What Warren Buffett saw in Tom Murphy of Capital Cities/ABC
One of my favorite books is The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success. The Warren Buffett Way is another great book to read if you want to learn more about Tom Murphy and Capital Cities/ABC.
For those who aren’t familiar with Capital Cities, it started as a radio station in 1946 and later added TV broadcasting in 1953. Tom Murphy became the CEO of Capital Cities in 1966, at a time when the station only had five TV stations and four radio stations in small markets. CBS was the dominant media business at the time with more stations in much larger markets. Yet when Tom sold Capital Cities/ABC to Disney 30 years later, it was three times as valuable as CBS. How was this possible? There were many reasons for Murphy/Burke’s success but I’d like to shed light on the biggest drivers:
1. Tom Murphy Made Unconventional Capital Allocation Decisions
“We just kept opportunistically buying assets, intelligently leveraging the company, improving operations and then we’d … take a bite of something else.”
During the 1960s and 1970s, the conglomerate era, CBS did what a lot of other companies were doing- they went on a shopping spree. CBS bought a number of non-core assets, like a toy business and the New York Yankees baseball team. Their claimed rationale was diversification and synergies, but it was clear that their main focus was on making the company larger, not maximizing shareholder value. Murphy’s approach was different, however. Murphy focused on rolling-up the broadcast industry and made over 30 acquisitions over his 30 years at the company. Once he acquired a firm, he would drastically improve the operations, pay down the debt quickly, then buy another firm. It was a virtuous cycle that helped the company benefit from scale over time as their broadcast network grew bigger and bigger.
“The business of business is a lot of little decisions every day mixed up with a few big decisions.”
Murphy’s first move upon becoming CEO was to promote Dan Burke (Murphy went to school with Dan’s older brother Jim) to the role of COO. Burke was put in charge of daily management of the firm and Murphy wanted to focus on capital allocation, a position he felt should not be delegated. Murphy went right to work buying 3 VHF TV stations by 1970. At the time, the FCC only allowed five VHF stations and Cap Cities had hit that limit. Deal prices were favorable and Murphy wasn’t going to let his acquisitions streak stop there. Instead, he started buying newspaper publishing companies in the 1970s (the industry had very close similarities to broadcasting, unlike the NY Yankees baseball team) and in 1980 he entered the cable TV business by purchasing Cablecom. In addition, between the long bear market of the mid-1970s into the early 80s, Murphy aggressively bought back his own stock (~50%) at extremely low single digit P/E multiples. In 1984, the FCC rules around station ownership were changed allowing Murphy to make his largest acquisition ever- ABC. ABC was the biggest non-energy industry business transaction to date at $3.5 billion (with funding from Buffett) and represented greater than 100% of Cap Cities’ enterprise value at the time.
2. Murphy & Burke Cut Unnecessary Cost & Made the Business Lean
“We expect our managers to be forever cost conscious and to recognize and exploit sales potential.”
“Cost control was the baseline of our company culture.” “We worked to make cost-consciousness a part of our company’s DNA. Budgets, which are set yearly and reviewed quarterly, originate with the operating units that are responsible for them.”
Capital Cities margins were industry-leading. Burke and Murphy were maniacal about cost-cutting. They knew they could improve ABC’s TV station margins from the low 30s up to their current levels of 50+ percent. This goal was achieved in only 2 years as they cut lavish perks, eliminated redundant positions, sold unnecessary buildings including their Manhattan HQ, stopped flying first-class, and utilized cabs over limos. The best story in The Outsiders that exemplifies Murphy’s frugalness is when Smith (the former CEO) had asked Murphy to get the former convent that was home to their WTEN studio painted as it was needed a serious facelift to appeal to advertisers. Murphy immediately responded saying that they should only paint the sides facing the road and leave the other two untouched. He would have rather spent that money on production inside the studios (talent, technology, etc.) to make sure that they maintained their leadership in local markets. It wasn’t just about cost-cutting, it was about balancing costs and spending where it mattered to drive revenue growth.
3. Murphy & Burke Believed in A Decentralized Management Approach
“Decentralization is the cornerstone of our management philosophy. Our goal is to hire the best people we can can and give them the responsibility and authority they need to perform their jobs.”
As we saw with the Wells Fargo sales scandal in 2016, a decentralized approach can lead to bad behavior if the culture and incentives aren’t appropriate. Cap Cities headquarters was a skeleton crew and its main goal was to support the managers of each business unit. Titles didn’t appear to mean much at Capital Cities. The firm was united around two main goals: to grow the business in a sustainable manner and to keep costs down.
4. Murphy Maintained a Differentiated, Disciplined Approach
Internal operating cash flow and debt were the biggest funding sources for Murphy. He rarely used his own stock as currency. He paid little dividends, and his high and consistent levels of operating cash flow aided in funding his capital allocation decisions. Once he paid off his debt on assets he acquired, he would leverage them again and use that leverage to buy more assets that produced high levels of cash flow. He had a strong track record of paying down debt ahead of expectations and the ABC debt was eliminated in only three years after the transaction. Murphy knew how much he was willing to pay for a deal before he stepped in a meeting. He was a value investor at heart. He once passed on a Texas newspaper deal involving three properties over $5 million. Buybacks were a huge component of Murphy’s capital allocation and over his career buybacks were the 2nd biggest spend of cash flow behind the ABC deal. Murphy committed nearly $2 billion to buybacks over his tenure and if you look when he opportunistically bought back stock, it was during periods in which the company was trading at single-digit valuation multiples.
Conclusion
In 1995, Murphy sat down with the CEO of Disney (Eisner) at the annual Allen & Co. event in Sun Valley and Murphy sold Capital Cities/ABC for a whopping $19 billion. This was a multiple of 13.5x the company’s cash flow and 28x their net income. It was a no brainer for his shareholders and a fantastic accomplishment as Murphy entered the final stages of his career.
Buffett once said that “Tom Murphy and Dan Burke were probably the greatest two-person combination in management that the world has ever seen, or maybe ever will see.”
After reading a simple 22-page chapter in The Outsiders, I have a pretty good sense that Buffett was 100% right in making this statement. Murphy and Burke had clearly defined separate roles and they both executed on those roles in a remarkable fashion. They created a strong corporate culture with minimal headquarter interference, they made acquisitions at fair prices that created scale and increased market share, they were maniacal about controlling costs, they aggressively bought back shares when the market was significant undervaluing the company, they maintained a disciplined approach, and never over-levered the company.
Capital Cities/ABC hit on all of the pillars of a great stock story. Tom Murphy had a 19.9% annual rate of return during his 29-year tenure, significantly above the 10.1% return of the S&P 500 and 13.2% average annual return of leading peer media companies. You don’t need to find a plethora of great companies like Cap Cities to make a career in value investing. It only takes a few. The key is to identify these great companies in the early stages of building out their defensible moats. In Cap Cities case, the underlying operating businesses were solid and slowly building momentum as scale increased, the management team was extraordinary, the company was structured in such a way that goals were achieved, and Tom Murphy was ridiculously good at strategic/opportunistic capital allocation decision making.