The Outsiders

by William N. Thorndike

Henry Singleton

Thorndike describes Singleton who was of Teledyne which was a conglomerate.

The author states that Singleton should be given the title as the best CEO in recent history due to this ability to effectively allocate capital. “CEOs need to do two things well to be successful: run their operations efficiently and deploy the cash generated by those operations. Most CEOs focus on managing operations, which is undeniably important. Singleton, in contrast, gave most of his attention to the later task.

If you think of capital allocation more broadly as resource allocation and include the deployment of human resources, you find again that Singleton had a highly differentiated approach..He believed in extreme form of organisational decentralisation with a wafer-thin corporate staff at headquarters and operational responsibility and authority concentrated in the general managers of the business units.

The great CEOs were all “outsiders” and followed the same set of principles:

1. Capital Allocation is a CEO’s most important job.
2. What counts in the long run is the increase in per share value not overall growth or size.
3. Cash flow, not reported earnings, is what determines long term value.
4. Decentralised Organisations release entrepreneurialism and keep both costs and rancor down.
5. Independent thinking is essential to long-term success.
6. Sometimes the best investment opportunity is your own stock.
7. With acquisitions, patience is a virtue..as is occasional boldness.

The author describes how all the CEOs mentioned in this book came from a variety of backgrounds. Isaiah Berlin introduced the contrast between the “fox”, who knows many things, and the “hedgehog”, who knows one thing but knows it very well. All the CEOs in the book were fox’s with their familiarity of other disciplines translating to new perspectives and approaches.

It is impossible to produce superior performance unless you do something differently — John Templeton (Investor)

In addition, these eight CEOs were not charismatic visionaries, they were practical and agnostic in temperament and they systematically tuned out the noise of conventional wisdom by fostering a certain simplicity of focus and cut through the noise and clutter to zero in the core economics of their business. All these CEOs managed to avoid the institutional imperative. In Berkshire Hathaway’s 1990 letter to shareholders, Warren Buffett defined the institutional imperative as “the tendency of executives to mindlessly imitate the behaviour of their peers, no matter how foolish it may be to do so.”

Tom Murphy & Capital Cities Broadcasting

When Murphy became CEO of Capital Cities in 1966, CBS was the dominant media company with CBS’s market cap 16x Capital Cities. Thirty years later, Capital Cities was three times as valuable as CBS.

How was this done?

There is a fundamental humility to decentralisation, an admission that headquarters does not have all the answers and that much of the real value is created by local managers in the field. At no company was decentralisation more central to the corporate ethos than at Capital Cities.

Decentralisation — The hallmark of the corporate culture was stated succinctly in a single paragraph on the insider cover of every Capital Cities annual report: ‘Decentralisation 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 or managers…to be forever cost conscious and to recognise and exploit sales potential”.

Hiring — The company’s guiding human resource philosophy was “to hire the best people you can and leave them alone.” The company’s hiring practices were equally unconventional. With no prior broadcasting experience themselves before joining Capital Cities, Murphy and Burke shared a clear preference for intelligence, ability, and drive over direct industry experience. They were looking for talented, younger foxes with fresh perspectives. When the company made an acquisition or entered a new industry, it inevitably designated a top Capital Cities executive, often from an unrelated division, to oversee the new property.

Frugality — Frugality was key to the Ethos. It was believed that the best defence against the revenue lumpiness of advertising supported businesses was a constant vigilance on cost. Managers were expected to outperform their peers, and great attention was paid to margins, which Burke viewed as “a form of report card.” Outside of these meetings, managers were left alone and sometimes went months without hearing from corporate. This autonomy was beloved by employees, who rarely left the company for any competitors.

Humility — Phil meek told me a story about a bartender at one of the management retreats who made a handsome return by buying Capital Cities stock in the early 1970s. When an executive later asked why he had made the investment, the bartender replied, “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.”

Henry Singleton & Teledyne

I change my mind when the facts change, what do you do? — John Maynard Keynes

Singelton co-founded Teledyne, Inc., one of America’s most successful conglomerates and was its chief executive officer for three decades.Over its first ten years as a public company, Teledyne’s earnings per share (EPS) grew an astonishing sixty-four-fold, while shares outstanding grew less than fourteen times, resulting in significant value creation for shareholders.

Dividends vs Buybacks

Singleton as did all the other “Outsiders” was against issuing dividends vs share buybacks.

Buybacks — A share buyback refers to the purchase by a company of its shares from the marketplace. The biggest benefit of a share buyback is that it reduces the number of shares outstanding for a company. This usually increases per-share measures of profitability like earnings-per-share (EPS) and cash-flow-per-share, and also improves performance measures like return on equity. These improved metrics will generally drive the share price higher over time, resulting in capital gains for the shareholders.

When a company pays a dividend it’s already been taxed once. And once the shareholder received the dividend, he or she will be taxed again. Where as buyback will not trigger any tax event for the shareholder.

