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Hello LPs! We are posting the audio of our book club zoom session with Will Thorndyke from The Outsiders. This discussion was just fantastic. Thank you to everyone who joined and
The video recording of the Zoom session is online in the LP Google Drive folder, so you can access that there. We have also posted Ben and my notes on the book, on The Outsiders, both online and right here below in the show notes. So feel free to share, copy those, add to them. There's a Google Doc version of them in the LP folder that anyone can jump in and add to.
And this whole thing, this book club, we're only, this is only our second one, but the series has just been fantastic. And thank you to everyone who's been joining and asking great questions of these amazing authors. And we want to make it a big part of the special experience for all of you as LPs going forward. So stay tuned for our next announcement of our next session. And with that, on to Will and the Outsiders.
To get started, A, Will, thank you so much for joining us. This is going to be awesome. We're like nothing I love better than 8 a.m. on a Friday morning discussing capital allocation and outsider CEOs. That's just capital allocation. Yeah, it's great. We thought maybe as a kind of warm up, we'd ask you a meta question about the book, which is how did it come about? How did you get interested in this question of what made for...
an outsider CEO, a radically successful CEO. And how did you end up writing this book? Yeah. So this book grew out of a talk that I gave about a dozen years ago at a biannual conference that, so I work in, I'm a private equity investor by profession. And every other year, our firm hosts a conference for our portfolio company CEOs.
So that includes sort of the current group of CEOs, as well as alumni, people whose companies we've exited from, and then sort of the farm team of CEOs who we hope to work with. We gather that group every other year and have sort of a series of speakers. And there's always a headliner speaker.
We've had Jim Collins and Michael Lewis and Nate Silver, people like that in the past. Then there's always a series of more pragmatic, practical talks. I raised my hand about a dozen years ago and said, I'll do one of those. I then had to figure out what I was going to talk about. I had read and heard about Henry Singleton, this sort of
CEO from the 60s, 70s, 80s who had run a conglomerate with extraordinary results. That's really all that I knew. And I decided that I'd do sort of a deep dive and profile him and try to share those learnings with our CEOs. And we had a Harvard Business School student working for us between years at business school. And I asked who is excellent.
And I asked him if he wanted to do sort of an independent study in his second year at HBS to do a deep dive into Singleton and his company Teledyne and his record. And he had been a varsity tennis player in college. So he looked at me and he said, well, unfortunately, I just committed to another independent study, but my doubles partner is looking, right? So by pure serendipity, I got connected with this guy, Aleem Chowdhury, who lives in the Bay Area.
He was just a super talented guy. And he'd been a Phi Beta in physics at Stanford. And he agreed to do this independent study. And what we did is we did an extremely deep analytical dive in the first semester into Teledyne and sort of the comparable group of 60 zero conglomerates. It was a comparable group of another seven or eight companies. We wrote up the analytical work. And then in the second semester, we interviewed everyone alive
who'd had anything to do with the company. Unfortunately, Singleton had passed away, but his longtime partner and COO, George Roberts was still alive in Southern California and a bunch of investors, board members, former employees. And we literally went all around the country and interviewed those people. And I went to go write that up to prepare for this talk. And as I was doing that, Aleem came to me and he said, "Well, there's a really talented guy in the class behind me who's looking for an independent study."
And I had just found that whole process to be intellectually way more engaging than I had expected. And so that guy, a guy named John Gilligan, who's now in Chicago, who's also a super talented guy, agreed to do it. And we ended up doing Capital Cities. So I just by happenstance got into this really talented vein of Harvard Business School students, each of whom did a full year independent study
for credit to support research of the chapters. And that sequencing worked for me because I had a day job. So I was sort of doing one of these a year. And after about the fourth one, I began to think, hey, maybe this will turn into some sort of a book project. I mean, I was writing them up as I was going along. And after about the fifth or sixth one, it became clear there was this
there was this very strong pattern, which I did not expect. As I was working on it, the model I had in my mind is a great book called The Money Masters. I don't know if any of you guys have read that, but it's a very good investing book written by a guy named John Train, came out in about 1980. And he just profiled great practitioners who he was aware of. First chapter is on Buffett. It's still a very good introduction to Buffett, 40 years later. But Phil Fisher and
John Templeton. But the message of that book is there are many different paths to investing success. And so I expected as I was going through and studying these CEOs who had these phenomenal records of relative outperformance versus their peer groups, I expected a variety of approaches, but there was more overlap.
than I expected. So anyway, the book evolved. This is a long answer to your question, David. Oh, this is great. It took about a year, a chapter, honestly. So for such a short book, it took me a really long time. But it was really fun. It sort of drew me in as it went along. That's so cool. What are some of your independent study HBS research students doing now? Yeah, so they're a really talented group that's been fun to keep in contact with.
And they generally have coalesced in investing type careers, but there's variability within that. Some of them have gone down sort of search fund CEO type paths. But they generally are doing, they're generally involved in allocating capital in some form or other, but more as investors generally. Although at least a couple of them went down a CEO type path. That's awesome.
One question, I'm already going to break ranks here and David doesn't know I'm asking this. Is there one or two chapters that almost made the book that didn't? Yeah, that's a great question. Yeah, I did it. I mean, I basically did all of the work for, yeah, that's not true. Maybe 80% of the work for a chapter on Lucadia National. But I didn't end up including it in the book because the CEOs were so reclusive that they wouldn't talk to me.
