Tom Murphy Warren Buffetts Favorite Manager

TITLE: Tom Murphy (Warren Buffett’s Favorite Manager) CHANNEL: Founders Podcast DATE: 2024-04-15 ---TRANSCRIPT--- Warren Buffett said 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. When he speaks to business school classes Warren Buffett often compares the rivalry between Tom Murphy’s company Capital Cities Broadcasting and CBS to a transatlantic race between a rowboat and the QE2. QE2 is the Queen Elizabeth 2, it is this giant transatlantic liner much much larger than the Titanic. So he compares it to a transatlantic race between a rowboat and the QE2 to illustrate the tremendous effect management can have on long-term returns. When Murphy became the CEO of Capital Cities in 1966 CBS was the dominant media business in the country with TV and radio stations in the country’s largest markets, the top rated broadcast network and valuable publishing and music properties. In contrast at that time Capital Cities had five TV stations and four radio stations all in small markets. CBS’s market capitalization was 16 times the size of Capital Cities but by the time Murphy sold his company to Disney 30 years later Capital Cities was three times as valuable as CBS. In other words the rowboat had won decisively.

That is from the book I’m going to talk to you about today which is The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success, written by William Thorndike, and specifically I’m going to focus on chapter one which is about Tom Murphy and Capital Cities Broadcasting and the name of the chapter is “A Perpetual Motion Machine for Returns.” Before I do that I’m going to put this book down and pick up last week’s book which was Ted Turner’s autobiography because Tom Murphy and his partner Dan Burke appear in Ted Turner’s autobiography as well. They essentially built Capital Cities from a small broadcasting company into a multi-billion dollar media conglomerate. This is what Ted Turner said about them: I like the Capital Cities people a lot. Dan Burke and Tom Murphy really understood the business. They had built their company up by buying TV and radio stations as well as newspapers and magazines and operating them efficiently.

That is not the first time I read Tom Murphy’s name in one of the books I’ve covered. All the way back on episode 286 I did an episode on Warren Buffett and Charlie Munger. They talk about Tom Murphy over and over again. They mention him in the shareholder letters, they mention him when they’re answering the Q&As at their annual meeting. This is what Buffett said: 40 years ago Tom Murphy gave me one of the best pieces of advice I’ve ever received. He said, Warren you can always tell someone to go to hell tomorrow. You haven’t missed that opportunity. Just forget about it for a day. If you feel the same way tomorrow then tell them that then, but don’t spout off in a moment of anger.

One more excerpt before we jump into the book, this comes from A Few Lessons from Warren Buffett, episode 202. This is advice Tom Murphy gave Warren Buffett on cost control. Cost control is something you and I are going to talk about a lot today, it’s central to understanding Tom Murphy’s incredible performance. Buffett says: 30 years ago Tom Murphy drove this point home to me with a hypothetical tale about an employee who asked his boss for permission to hire an assistant. The employee assumed that adding $20,000 to the annual payroll would be inconsequential, but his boss told him that the proposal should be evaluated as a $3 million decision given that an additional person would probably cost at least that amount over their lifetime factoring in raises, benefits and other expenses, down to the amount of toilet paper that person would use. This is how insane this guy paid attention to cost and efficiency. And unless the company fell on very hard times the employee added would be unlikely to be dismissed however marginal his contribution. So as we go through this overview of Tom Murphy’s life and business philosophy, just remember that he watched headcount like a hawk.

Let’s go back to the book. How does this happen? How did this seemingly insurmountable gap between these two companies get closed? The answer lies in fundamentally different management approaches. CBS spent much of the 1960s and 1970s taking the enormous cash flows generated by its network and broadcast operations and funding an aggressive acquisition program that led it into entirely new fields. Instead of focusing on other media businesses they knew well they bought things like a toy business and they even bought the New York Yankees. They also would issue stock to fund some of these acquisitions. This is under Bill Paley who’s the founder of CBS. They’re getting into new fields they don’t know enough about, they’re issuing shares, they’re building a fancy headquarters in Midtown Manhattan at enormous expense, and they developed a corporate structure with 42 presidents and vice presidents and generally displayed what Charlie Munger calls a prosperity-blinded indifference to unnecessary cost. When I got to this section it made me think of one of my favorite Munger lines. He was touring the Buffalo Evening News after they bought it and he was really against spending money on luxurious offices and he has this quip: why does a newspaper need a palace to publish in?

