than blindly pursuing growth. They rarely pay dividends, actively use debt, and adopt decentralized organizational structures. They are all skilled at independent thinking and seldom deal with Wall Street. In short, they do not seem like managers, but rather like investors.
Tom Murphy and Capital Cities Broadcasting
In 1966, CBS was the largest broadcasting company in the United States, with its CEO Bill Paley buying a toy company and the New York Yankees baseball team, building a huge office building in Manhattan, and having 42 presidents and vice-presidents. On the other hand, Capital Cities had only five TV stations and four radio stations, but its CEO Murphy focused on the media industry he was good at, continuously acquiring TV stations, managing them well, occasionally buying back stocks, and ultimately, after thirty years, Capital Cities' market value was three times that of CBS.
Murphy's secret was to focus on industries with strong economic advantages, selectively use leverage to purchase large assets, improve operations, repay debt, and repeat the process. At the same time, he avoided diversification, rarely paid dividends, rarely issued new shares, actively used leverage, frequently bought back stocks, and made a big acquisition every long period of time. He used free cash flow to buy back stocks and leveraged mergers and acquisitions. Although revenue was uncontrollable, costs were controllable, so they needed to be minimized as much as possible.
Statistics show that about two-thirds of acquisitions destroy shareholder value. However, decentralization led to Capital Cities' business profits being higher than its competitors, so the acquisition often improved profitability. From 1966 to 1995, its annual compound growth rate was 19.9% over 29 years, compared to 10.1% for its peers in the same industry and 13.2% for the S&P 500.
Henry Singleton and Teledyne
In 1966, CBS was the largest broadcasting company in the United States, and its CEO Bill Paley purchased a toy company and the New York Yankees baseball team, built a huge office building in Manhattan, and had 42 presidents and vice presidents. In contrast, Capital Cities had only five TV stations and four radio stations, but its CEO Murphy focused on the media industry he was good at, constantly acquiring TV stations, improving operations, occasionally buying back shares, and after thirty years, Capital Cities' market value was three times that of CBS.
Murphy's secret was to focus on industries with strong economic advantages, selectively use leverage to purchase large assets, improve operations, repay debt, and repeat this process. At the same time, he avoided diversification, rarely issued dividends, rarely issued new shares, actively used leverage, frequently repurchased shares, and made a big acquisition every once in a while. He used free cash flow to repurchase shares and used leverage to acquire and merge. Although revenue is uncontrollable, costs are controllable, so minimizing costs is key.
According to statistics, about two-thirds of acquisitions destroy shareholder value. However, the decentralization of Capital Cities resulted in higher business profits than its competitors, so acquisitions often increased profit margins. From 1966 to 1995, for 29 years, the annualized growth rate was 19.9%, compared to 10.1% for its industry peers, and 13.2% for the S&P 500.
Bill Anders and General Dynamics
After the collapse of the Soviet Union, revenue for military-industrial companies, including General Dynamics, dropped significantly. After Anders became CEO of General Dynamics, he withdrew from many businesses: those that were not the first or second in their field, low-return commodity businesses, and businesses that they were not good at. He was more focused on shareholder interests than an engineer's mindset, always striving for better weapons. He also improved business and management, increasing profit margins. He reduced the workforce by 80%, moved the headquarters from St. Louis to Northern Virginia, established a funding approval process, and greatly reduced working capital. As long as the price was right, core businesses could be sold. In less than three years, more than half of the company was sold, generating $5 billion in cash, most of which was returned to shareholders through reasonable tax avoidance methods.
Anders' successor Mellor spent $400 million to acquire Bath Iron Works, one of the largest naval shipbuilders in the United States. Mellor's successor Chabraja's acquisition strategy: focus on small acquisitions around the existing business chain. In 1999, Chabraja acquired Gulfstream, the world's largest manufacturer of commercial aircraft, for $5 billion, which was equivalent to 56% of the company's market value. The acquisition was completed through the issuance of shares, with a PE of 23 times, compared to the historical average of 16 times. The revenue from commercial aviation business can balance the volatility of military-industrial revenue. The organizational structure is also decentralized, with power delegated, but with strict budget assessment indicators. At the same time, it aligns the compensation of management with shareholder interests, with bonuses and preferred stock options as a core component of management compensation. From 1991 to 2008, the compound annual growth rate was 23.3%, compared to 17.6% for peers and 8.9% for the S&P 500.
John Malone and TCI
In late 1970, Malone jumped from McKinsey to TCI because he was optimistic about the cable television business: highly predictable and reliable income, tax incentives, and fast growth. Cable TV users pay monthly fees, rarely stop using the service, and revenue is easily predicted. TCI initially expanded rapidly by leveraging debt, and when Malone joined in 1973, the debt was 17 times the operating income. Then they faced new regulatory rules, the Arab oil embargo caused liquidity stress, and the heavy debt burden made the market pessimistic, and they couldn't issue new stock to pay off the debt.