And I felt it was important to speak to every living CEO. So I didn't include it, but that's a fascinating story. And then I had another sort of chapter that I was researching and I discontinued because the student wasn't doing a good enough job, to be honest. So it was really important. The way it worked is that first semester, the work we did was really detailed and it was the key to getting the students
the interviewees to participate, including the CEOs, they needed to see that. And they actually then became very responsive once they saw the depth of work. But the depth of work was key to getting the getting the interviews. So I had one that was, you know, never, never made it to that second semester. Just say, yeah, it's funny. I mean, we we definitely find the same thing with guests on acquired. These people are so busy, like they get requests for their time all the time. And most of the requests have not done the work.
That's actually for, that's how the Sequoia episode with Doug Leone came to be. We did the first one and then they emailed us and they were like, oh, we didn't realize you were really serious about how much work you were going to do on this. Like, can we be involved now? That's cool. I mean, I did listen to those two episodes. I thought they were excellent. I can see how that first episode would have led to Doug getting involved. Yeah, it was really special. All right. All right.
Shatij, you are up first. The floor is yours. Yeah. So I guess my question is really around whether the lessons from the CEOs in the book are more a function of time and place of basically when the CEOs operated in a pre-internet era.
are there lessons sort of applicable today to like high-tech 21st century companies, right? And if so, maybe kind of what are the metrics that an outsider CEO would look for today, especially given that like optimizing solely for shareholder value is not cool, right?
Yeah, that's a good question. So I, you know, I might quibble with the, I think optimizing for long-term shareholder value should still be cool because, you know, in order to do that well, you really have to be, you really have to be taking care of all of your stakeholders, all of your constituencies, you know, so I think that it's not inconsistent to be, you know, you
It implies like loan focus on per share value implies sort of a cold calculating heartless approach to management. I don't think that those, I don't think that's accurate. So I would just quibble a little bit. I think the objective for any CEO should still be to optimize very long-term per share value, per share value. But in the world of, you know, high-tech businesses, you know, I think the metrics, you
the near-term metrics that you'd optimize for would be different than the metrics this group of CEOs was optimizing for. If you take a SaaS business, it's super rational to be optimizing around ARR growth over time and making sure that your customer acquisition cost to long-term value math is compelling. I think that the metrics that
are going to drive long-term, you know, long-term per share growth are going to come out of the, you know, kind of core economic realities of those businesses. So if you have a low churn SaaS business with high gross margins and a compelling ratio between your customer acquisition cost and your long-term value, you should be aggressively growing that. And I would argue, I think Jeff Bezos,
If you read his letters in sequence, which are excellent, I'm sure many, most of you probably have, there's no question that he's rationally thinking about building long-term per share value, but with an intense focus on the customer all the way along. So I don't see those two as being inconsistent. I think the specific metrics are different. And one of the common commonalities across
the eight CEOs in the book and one of the markers of this sort of way of thinking about things is CEOs get extra credit for carefully thought out new metrics. You know, people who sort of arrived at different ways of crisply thinking about what the core economics are, the core economic objective is in their business, that can be a marker of this. If they're blindly using kind of the conventional set of metrics, that can be a warning sign that maybe they're not
Maybe they're not as focused on what really matters longer term. But clearly, the importance of customer retention in any business is paramount. But the SaaS model really, really highlights that pretty crisply. It's amazing those businesses are valued where they are today. I think the most recent thing I saw was 15 times next year's ARR, where the public universe is trading. But it's not like if you...
If you look at like long-term ARR math should ultimately correlate with what you think the EBITDA margins on those businesses are going to be at maturity. And then they're just exceptional businesses, right? They're super capital efficient. They're super predictable. So they should ultimately trade at high multiples of end of day free cash flow or EBITDA.
So it's not crazy that those ARR multiples should be high. 15 times next year, you need a lot of growth to make that math work, but they're pretty great businesses. Thank you. Just a side note on the devising and discovering new metrics that make sense for your business. That story we were talking about when we were prepping with you, Will, of John Malone inventing EBITDA. I had no idea. That is so cool.
Yeah, that whole concept of EBITDA, see I'm old enough that I call it EBITDA before it was a together acronym, but the whole idea of that came out of the cable television business, right? It was going far enough up the income statement to sort of highlight the recurring discretionary cash flow. Do you know if John Malone called it EBITDA because now I look very knowledgeable to my partners?
Oops, I cut out. Now I feel very knowledgeable to my partners if I say EBITDA. Sorry about that. I think your older partners will appreciate it. I think it's sort of a generational thing. But yeah, it was originally EBITDA before it was EBITDA. Yeah. Ah, cool.
Well, there's also like, some people say, so I say EBITDA. Some people say EBITDA. And then there's EBITDA. There's like all sorts of ways to pronounce it. Turns out it's not a real word. So you can pronounce it however you want. We had a CEO who named his dog EBITDA. We appreciate the focus. That's great. That is an outsider CEO there. Yeah.
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I just want to chime in and say I also was shocked by the EBITDA story. I was like, I wish they had told me this in accounting class, but they did not.
But I really love this book. I think that at the end, Will, you say that you don't need to be a visionary or a marketing genius to be a great CEO. And that's been my experience, but I've never heard it written in a book before. So thank you. This is phenomenal. And the blue ocean thinking around like how are people thinking differently? Awesome. So thank you. But my big question is sort of similar to what was just asked.
I mean, now like SaaS companies and reinventing how we interact on the web or the companies that are dominating the stock market and shareholder value. But I'm wondering, you know, thinking, looking through all the hype, what are some CEOs that would probably fit into the outsiders to share?