The strategy at CBS was consistent with the conventional wisdom of the conglomerate era which espoused the elusive benefits of diversification to justify the acquisition of unrelated businesses. At its core CBS’s strategy implemented by Bill Paley was focused on making CBS larger. In contrast Murphy’s goal was to make his company more valuable, not just larger but more valuable. As he said to Thorndike: the goal is to not have the longest train but to arrive at the station first using the least fuel. So I jotted down a few notes: find your edge, don’t diversify, then repeat what works. Murphy and Burke rejected diversification and instead created an unusually streamlined conglomerate that focused laser-like on the media business it knew well. Murphy acquired more radio and TV stations as opposed to buying the Yankees or a toy company, operated them superbly well and regularly repurchased his shares.

The formula that allowed Murphy to overtake Paley was deceptively simple: number one, focus on industries with attractive economic characteristics; number two, selectively use leverage to buy occasional large properties; number three, improve operations; number four, pay down debt; and number five, repeat this loop. What’s interesting is that his peers at other media companies did not follow this path. They followed fashion and diversified into unrelated businesses. This made me think of Warren’s shareholder letters where he says the behavior of peer companies will be mindlessly imitated. They’re just following fashion. They diversified into unrelated businesses, built large corporate staffs and overpaid for marquee media properties. Murphy did none of those things.

Capital Cities under Murphy was an extremely successful example of what we would now call a rollup. In a typical rollup a company acquires a series of businesses, attempts to improve operations and then keeps acquiring, benefiting over time from scale advantages and best management practices. Just because it sounds simple does not mean it’s easy. A lot of companies that tried rollups in the ’90s and 2000s wound up going out of business. They collapsed under the burden of too much debt, they acquired too rapidly and underestimated the difficulty of integrating acquisitions and improving operations. Murphy’s approach was different. He moved slowly, he developed real operational expertise — which is one of the benefits of not diversifying. By the time he does his biggest acquisition three decades into his career he’s going to buy ABC with Warren Buffett’s help, and he can have real conviction. He focused on a small number of large acquisitions that he knew to be high probability bets. Capital Cities combined excellence in both operations and capital allocation to an unusual degree. As Murphy told me: the business of business is a lot of little decisions every day mixed up with a very few big decisions.

So how did Tom Murphy even get associated with Capital Cities? He graduates from Harvard Business School and gets a normal job working for Lever Brothers, a massive consumer packaged goods company. He goes to an event at his parents’ house and meets a guy named Frank Smith. Smith tells him about his latest venture: he bought a struggling TV station out of bankruptcy. This is before cable, the early days. Before the evening was over Murphy had agreed to leave his job in New York City and relocate to Albany to run the TV station. The crazy thing is he had no broadcast experience nor any management experience of any kind. Tom Murphy is 29 years old. It takes him three years to turn the station around. The station has a bunch of operating losses because it was bought out of bankruptcy, and he turns it into a consistent cash generator by improving programming and aggressively managing costs. That phrase is going to come up over and over: aggressively managing costs. Warren Buffett says Tom Murphy was one of his heroes, that Murphy made him a better person, and that’s the ultimate gift you can give somebody.

This is a formula the company would apply repeatedly. In 1957, three years later, Smith and Murphy buy a second TV station, then a third, and they change the name of the company to Capital Cities. The third station is important because this is when Murphy hires a young 30-year-old, also with no broadcast experience, as his replacement to run the Albany station. That is Dan Burke. Murphy spends time training Burke and quickly indoctrinates him into the company’s lean decentralized operating philosophy. Then Murphy moves back to New York to work with Smith to build the company through acquisition, selectively acquiring additional radio and TV stations. Smith unexpectedly dies in 1966. By this time Smith and Murphy had been working together for 11 years. So at 40 years old, after Smith’s death, Murphy becomes CEO, a position he holds until he sells to Disney. At the time he takes over the company has revenue of just $28 million.

Murphy’s first move as CEO: he elevates Burke to President and Chief Operating Officer. This was an excellent selection of a partner because they have such opposite skill sets and a very clear division of labor. Burke was responsible for daily management of operations and Murphy for acquisitions and capital allocation. As Burke told me: our relationship was built on a foundation of mutual respect. I had an appetite for and a willingness to do things that Murphy was not interested in doing. Burke believed his job was to create the free cash flow and Murphy’s job was to spend it.