Malone also adopted a decentralized structure while strictly controlling costs. He told each business manager that with a 10% annual user growth rate while maintaining profits, they could make independent decisions. The headquarters were very simple, and the staff was few, and they stayed in motels when traveling. According to statistics, there is a clear negative correlation between building a sophisticated new headquarters building and investor returns. Malone was an investor and capital allocator, and his partner COO Sparkman managed the company's operations, and managers who did not complete their tasks were fired. Cable TV business has obvious economies of scale: 40% of the cost is the cost of program suppliers, and the more users, the higher the profit. Therefore, the benefits of acquisitions are significant. Cheaper debt can be borrowed from insurance companies.
Malone created the concept of EBITDA, which is now widely used. The best strategy for cable TV companies is to use all available means to minimize revenue and taxes and use pre-tax cash flow as internal growth and acquisition funds. From 1973 to 1978, Malone completed 482 acquisitions, an average of one every two weeks. Malone did not participate in the franchise wars in major cities but focused on spending less on rural and suburban users. When he obtained a franchise and the company disintegrated due to debt and other reasons, Malone acquired the franchise at a low price. He also actively bought the ownership of program production units because TCI has a large user base and there are joint effects. In the late 1990s, Malone decided to sell the company: competition from satellite TV was increasingly fierce, the huge cost of updating rural systems, and uncertainty about management succession. Finally, it was sold to AT&T, and Malone personally negotiated and made the entire transaction a stock deal, enabling shareholders to avoid capital gains tax. Financial leverage can expand financial returns and provide debt shields for tax exemption, but excessive leverage also has the risk of cash flow disruption. Malone believed that total debt should be 5 times EBITDA. Avoid cross-guaranteeing subsidiaries, so that even if one company defaults on debt, it will not affect the credit of the entire company, like a sealed compartment of a ship. Malone made the company in a net operating loss state through depreciation and pre-tax interest deductions, so that assets can be sold without being taxed. He also hired many tax experts and held weekly meetings to formulate tax strategies. Let peers try new technologies and be followers. The standard for acquiring companies: they can easily save costs from program production and expenses, and the acquisition price is no more than five times the cash flow. During Malone's tenure, more than 40% of the company's shares were repurchased. There was an employee stock ownership plan, and no senior management left the company in the first 16 years. The compound annual return from 1973 to 1998 was 30.3%, while other cable TV companies were 20.4%, and the S&P 500 was 14.3%.
Warren Buffett and Berkshire Hathaway
Berkshire started as a textile company, but Buffett used the company's earnings to acquire an insurance company and used the excess cash for investments. Only companies with low capital requirements and pricing power are best suited to resist inflation, such as consumer goods and media companies with franchise rights, dominant market positions, or well-known brands. Graham focused on current assets, such as the balance sheet, while Buffett focused on the future, such as brands and market share, relying on discounted cash flow and asset reset values. In 1973, Buffett fully acquired Sees's Candies for $25 million, even though the company's tangible book value was only $7 million and pre-tax profits were $4.2 million. According to Graham's standards, this price was too high, but Buffett believed the brand was popular and had potential pricing power. The company later delivered a compound annual return of 32% over 27 years. Charlie Munger said the secret to success is forming funds at a cost of 3% and achieving returns of 13% on investments. Buffett's investment method is to purchase businesses that generate a lot of cash and use that cash for new investments. Management activities are decentralized, but capital allocation is highly centralized.
The more investment options a CEO has, the greater the likelihood of making high-yield decisions. Exiting low-yield businesses and investing in high-yield ones. Long periods of inactivity, with occasional large investments. Prices far below intrinsic value provide sufficient margin of safety. Corporate culture: emphasis on thrift, independent thinking, and long-term management.
Common traits of outsider CEOs:
Calculate investment returns.
Maximize per-share value, which can be achieved by reducing the denominator through share buybacks.
Confident and independent, with highly centralized investment decision-making.
Extraordinary charisma is not so important.
Patiently wait for the right opportunities.
Act quickly when good opportunities arise.
Make rational decisions and allocate capital to the most efficient and highest-yielding projects.
Take a long-term view, even if it requires sacrificing short-term gains.
Insights for investing
Investors should look for CEOs whose goal is to maximize shareholder value, but the majority of CEOs aim to make the company bigger, which may not always align with investor interests.
These outsider CEOs are more like investors themselves and are skilled in mature market capital allocation; in the early stages of a company or an industry with an unclear landscape, this type of CEO may not be suitable.
It is unlikely to find these outsider CEOs among the founders of companies, as they would rather focus on making the company's core business bigger and stronger, rather than prioritizing investor interests.
When the various business units of a company are closely related, such as in the current era of the internet, can this decentralized and autonomous structure still play a role in reducing costs and increasing efficiency?
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