And I know that you probably don't have like four Harvard students looking at this right now and otherwise the book would be out. But if you could share some who are doing things under the radar that are really compelling, I would love to hear it. Yeah, of course. So let's see. I'll try to take through a few of those, Francesca. So a couple that were mentioned in the book, there's an amazing company called Transdime, which focuses on
niche aviation component businesses and acquiring and operating those. It's got a phenomenal long-term record run by a guy named Nick Howley, you know, very much along these lines. There are two companies in, you know, cyclical
Horrible sounding businesses that have generated incredible long-term returns through laser-like capital allocation, including taking advantage of the inherent cyclicality of their businesses and the related stock market trading patterns. So one is a company in the DC area called NVR. It's a home builder. Hard to think of a more mundane, cyclical, in many ways difficult business.
But they've evolved an entirely different, much less asset intensive model for that. And they've been incredibly savvy in aggressively repurchasing shares when the whole sector gets pounded in cyclical downturns. So NVR is interesting. There's a company that is in the auto finance market called Credit Acceptance Corp.
Again, subprime, I should say, mostly auto finance. So again, just a horrible industry niche generally, tough economic characteristics, but they've evolved a model that has some cost advantages and then they've been exceptional capital allocators, again, throughout the cycle. So have generated pretty extraordinary returns. So those are two that are pretty interesting in some out of the way industries.
The Constellation Software, I know you guys have talked about that on the podcast. What Mark Leonard's done is just extraordinary over a long period of time and continues to do. The most remarkable, it's like a math problem, Constellation Software, and how can you create that much equity value without using debt and with very little organic growth? It's just remarkable. The amount of equity that went in, which you can trace, and you look at the market cap today,
It's, you know, and his organic growth has been four or 5% across that period of time, organic revenue growth. And he's only recently begun to use debt. And even now the debt is less, it's around, it's one times or less EBITDA. So Mark, I mean, Mark Leonard's amazing. You know, the Rails Brothers have a pretty extraordinary record at Danaher over time, which is,
is just sort of on its third iteration. It's an entirely different business than it was 10 years ago. And 10 years ago, it was a wildly different business than it was 25 years ago. So they've sort of proven to be learning machines. And then one other one that I'd mentioned, because it's international and you guys have talked about it, at least indirectly, is NASPRS. It's just extraordinary how much value NASPRS has created over time through capital allocation. If you remove Tencent,
from their record, it's still excellent. Now, Tencent is a candidate for the greatest investment ever made. I mean, you guys have talked about it, you know, compellingly, and we'll maybe talk more about it. But NASPERS, a big part of what makes Tencent interesting is NASPERS is involved in capital allocation there. NASPERS had capital allocation DNA that went back way before that to when it was a traditional media company. And it had an excellent record, you know, in that era as well. So it's sort of a
long history there. And then, so that's a pretty good, that's a, that's a starting list anyway, Francesca. Um, and I, I'm an investor in trans dime. So I was, that was the first one you mentioned. I was like, wow, maybe I have a little Will Thorndyke in me. That's a phenomenal company, Francesca. I don't know how long you've been invested there, but almost regardless, it's been great. Except maybe the last six months, if you started your position then, but it's been, that's just a phenomenal company. One, um, one follow-up I'd love to ask on that, uh, is, uh,
Talking about Constellation, Will, I'm curious what you think. I think pretty much every case study in the book, the actual operations of the companies were very decentralized, but the actual capital allocation was great.
extremely centralized and in many cases just done by one person, the CEO. Constellation is an example of totally decentralized capital allocation where it's spread down as far as possible in the organization. Probably the number of deals that Mark is involved in out of, I think they've acquired 500 companies now. I think his goal is as few as possible. What do you think about that? Do you know any other companies that operate that way?
It's interesting. If you looked at from the book, the most acquisitive company in the book was TCI, just in terms of number of transactions over time. They were literally buying one every two weeks or something like that for a long period of time, little small cable systems. And I think similarly, Malone and Mark evolved an approach where there were clear decision rules
And the businesses were predictable enough that within those decision, that system just worked really well. And it got to the point in TCI where literally on the back of a napkin, you just had to be able to, in TCI, the way it worked is you had to be able to show that any acquisition within a year's time after the effect of the programming discounts, you know, the ability to buy HBO, ESPN with the purchasing power within a year, if you were at five times EBITDA, you could do the deal.
Anywhere in the company. That happened to be the amount they, that was also the amount of their leverage, right? So that was those two, those two things were tied together, right? And lenders would often lend against pro forma EBITDA. Mark has similar, I think, you know, his whole amazing comment about hurdle rates are magnetic. You know, he's set the bar for the hurdle rates and he set the template that they use internally. And I mean, you get, you know, probability weighting, different scenarios. And so that the decision rules are clear and the bets are typically small.
500 plus acquisitions, average enterprise value is $5 million. It's amazing. He's created a machine to systematically target the least efficient part of the vertical software market. I think that with those sorts of decision rules in place and small enough discrete acquisitions, a system like that can work well, but the rules are still coming
the sort of system, the machine has been put in place, set in place by the CEO. Yeah. Yeah. So the hurdle rates are magnetic comment. Anybody who hasn't read some of Mark's old shareholder letters that he used to do, and now he does Q&A on the website where he talks about this. It's well, well worth your time. All right, Ben Greinall, you're up next. Perfect.
So I had a question around acquisition integration. It's pretty apparent in the book that the CEOs across the board were really good at identifying exceptional value in the acquisitions they made. But from some of the HBS research that's been done around like 70 to 90% of acquisitions end up failing for various reasons.