By this time Capital Cities owns five TV stations, the maximum allowed by the FCC. So they next turned their attention to newspaper publishing which, as an advertising-driven business with attractive margins and strong competitive barriers, had close similarities to broadcasting. After buying a bunch of newspapers he asks what other businesses are very similar to the ones he already owns. Then there’s this new invention, cable television, which looks very similar to the broadcast TV stations he owns. Like Ted Turner, Murphy was one of the first in the industry to embrace cable. Every other broadcaster thought cable was a threat to their broadcast business; Turner and Murphy thought it was an opportunity and a better product offering — the genie out of the bottle.

During the extended bear market of the mid-1970s to early 1980s Murphy became an aggressive purchaser of his own shares. He eventually bought back close to 50% of his outstanding shares, most of it at single digit price-to-earnings multiples. In 1984 the FCC relaxed its station ownership rules and Murphy, his master stroke, bought the ABC network. Stay in the game long enough to get lucky — this is the most important thing he does in his entire career and it happens 30 years in. He buys ABC for nearly $3.5 billion with financing from his friend Warren Buffett. The ABC deal was the largest non-oil-and-gas transaction in business history to that point, representing over 100% of Capital Cities’ enterprise value at the time. The Wall Street Journal reported it with the headline “The Minnow Swallows the Whale.” Murphy’s partner Burke said this is the acquisition I’ve been training for my entire life.

Why would Murphy bet the entire company on one transaction? Murphy’s conviction was that he could improve the margins of ABC’s TV stations from the low 30s up to Capital Cities’ industry-leading levels of 50-plus percent. Under Burke’s oversight the staff that oversaw ABC’s TV station group dropped from 60 to eight people. The margin gap was closed in just two years — they brought ABC’s margins from 30% to over 50%. A story from this time demonstrates the culture clash: ABC was a limousine culture, executives had the habit of taking a limo for even a few blocks to lunch. Murphy was a cabman. Before long this practice of taking cabs rippled through the executive ranks. When asked whether this was a case of leading by example, Murphy responded: is there any other way?

Capital Cities never made another large-scale acquisition after ABC, focusing instead on integration, smaller acquisitions and continued stock repurchasing. In 1995, 10 years after he bought ABC, Buffett suggested Murphy sit down with Michael Eisner, CEO of Disney. They met at the Allen and Company gathering in Sun Valley. Eisner expressed interest in buying the company and Murphy negotiated a buyout price of $19 billion, then retired from active management. He left behind an ecstatic group of shareholders. If you had invested a dollar with Tom Murphy as he became CEO in 1966 that dollar would have been worth $204 by the time he sold to Disney.

One of the major themes in the book is resource allocation. The outsider CEOs — not just Murphy but the eight covered, including Henry Singleton and John Malone and Warren Buffett — shared an unconventional approach that emphasized flat organizations and dehydrated corporate staffs. They also talked about headquarters staffs being anorexic. The culture at Capital Cities meant extraordinary autonomy for operating managers, and this principle was stated in a single paragraph on the inside cover of every annual report: decentralization 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. We expect our managers to be forever cost conscious and to recognize and exploit sales potential. Headquarters staff was anorexic — no vice presidents in functional areas like marketing, strategic planning or human resources, no corporate counsel and no public relations department. The publishers and station managers had the power and the prestige internally and they almost never heard from New York if they were hitting their numbers. The guiding HR philosophy, repeated over and over by Murphy: hire the best people you can and leave them alone.

Capital Cities ate their own cooking. The guinea pig in the development of this philosophy was Dan Burke himself. In 1961 after he took over as general manager at WTEN in Albany, Burke began sending weekly memos to Murphy as he’d been trained to do at General Foods. After several months of receiving no response he stopped sending them, realizing his time was better spent on local operations than reporting to headquarters. As Burke said: Murphy delegates to the point of anarchy.

Frugality was also central to the ethos. The two main ideas you see over and over in the history of entrepreneurship are the importance of focus and “gentlemen, watch your costs” — a quote from Andrew Carnegie. Murphy and Burke realized early on that while you couldn’t control your revenues you could control your costs. They believed the best defense against the revenue lumpiness inherent in advertising-supported businesses was a constant vigilance on costs which became deeply embedded in the company culture. One of the earliest and most often told corporate legends: Murphy even scrutinized the company’s expenditures on paint. They wanted to repaint one of their TV stations and Murphy said paint the two sides that face the road and leave the other sides untouched. This reminded me of Sam Walton — one reason he picked the name Walmart is it had fewer letters than the other options and therefore less lighting you had to light up on your stores. Less letters, less lighting, less cost.

