INTERVIEWER: Hello, everyone.
We have a very special guest with us today.
He is a graduate of Harvard College
and Stanford Graduate School of Business.
He has also founded Housatonic Partners,
which is a private equity firm with offices in Boston and San
Francisco.
Interestingly, he has written one
of those rare and special books, which
has won claim from none other than Warren Buffett and Charlie
Munger.
The book is called "The Outsiders."
And we are thrilled that the author, Mr. William Thorndike,
is here with us, in person, today
to talk about "The Outsiders."
Welcome.
WILLIAM THORNDIKE: Thank you, [INAUDIBLE].
[APPLAUSE]
INTERVIEWER: So I guess to kick it off,
why don't you give the audience here
and the thousands on YouTube an elevator pitch of the book
and what it's all about.
WILLIAM THORNDIKE: OK.
Great.
So I think the best analogy for the book is duplicate bridge.
So how many of you play bridge?
[LAUGHTER]
That's a rather low penetration.
That would be zero.
So duplicate bridge is an advanced form a bridge in which
a group of teams of two show up in a room,
they're divided into tables of four, each of which
is then dealt the exact same cards
in the exact same sequence, minimizing the role of luck.
Then at the end of the evening, the team with the most points
wins.
So I would contend, over long periods of time,
within an industry, it's duplicate bridge.
So if one company materially outperforms the peer group,
that's worthy of study.
So the eight companies and CEOs profiled in the book, they each
fit that pattern.
They had to meet two tests.
The first was an absolute test.
They had to have better performance relative to the S&P
than Jack Welch had during his tenure at GE.
And then the second test was a relative test.
They had to materially outperformed the peer group.
And so if you look across that group of eight, seven men
and one woman, by definition, they
had to do things differently than the peers.
But it turned out that the specific actions that they
took, the things that they did, were remarkably similar
across the eight.
So they competed in a wide variety of industries,
ranging from manufacturing, to defense, to consumer products,
to financial services, and across very different market
cycles, but the specific actions they took
were remarkably similar to each other.
And the primary area of overlap was in the area
of capital allocation.
And so I think the easiest framework for thinking
about capital allocation is that to be a successful CEO,
over long periods of time, you need
to do two things well-- you need to optimize
the profits of the business you're running
and you then need to invest or allocate those profits.
And again, I think the framework for that
is there only three ways that business can raise capital
to invest.
It can cap it's internal cash flow, it can raise debt,
or it can issue equity.
And then there are only five things
you can do with that capital.
So you can invest in your existing operations,
you can buy other companies, you can pay down debt,
you could pay a dividend, and you
could repurchase your shares.
That's it.
So over long periods of time, the decisions
CEOs make across those alternatives
have an enormous impact on per share values.
So if you took two companies with identical operating
results, same level of revenue and the same level
of profitability, and two different approaches to capital
allocation, over long periods of time,
they drive two very different per share outcomes
for their share holders.
Second piece is that if you looked at this group of eight,
they fit an interesting sort of personal profile.
So all eight were first time CEOs.
So very surprising finding.
Over half were under 40 when they got the job,
only two had MBAs, four had engineering degrees.
And as a group, if you were reaching for adjectives
to sort of try to describe them, you
would not use the traditional, CEO adjectives of charismatic,
strategic, and visionary.
Instead, you'd use other adjectives
like pragmatic, flexible, opportunistic, dispassionate,
rational, analytical.
Words like that.
So they fit a slightly different profile.
So I'll stop there, but that's a bit
of an overview of some of the themes in the book.
INTERVIEWER: William, picking up on how
you describe their personality.
You're saying you would not associate it
with charisma and so on.
You also mentioned, early on, Jack Welch,
who's arguably one of the most celebrated CEOs in business
history.
But I remember reading in your book, and correct me,
if I'm mistaken, you say that Jack Welch does not even
belong to the same zip code as Henry Singleton, who
is one of the CEOs profiled in your book.
Can you say more about that?
WILLIAM THORNDIKE: I mean, Jack Welch was a great CEO.
Period.
And it's the reason that he was the benchmark used
as one of the two tests for selecting
the eight for the book.
But if you look at his-- so his returns are extraordinary.