Did you come across or did any of the students come across any research where the CEOs did something exceptional from an integration standpoint to make those more valuable than just identifying a good initial purchase? Yeah, that's a good question, Ben. The short answer is yes. They were all excellent at integration. Integration was a key component
key component of the total value creation. And generally across the group, the acquisitions required, the integration resulted in meaningful near-term cost savings and thus EBITDA growth. So it's very, very high probability these CEOs could model like a very near-term first 12 to 24 month improvement in operating cash flows.
almost always from something specific on the cost side. So the most specific example is the example of TCI's programming discounts where they would buy a cable system and literally the next day, they would buy all of the programming for that acquired system using their programming discounts, which were typically 25 to 30% lower than the predecessor company. So overnight, the cost structure was dramatically changed.
In the case of Capital Cities, it was more of a lean operating system. But whenever Capital Cities bought a new newspaper, television station, whatever, they would very quickly implement their operating model. And it meant that with high probability, they could reduce costs. And the most specific example there was the acquisition of ABC when they, in the first 18 months, improved operating margins by 1,000 basis points.
while improving the ratings of those stations. So they didn't sacrifice the quality of the programming, but they just ran the operations more efficiently. And so integration was essential and almost always there was some very specific program around cost side improvements that was core to the logic for the acquisition. It's an interesting difference from David and Ben's episode on the 10 greatest acquisitions
of all time, where in almost every case, there was some form of revenue synergy there or something. The logic for those was not cost driven, or at least there may have been a cost component, but it was a relatively minor piece of the logic for those deals. So just very interesting to see that difference. But in the book, that was the integration was essential. So one, one to add on to that. So one part of the question is,
Was it something exceptional they did in the way they communicated to the rest of the organization? Because from what I understood in the book, many of the CEOs were great about decentralization of operations and decision-making other than capital allocation, which David had touched on saying. There's one point person makes the decision and go. Was there something that they did from a...
an engagement standpoint to get all the, like this new team, this greater team, everybody moving one foot in front of the other at the same time that said, here's our mission. Here's what we're doing and why go now you're, you're autonomous to make those decisions. Ben, do you mean with the acquired companies? Exactly. Exactly. Yeah. Yeah. Yeah. They, um, they,
They did. And I'm trying to boil that down into something that's, you know, crisp, but just extreme, extreme candor and clarity around kind of how how they were going to be running the business going forward in the first 90 days.
The best example of this is the way that capital cities integrated ABC. These two entirely different cultures. There's actually a very good book called Three Blind Mice that was written by a guy named Ken Auletta, who's the New Yorker's media guy. I didn't know about this. Back in the 90s. It's about the three networks.
back then, and each of them had undergone an ownership change very recently around that period of time, around 1990. Capital Cities bought ABC and NBC was purchased by GE. And then Larry Tisch, the Tisch family bought CBS. So it's the story of what happened. And it explains why Capital Cities, which was itself a broadcaster before they bought the network, was sort of uniquely able to blend two very different cultures. And of course,
I mean, Capital Cities was the training ground for Bob Iger, right? Who ultimately, he ultimately went out to run ABC Entertainment. Once the ABC, he was part of that integration. He was a key agent of that integration when Capital Cities bought ABC. And then of course, once Disney bought the combined entity, he flourished there and,
his book, which you got the Disney plus episode, which I also listened to was very good. It does a good job, but Iger's amazing. But a lot of what Bob Iger still, when he was CEO of Disney across those major transactions, every single time he consulted Murphy, Murphy and he remain very close to this day. Tom Murphy's 95, but still on the Berkshire board, still active. Anyway, Ben, does that, so I guess I, so read that book at crisp, the crisp thing would be
In the first 90 to 120 days, very open, clear communication, which would include discussion of, you know, mission, values, culture, and then any changes, any leadership changes or, you know, cost side reductions, headcount reductions, you know, always implemented in the first six months post-acquisition, not drawn out over time.
Very cool. Thank you. To jump in, like Ben, I think the thing that you're probably, you asked a research-based question, but I think you're probably informed the same way I am by the way that we sort of observe this in the tech industry. I think there's very, people are often kidding themselves when they do acquisitions of what the synergies are going to be. And they're also not straightforward about headcount reductions around merging groups together. They're, yeah,
Oftentimes, I think tech CEOs
um, build a culture of transparency and in many ways, niceness. And it feels wrong to play this sort of like overly heavy handed. Um, I'm buying you for this specific thing of your business. I'm going to roll it in here. So I'm going to realize all that value. And then I'm going to let a bunch of your team go. It feels draconian. And I think it's counter to the culture that a lot of these CEOs try to build. And so then they end up
even though that's where the most of the value might be, I think they end up in these difficult situations over and over and over again where they even convince themselves that that's not how it was going to turn out. And then you that's when you end up with a massive culture clash or big disagreements over what the internal decision should be or people feeling like they got sold a lemon. I mean, I think it's a frankly, I think people don't have the hard conversations early enough.
Yeah, I think sort of radical candor would be, you know, candor and rationality were core principles for this group. And Ben, I'm reading your comment in the chat, which I agree with. I think, you know, cost side synergies are just generally higher probability and more repeatable, but there's more upside with true revenue synergy. It's rarer, but I think it's more common in technology companies than it is, you know, more broadly in the, you know, in the broader economy.
Cool. Yeah. Fun. Bob Iger said before, Josh, I think you're up next. Ben and I went on Jason Picalcanis' podcast again yesterday. And Jason said we were talking about Kevin Mayer and TikTok. And Jason said at some point that, oh, yeah, like, you know, Kevin came from...