The Whiz Kids

The Whiz Kids were a group of ten United States Army Air Forces veterans of World War II who became Ford Motor Company executives in 1946.

After the war ended in 1945, the ten Air Force officers who ran Stat Control sold themselves as a group to Henry Ford II. They met with Henry and promised to bring statistical rigor to Ford using the techniques they had developed. They had a huge impact at Ford in the 1950s and 1960s, creating a dynasty and legacy that has influenced almost every American corporation and MBA student ever since.

In many ways, Tex’s group were among the first management consultants. They made decisions based on facts instead of intuition (as they didn’t have any intuition or industry knowledge). They didn’t really care about the product that Ford was making; to them, Ford was a collection of statistics. They could just as easily have been working for a firm that manufactured soap or televisions.

How did Teledyne perform so well?

Cash Flow — Singleton eschewed reported earnings, the key metric on Wall Street at the time, running his company instead to optimize free cash flow. He and his CFO, Jerry Jerome, devised a unique metric that they termed the Teledyne return, which by averaging cash flow and net income for each business unit, emphasized cash generation and became the basis for bonus compensation for all business unit general managers.

Sharebuybacks — The next phase in Teledyne’s value-creating process was Singleton’s iconic share repurchases, where he bought back an outlandish 90 percent of Teledyne’s outstanding shares. “No one has ever bought in shares as aggressively,” stated Charlie Munger, which reveals the extent of the contrast between the Teledyne strategy of the 1960s and the 1970s. This showed the flexibility of Singleton to understand the right times to sell his stock (at high valuations) and buy his stock (at low valuations). Singleton executed this remarkably well, issuing shares at an average P/E of 25, and buying back at an average P/E of less than 8. 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.

Bill Anders and General Dynamics

Bill Anders’ turnaround strategy for General Dynamics rested on a few key principles:

Focus On Shareholders — Anders’s first order of business was to refocus the company on the shareholders. Over the years, General Dynamics had become cash flow negative due to a focus on creating the most innovative, new, weaponry instead of making expenditures to develop the best returns. To begin the turnaround, Anders brought his own team to replace 21 of 25 top executives, to completely reshape the culture of the company. The newcomers were led by Jim Mellor, COO, “the type of person who would look for the last nickel and hold people responsible.”

Only be in businesses where General Dynamics had the number one or number two market positions,

Exit commodity businesses with low returns, and

Stick to business it knew very well.

Rationality rules

Anders made the rational business decision [to sell General Dynamic’s F-16 business to Lockheed], the one that was consistent with growing per share value, even though it shrank his company to less than half its former size and robbed him of his favorite perk as CEO: the opportunity to fly the company’s cutting-edge jets. This single decision underscores a key point across the CEOs in this book: as a group, they were, at their core, rational and pragmatic, agnostic and clear-eyes.

Warren Buffet

The most powerful force in the universe is compound interest.— Albert Einstein

Although Warren Buffet’s successful history career with Berkshire Hathaway is far too detailed to briefly summarise, it is important to note the three areas that drive Warren Buffett, coined “the capital flywheel.”

The Secret Of The Float — As quoted by Charlie Munger, iconic lieutenant at Berkshire, the secret to their long-term success has been the ability to “generate funds at 3 percent and invest them at 13 percent.” For capital generation, the amazing truth is Berkshire has generated a grand majority of it’s investment capital from internal sources — primarily, it’s insurance float. Insurance companies, the groundwork of Berkshire Hathaway, require premiums to be paid to the insurer before anything bad happens to enact payment. The insurer holds the money until something goes wrong but does not own it, rather referring to it as the company float. During the time the insurer holds the float it is invested, similarly to debt but generally at a much lower implied interest rate. Float has grown enormously for Berkshire over the years, from $237 million in 1970 to $70 billion in 2011, fueling the investment returns found all around their business.

Capital Allocation — When it comes to capital allocation, Berkshire levies the most central approach in the world and goes against his philosophy of decentralisation. Mr. Buffett insists on all extra cash being sent to Omaha for allocation, from where he uses his wide variety of industry expertise to choose the next high-return investment. More so than any other CEO, Mr. Buffet has a wide palate of expertise areas that serves as a possible investment zones, creating a competitive advantage to Berkshire’s shareholders.

Cash Flow — As far as Berkshire goes to control cash for allocation, the company may go even further in their efforts to decentralize their operations. In a company with over 270,000 employees, Berkshire employs a grand total of 23 individuals at the corporate headquarters. The companies hold no regular budget meetings with Berkshire, and simply never hear from Buffet unless they themselves seek him out for advice. His approach to “hire well, manage little” has shown to be successful over the years.

What Did The Outsiders All Have In Common?

Relied On Simple 1 Page Analysis For Decision Making — Outsiders boiled down decisions to their simplest form.

Decentralisation & Centralisation —As Charlie Munger described it to me, their companies were “an odd blend of decentralised operations and highly centralised capital allocation,” and this mix of loose and tight, of delegation and hierarchy, proved to be a very powerful counter to the institutional imperative.