Phil Meek ran their publishing division — six daily newspapers, several magazines and a bunch of weekly shoppers — with only three people at headquarters. They had very few meetings. People would come to New York and go through line by line everything they were spending. Particular attention was paid to capital expenditures and expenses. Managers were expected to outperform their peers and great attention was paid to margins — the profit margin your company operated at was viewed as a form of report card to HQ. Outside of these meetings managers were left alone. The company did not simply cut its way to high margins. Murphy and Burke realized the key drivers of profitability in most of their businesses were revenue growth and advertising market share, and they were prepared to invest in their properties to ensure leadership in local markets. They realized early through trial and error that the TV station that was number one in local news ended up with a disproportionate share of that market’s advertising revenue. As an early employee put it: the company was careful, not cheap.

The hiring practices were equally unconventional. Murphy and Burke shared a clear preference for intelligence, ability and drive over direct industry experience — because neither of them had direct industry experience when they were hired. They targeted what they called talented younger foxes with fresh perspectives. They were comfortable giving responsibility to promising young managers. One of the people they hired young was Bob Iger, at 37, who’d spent his entire career in broadcast sports, to assume responsibility for ABC entertainment. They had exceptionally low turnover. A rival broadcaster once remarked: we see lots of resumés but we never see any from Capital Cities. Why? The system in place corrupts you with so much autonomy and authority that you can’t imagine leaving.

In the area of capital allocation Murphy’s approach was highly differentiated from his peers. He eschewed diversification, paid minor dividends, rarely issued stock and made active use of leverage. He would regularly repurchase shares and between long periods of inactivity made the occasional very large acquisition. The two primary sources of capital were internal operating cash flow and debt. The company produced consistently high industry-leading levels of operating cash flow. Murphy frequently used debt to fund acquisitions. Once he summarized his approach: we take the assets and once we’ve paid them off we leverage them again to buy other assets. Acquisitions was where Murphy spent the majority of his time. He did not delegate acquisition decisions and never used investment bankers. The company’s extreme decentralization gave it an advantage in acquisitions: it allowed Murphy to buy properties knowing that under Burke they would quickly be made more profitable, lowering the effective price paid.

When he had conviction Murphy was prepared to act aggressively, but he was not impatient. He was willing to wait a long time for attractive acquisitions. He once said: I get paid not just to make deals but to make good deals. Much of the value created was the result of a handful of large acquisition decisions, each representing 25% or more of the company’s market cap at the time. Murphy was a master at prospecting for deals. He knew what he wanted to buy and would spend years developing relationships with the owners of desirable properties. He had a very unusual negotiating style: he would often ask the seller what they thought their property was worth, and if he thought their offer was fair he would take it. If he thought their proposal was high he would counter with his best price, and if the seller rejected his offer Murphy would walk away. He would never do well at auctions — he usually bid 60 or 70% lower than the winning bid.

Outside of acquisitions the second largest amount he spent was share repurchasing. He spent over $1.8 billion on buybacks. That investment alone generated an excellent return for shareholders, 22.4% over 19 years. As Murphy says: today I only wish I had bought more.

The chapter closes with an anecdote about this unique culture. Murphy told 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 the bartender was later asked why he made the investment he replied: I’ve worked a lot of corporate events over the years but Capital Cities was the only company where you couldn’t tell who the bosses were.

There’s a postscript: a contemporary analog for Capital Cities can be found in TransDigm, a little-known publicly traded aerospace components manufacturer. Like Capital Cities the company focuses on very specific types of business with exceptional economic characteristics and evolved a highly decentralized corporate structure for optimizing the profitability of these specialized businesses. The author Thorndike did a four-part series on TransDigm called 50x. I wish there were more books on Thomas Murphy — I can’t find a biography or a company history on Capital Cities, which seems like a massive mistake. The fact that Warren Buffett calls Thomas Murphy his hero, that Ted Turner says these guys know what they’re doing, really piqued my interest. The Outsiders was number one on Warren Buffett’s recommended reading list for a long time and they sell it at the Berkshire annual meeting every year. That is 328 books down, 1,000 to go.