I think he was actually defending Kevin, but he said, you know, Bob Iger was just like a corporate, you know, gun hired CEO at Disney. And we were like, hold on. Absolutely not. That guy is like, let's look at the record. Do the math. Right. Well, as the point Jason was like, he was trying to say Iger didn't have a founder mentality at Disney. And we're like,
If anybody could ever have a founder mentality of a company that they didn't found, like, Iger is the classic case. All right, Josh, jump in. I guess I was really curious, like, how much financial engineering kind of went into, like, a lot of these, like, managers. Like, you know, the ones that struck me, like, the most were, like, taking, like, owned property and kind of, like, restructuring it to, like, just make...
Because the return might be great, but it's way better if you don't have any capital tied up in all these various pieces to it. But that kind of makes me wonder, a lot of these strategies are for high capital expenditure businesses where you could pay all up front or you could finance them, amortize those costs over the length of the business, which is obviously much better from a return perspective if you're actually exceeding the hurdle rate for what you can get financing at.
Yeah. So I think, I mean, financial engineering is a pejorative term, right? I think, you know, generally. Yeah, I'm not using it pejoratively. So I just want to, so I think that I just like the idea of rationality around these decisions, right? I mean, if you're, if you're running a business, you want to be rational about how you source and how you allocate capital, right? So if you're in a business that is capital intensive and you have a
creative way to finance some of your chunky CapEx items, bricks and mortar, whatever they might be, that frees up capital that you can then productively invest elsewhere. That just seems rational to me. Enormous value can be created over long periods of time in how you finance these things.
And that can be through debt for sure, but it can also be through equity. One of the things that's oversimplified, I think, in the book is, in fact, there's a funny story. The book is translated into Japanese and the subtitle in Japanese reads, don't pay dividends, repurchase your shares.
or worse to that effect, which is a dramatic oversimplification. That's amazing. Yes, all these CEOs did end up repurchasing shares but also significant value was added by issuing shares at high PEs. Singleton did it. The first part of his career is a story of him
buying companies at 10 times earnings while issuing stock at 25 to 50 times earnings. So he created a lot of value doing that before the PEN stock fell and he switched and began to repurchase shares. Similarly for Buffett, the largest acquisition that Berkshire has ever made as a percentage of its enterprise value is General Re, reinsurance company that it bought in '98.
it paid for the whole thing with stock. Buffett's famous for not using stock. The largest deal he ever did, he did all with stock. The stock at that point in time was trading at three times book value. So if you pull up like a price to book value chart for Berkshire, it looks like Mount Fuji.
It's like, and the absolute summit point is 1998 when he does the Gen Re deal, right? So, you know, so financial, I mean, so that's just rationally trying to source capital in a low cost way and then deploy it into things that have high probability attractive returns.
I don't know, Josh, if I'm answering your question, but... I guess I was just more thinking of how to... If you look at some businesses that try to be highly acquisitive, it seems like a lot of the initial upside for a lot of these acquisitions was the ability to dramatically improve their financial structure. Less calling it financial engineering and...
Obviously, let's say a large tech company bought another large tech company and they kept them as a standalone business. That company could then issue additional equity or debt in a way that might fit their operating business, but it seems less likely for those same tools to even be available to improve the operational efficiency of those types of businesses.
Yeah. So that's helpful. Thank you. That's helpful clarification. So what you just described, Josh, that does strike me as financial engineering, right? I mean, that's trying to assemble pieces to get enough size that you can quote unquote lower your cost of capital by accessing different sources of debt financing or equity financing. So the underlying premise there isn't, look, we can buy these companies and we can improve their cash flows.
and grow them systematically that way. It's more the let's get big so we have financing options and we can create an arbitrage of some sort between the cost at which we're financing things and the ability to... It's the sort of mindset that in consolidations, sometimes you see this in private equity where the goal is to buy lots of little companies at low multiples
put them together into a larger corporation and sell them on exit. And the majority of the returns comes from the multiple expansion. The whole thing is premised on the ability to expand the multiple.
And we're always extremely skeptical of that. The only way these things work is if you can make an interesting return with entry multiple equaling exit multiple, no multiple expansion. If you're counting on multiple expansion, that's a fool's errand. That is financial engineering. And then how much leverage can you use? That's very much dependent on the nature of the revenues, how strongly recurring are they.
And you always want to be conservative in your assessment of that. And so it's very common in private equity to see what you're talking about, which is very high degrees of leverage relative to the predictability of the revenue stream. And then if you looked at the components of the core IRR and the base case model, it's heavily concentrated on being able to buy these things at five or six times and sell them at eight to 10 times to another private equity owner. So that's a different game, I think.
I kind of get what you're saying, but I feel like some of the deals in the book kind of feel like that a little bit, at least initially, right? Because they wouldn't have done the deal had it not been for the ability to unlock a lot of the capital that was going into the investment. And sometimes it looks like when an acquisition, it looks like financial engineering in that way, but it also is like a way of...
getting at the core piece of the business that's actually making money in some ways too. Because you're like, "Oh, well, if we're only making money because we own these properties, then we're not really making money. We should sell the business and lease out these properties as a landlord or something like that." Yeah, I think I disagree with you on that slightly, Josh. I think for this group, as they modeled out acquisitions,
that the return was coming almost exclusively from cash flow growth, not multiple expansion. And they were also applying prudent leverage, right? So there was leverage and cash flow growth were the drivers as opposed to multiple. But that cash flow growth piece of it is very, very important and very differentiated. And I think if you look at the 75 to 90%, you know, whatever that number is that was referenced in the earlier question of acquisitions that fail,
It's because they're not able to realize the modeled projected operating improvements in the acquired company post-acquisition. Maybe in combination with that, they took on debt to do it, which obviously compounds that problem. But I think that's typically the underlying reason that acquisitions shrink shareholder value versus creating it. Makes sense.
All right, Packy, jump on in.
Right. Thanks for doing this. Love of the book. My questions are kind of on both sides of really the prime capital allocation period. So I was listening to a podcast with John Collison of Stripe this morning. He was referencing the book and talking about the fact that at some point you switch from an early startup to a capital allocator. And then on the other side, so I guess the question is, when is that point? And then on the other side, when you're looking at Iger leaving Disney,
What do you kind of predict happens there when you lose your capital allocator? Yeah. So that, yeah, that, Paki, that's a really good question. I think that is that John is correct that, you know, for founders, we see this in our companies, which are, you know, they have revenue and cash flow and we get involved. But typically for the first 24 to 36 months, even in a private equity investment,
there isn't a giant conundrum around capital allocation. It's sort of clear how you're going to source the capital and what it's going to be deployed into, right? So that the opportunity to allocate across multiple options is the result of success down the road.
And so in a founding startup situation, you're going to source equity capital, maybe some venture debt, but equity capital. You're going to do that at the best possible price, right? So the lowest possible cost, the least possible dilution. Then you're going to invest it as efficiently as possible in growing the business to the point it can be self-sustaining. And then past that point, as it continues to grow and generate recurring free cash flow, you're then in the high class position.
being able to decide how to allocate that cash flow and the related debt capacity or if the stock is trading at a high PE the ability to issue it. You can then figure out how you want to source capital and what projects to deploy it into but that having that array of options and choosing amongst them is a function of you know more mature businesses or businesses that have already had a degree of success. I think that's absolutely right. And then to your second question
Disney, you know, it's a good, I mean, I don't have a, I'm not as knowledgeable, although having listened to the Disney Plus episode, I'm feeling, you know, well-equipped. But I do think they've made sort of a fascinating, you know, Iger on the way out made a fascinating, gigantic bet around Disney Plus. And it's going to be fascinating to see how that plays out over time. I think that's going to turn out to have been brilliant, you know, that he's going to have
effectively, it makes this broader trend, right? That you're seeing in the economy where businesses are increasingly moving to subscription models, kind of even in places you had never expected in the oldest industrial parts of the economy. And as a result, those businesses are just getting better. They're getting, the businesses are becoming more predictable as a result of that. I think as Disney is, if Disney is successful with Disney plus, it's going to much higher percentage of its revenues are going to be recurring revenues, right? It's that's,
super positive, but it will be, it's a giant bet, including the, you know, including the acquisition of the Fox assets. So it'll be, it'll be interesting to see how that plays out. I don't think as a result of all that, that Iger's successor, he's going to have to be optimizing around that bet, you know, for, for a long period of time. I don't think he's going to be making a lot of large move the needle capital allocation decisions.
the next 24 to 36 months, but we'll see. And it's smiling here. This is exactly the point he made to Jason yesterday. I mean, well, it's just very clear, like Bob couldn't stay away. I think they picked someone who is an execution guy who's going to run the same, who's just going to let the strategy play out. But then obviously in tumultuous times, Bob came back to just make sure a little
needed to do anything crazy that he was the one. Oh, sorry. I keep falling out guys. But anyway, yeah, Bob, Bob coming, Bob coming back to make sure that if they did need to shift strategy at all in this, then it was congruent with his previous strategy and not someone sort of new with an incongruent strategy. So I, I,
Yeah, I guess similarly, I'm trying to reflect back on any of the chapters. Was there an example in the book of someone who is an amazing capital allocator being succeeded by someone else who is an amazing capital allocator, like double outsider of CEOs in a row? Yeah, General Dynamics is the example of that.
Yeah, two exceptional capital allocators sort of back to back there. Actually, by the way, General Dynamics continues to have sort of differentiated DNA around capital allocation. So that continues sort of two further CEOs down the road. You can sort of look at their returns, again, relative to the peers, which is, that's the way to evaluate performance, I think, over time, sort of this duplicate bridge idea. But yeah, there's one example of that in the book, Ben, it's General Dynamics.
That's right. I want to hop in. Chris, we'll get to you in one sec, but grab the mic and hijack for a sec. Since Paki just asked his question, can we talk about Tencent for a minute? Will, I'm just... So we've touched on it a little bit in this session already, but...
You know, there's this growing meme in large part forwarded by Paki of Tencent as an ultimate outsider company and certainly excellent capital allocator right now. Will, have you thought about the company? What are your thoughts? Yeah, so a little bit, David. And coincidentally, a couple of investors who I'm quite close to had reached out to me in the last sort of 60 days.
on Tencent specifically and specifically in those conversations, the analogy of TCI arose independent of that blog. I mean, I think that analog, that analogy is just really accurate, spot on. I think it's just, it's fascinating to, I was not prior to that, you know, really familiar with Tencent and it's amazing to see how they've, I mean, I like the distinction you guys draw between platforms and aggregators, you know, the
The power of that platform is extraordinary, and they've done an excellent job optimizing around that. It's amazing to see the ownership interests in that range of businesses, including Tesla. I know. It's just amazing to see that. I mean, I think generally sort of this generation of technology CEOs get really, really high grades for capital allocation.
which I don't think you could have predicted. I think overall, I mean, there's some-- it's too early to make the call on some things. But just going through that list of, again, your top 10, Google's record is pretty extraordinary.
Facebook's record. I mean, we'll find, I guess we still have to see how, you know, some of the, some of the bets play out, but Instagram is pretty, no doubt. Even just Instagram and what's that? Yeah. It's just, so it's sort of interesting, but Tencent, I'm, I think that's a really interesting and apt, you know, analogy. Yeah. And also just so like Pony doesn't talk to anybody. Basically he sits there in Hong Kong and, you know, they're very, very happy with, you know,
relative obscurity for a $650 billion market cap company. Well, I do think a piece of that that is worth looking into that you guys might find interesting is spending a little bit of time on the NASPR's piece of it. And there's this entity process, which is the spun off NASPR's technology interests. So Tencent is 90% of the value there, but there's other interesting, amazing stuff there. And if you just read the way that
You read the way they describe what they're doing, their philosophy, how their compensation systems work. There's a deep history of kind of rationality and capital allocation there that I think the Tencent team is benefiting from. And I don't think that's
necessarily fully appreciated. I mean, Pony Ma is amazing. The team at Tencent is amazing, but the linkage of those two is very powerful. And I think the NASPR's piece is not as well understood maybe. Yeah. I hadn't heard of Process. I'm excited to go dig into that. Check out Process and check out just the reading, the specifics. It's a little bit like Mark Leonard, like read this, you know, or actually that group of, in Francesca's question,
NVR's letters are excellent. Credit acceptance letters, top five letters anywhere. Those are great letters. Generally, there's something about this general philosophy. The people who are successful at it are often very clear, crisp communicators in their letters. And the process materials are good on that dimension too.
There's one follow-up question that I have here. So you mentioned the tech CEOs of this generation are unexpectedly good capital allocators. On our call last week, Willie, you mentioned like the generation prior to this one wasn't as much. And I'm curious to hear your thoughts on like, why is it that when we look at today, Microsoft, Amazon, Apple, Apple,
I'm trying to not say Fang to not include Netflix, but you get what I'm saying. These sort of companies that are responsible for most of the growth in the S&P over the last, especially six months, but five years. Why have they been so excellent when the like 2000 to 2010 weren't? It's a good question, Ben. I mean, I think if you look at that group, it's Microsoft, you know, pre-Nedella, right? Microsoft. Yeah.
really hard to make a case they were good at capital allocation, right? Just, you know, Dell, Cisco, you know, Apple, you know, so I think there was a general mindset in those companies that are near enough to the founding era that the default capital allocation alternative was R&D.
That was the mindset. Understandably, that is what had gotten them. I think for most companies, there is a default capital allocation outlet, something that they're good at. For Mark, it's buying vertical market software companies. The key is to have, hopefully, if you're publicly traded, you've got that and then every morning you can repurchase your shares.
And you better than anyone else can calculate the IRR from repurchasing your shares. And markets are efficient. Most of the time that return is not going to be interesting. Every now and then it's going to be interesting. And when it is, you should buy it. And then it's just a handy yardstick. But those, that prior generation, they didn't repurchase shares. They didn't generally acquire companies. And when they did, they were terrible diversifying acquisitions, not things that were strengthening or around existing core, of course.
They didn't pay dividends. I mean, I'm not advocating dividends. They didn't even pay special dividends. It's actually in the book, there's a section on this because at the time the book was being written in that sort of '09 and '09 to '12 period, kind of when the markets were really still recovering from the financial crisis and the technology companies were trading at many of them single digit PEs. They had gigantic cash balances and they just sat on them. And Microsoft is a stark example, right? Because you have a leadership change.
Look at everything that's happened since Nadella took over. It's really remarkable. And a lot of it's capital allocation related. Similarly, Apple, you know, Apple's done a bunch of interesting things capital allocation wise. And then the new, I can't explain why the new guys are sitting in quote unquote, the new guys are so, but they've, they've been savvy about it. They, I think they're just, I don't know, more thought, more open to acquisitions, more, more open to creating value and in other ways. I wonder if part of it has to do with just the business models of,
those companies and of technology as it's evolved in the last few years with the advent of SAS and, and with social media and, you know, advertising and being more of a capital cities type dynamic versus, um,
Old school software, you know, Oracle, Cisco, Microsoft, Prima Della. You're talking about build large R&D projects, capitalizing software, large sales forces to sell it. That's just a way more capital intensive business. So if your mindset is already in, I built something light, I'm going to stick it into a subscription or subscription like business that's easy to acquire customers. Then you just start naturally looking for more opportunities to do that.
Yeah, I think that resonates with me, David. And then it's just amazing, to your point, how capital efficient these business models are. I mean, if you look at the base of recurring free cash flow that the FANG company, I mean, just look at Facebook and Google, and then you look at the amount of equity required to create that.
It's just amazing. There's never been anything like it. They're just such incredibly capital efficient, equity efficient business models. And the prior generation in tech was substantially more capital intensive, no question, which probably led them to shepherd their capital. That was probably a reason that they were comfortable keeping so much cash as a percentage of enterprise value on the balance sheet. All right. Sorry, Chris, that we hijacked you. Jump on in.
No worries. Thanks for doing this, Will. I had a question about survivorship bias and how you thought about the companies and CEOs that you picked. And maybe there were just a scenario here, maybe there were similar type of allocators or great CEOs who may have also done all the right things but not survived, essentially. So I was just wondering what your thoughts were on that.
Yeah, well, we basically used two tests, Chris, for inclusion, right? And both of them required-- looked at very long-term records. So the idea was in order to evaluate a record, you really need to be able to see how a CEO has performed across multiple cycles, not just a single cycle, because you could have timing, sort of lock-in timing on either end of a cycle on a record that looked great.
And so the average tenure in the book is 20 years. Now that's the average and it's skewed a bit because there's some exceptionally long tenured CEOs in there, including Buffett. But the two tests were better performance relative to the S&P than Jack Welch had during his 20 years at GE. That was Welch's tenure. That's sort of the absolute return threshold.
but I think the more relevant test is performance relative to the peer group, right? So dramatic outperformance over long periods of time relative to the peer group, and the idea there being this idea of duplicate bridge, right? Where everyone's dealt effectively the same hand over long periods of time in an industry. So if one company significantly outperforms the peer group, it's worthy of study. That was basically the idea around each of these things. And so
you know, the, those were the, those were the, that was the core sort of filter that we used in, in finding it. You know, I think there are for sure false positives, right? So the, the clearest example of that is Mike Pearson at Valiant, right? And Mike Pearson was at Valiant for seven years. And for the first six of those, he looked pretty good.
Right? On a lot of these dimensions, right? And so, and part of it, that's a very, there's a lot there to unpack. - Can you summarize that real quick? I'm not super familiar with Valiant. I assume other folks may not be too. - Okay, so Valiant, that's just an extraordinary, someone, I think someone's working on a book. That will be an incredible book when it comes out.
Valiant was a pharmaceutical company run by a guy named Mike Pearson who had run McKinsey's worldwide pharmaceutical practice. He's a talented guy. He was brought in by activist investors to run this pharmaceutical company. And he brought with him sort of two insights from his years at McKinsey. The first was that pharmaceutical companies generally overspend on R&D.
that there are sort of rules of thumb, industry conventions that you ought to spend 8% of your revenue on R&D and everybody does it, but they get very, very poor returns overall in those investments. It's sort of done reflexively. And the second insight was that
acquisitions that leverage existing sales forces and distribution channels can be highly accretive. So you can sort of come in with these insights and you pretty quickly did some, lowered the R&D spend, you did some acquisitions, those acquisitions were accretive, used debt to do those. The stock did phenomenally well. And then sort of halfway along, the stock had gone up a lot. He signed a new compensation, a very aggressive compensation deal
that was famously asymmetric and gave him the opportunity to earn a billion dollars, right? So he got a lot of headlines, but it was asymmetric. And that only happened if he got, you know, a 35% IRR from this already high stock price level. And his pace of activity began to pick up very dramatically after that. And I'm going into maybe more detail than you want, but- Oh, it's actually fascinating. He ended up doing, you know, a lot of acquisitions, a lot of debt, a lot of it was premised. What he began to default to was just
blatant price increases for niche pharmaceutical products. So he got regulatory attention for that. And it then, it then became clear that there was some accounting fraud and the whole thing began to unwind. Um, and so it was a very dramatic Icarus like story. Um, but, but it's for, for a long time, it was hard to unpack that. And he did an interesting thing where he, he, um,
headquartered the company in the Netherlands to get a lower tax rate, which was prudent in one sense, but also removed a key sort of check and balance on the system. So he then, because he wasn't paying any taxes, his goal was just to grow EBITDA as fast as possible to build leverage capacity. And so he sort of got on this treadmill
The incentive, it's really a story of incentives at some level and hubris. Show me the incentives and I'll tell you the behavior. Exactly. Exactly. Yes. Munger has a fair amount of really good quotes relating to Valiant specifically, which he was on early, by the way. He spotted that one early on. Yeah.
Um, this has been awesome. I don't want to take too much more of your time. We'll, um, maybe, uh, one last question for me. And if, if anybody else has any burning questions, uh, think of them and jump in quickly. Um, but, uh, Ho Nam at, uh, at Altos would be, uh, would be angry at us. We didn't ask his question. He's, uh, he really wants to know how you chose the furry animal for the
The CEO's because he fervently believes they should be hedgehogs as outsiders, not foxes. So what's the story of Jim Collins' famous, you know, furry animals for CEOs? Why are they foxes and the outsiders? Yeah, and I've actually had this debate with Jim Collins. So I had Jim Collins. Jim Collins was a lecturer at the GSB when I was a student there. So I actually had him as a student. And so he and I had this conversation.
He asked the same question and pushed hard. I think that they are net foxes. And the reason is that if you look at the most, maybe the most surprising finding in the whole book is that all eight of the CEOs were first-time CEOs.
like eight for eight, half of them under 40 when they got the job. So they're just as interesting. This idea of talented newcomers figuring things out, the power of that, I think is a core touch point for all eight of them. And it's this idea that foxes, they're rangy. They bring learnings from different areas,
The hedgehog knows one thing, right? Going back to the original Isaiah Berlin, right? Or Tolstoy. Hedgehog knows one thing. Fox knows many things. It's that many things piece that I think was, Malone came into the cable industry from a totally different background with a very analytical mindset. And he just systematically thought about how do I create the most per share value over time? Like, what do I do? Same with Singleton. Both those guys were sort of high level PhD students
quant math types. And so I think it, I come down on the side of Fox, but, but it's a fair point because once they're in the company and they've sort of figured out what the key levers are, they do focus intently on those. Maybe they're Fox foxes who then eventually develop a hedgy, hedgy focus.
you know, in one, in one core, you know, default capital allocation area. But I think Fox is first. Yeah. Love it. I'm going to defend the furry animal. Yeah. It also strikes me how many, you talk about this in the book, but how many of the CEOs are engineers and come from an engineering background, which I think is related. We, um,
We'll release this hopefully next week, but we just did a huge episode on Epic Games. And Tim Sweeney, the CEO of Epic, is like the ultimate, you know, both engineer and outsider CEO. I mean, he takes an engineering mindset to everything, but he also just like literally doesn't care about anything else. Like he's not married. He doesn't have kids. He just only cares about Epic and like presentation.
like preserving forest land in North Carolina. Like he just literally does not care about anything else. It's kind of amazing. Yeah. Interesting. Well, I look forward to listening to that episode. Thank you guys for having me, having me on for this. Thank you so much. Take care everyone.