He ran GE for 20 years and he averaged
about a 20% compound annual return
across that period of time, which is extraordinary.
However, his tenure coincided with a record bull market run
and a broader stock markets.
So I think really the way to frame
that is, how did he perform relative to the broader market?
And he meaningfully outperformed the market.
3.3 times the S&P over the time he was there.
But if you look at that metric, relative performance compared
to the S&P across a CEOs tenure, I
think these eight materially outperformed Welch.
And Singleton is an interesting case
because he's got such an interesting background.
We could spend more time on him.
But he, by that same metric, outperformed the S&P
by 12-fold over a much longer, nearly 30 year tenure
at a company called Teledyne.
INTERVIEWER: I want to maybe pause on Singleton for a second
before we move on because you said that he was not just
a pioneer in stock buybacks, he was much more than that
because he sort of built a framework
in thinking about them.
And later on, in your book, you also
mention the straw buyback approach versus sucking hose
buyback approach.
Can you share more on that with us?
WILLIAM THORNDIKE: So I'll give you a little background
on Singleton first.
INTERVIEWER: Yes.
Sure.
WILLIAM THORNDIKE: So Singleton is a very interesting case
and I think it would resonate particularly with this audience
because he had advanced math background.
So he was an undergraduate, earned his Masters and PH.D.
in electrical engineering from MIT.
While at MIT for his PH.D. dissertation,
he programmed the first computer at MIT.
So when he was 23 years old, he won
an award called The Putnam Medal, which
is awarded to the top mathematician in the country.
So he's very capable, competent, mathematician, engineer.
He designed an inertial guidance system
that is still in use in commercial and military air
crafts.
So he had this extraordinary career before he became a CEO.
And during the 60s, and 70s, and end of the 80s,
he ran a conglomerate called Teledyne.
And what's interesting about Singleton--
and he had extraordinary returns in doing that,
but what's interesting is the range he
showed as a capital allocator.
So for the first 10 years, he ran Teledyne.
Conglomerates were sort of the social media
companies of their day.
They traded extremely high P/Es.
And so Singleton used the inexpensive currency
of his high PE stock to buy 130 companies.
So he was an active issuer of shares.
At the very end of the decade, 1969,
a couple of the larger conglomerates
missed earnings dramatically and the entire sector got pounded.
So PE multiples came down across the group
and Singleton never bought another company.
He fired his business development team,
the group that was going out and finding acquisitions for him.
Instead, he'd focused on optimizing his existing
businesses and then he began a pioneering program
of repurchasing his shares.
And over the next dozen years, he
repurchased 90% of his shares outstanding.
So he showed this amazing to sort
of pivot it as the opportunities presented themselves
and the result was this extraordinary return over a 28
year period at the helm.
So that didn't answer.
So buyback.
So in that second period, the last dozen
years when he bought in 90% of his shares,
he had an approach to that that is wildly
different than the way most public companies repurchase
shares today.
Corporate America, as a group, is a completely ineffective
repurchaser of its shares.
So last year, 2014, corporate America
set the record for most capital allocated to share buybacks
and they exceeded the record that was set before,
in October of 2007.
So the absolute trough for buyback volume
by corporate America was in the first quarter of 2009.
So corporate America, as a group,
has a perfect record of buying high and effectively
selling low.
And not surprisingly, the returns aren't great.
And if you look at the way buybacks are typically
implemented in public companies in the US, it's not surprising.
So the typical way that works is the board
will authorize an amount of capital
that can be deployed for repurchasing shares.
And that will then be implemented
in even, quarterly increments, usually designed
to offset option grants.
So there's very little net shrink of the share base.
And not surprisingly, that approach rarely
produces interesting returns.
If you look at what Singleton did
and what the other CEOs in the book
did when they repurchased shares,
it was a very, very different approach.
They went long periods of time without doing anything
and then they would repurchase large chunks of stock
when they felt it was inexpensive.
Singleton did that through tender offers,
which is unusual, but that was his method.
Most of the others in the book used open market purchases,
but, in any case, a very different approach.
INTERVIEWER: Similarly, everyone looks at Berkshire Hathaway
over the years.
A lot of acquisitions have happened
when the price to book ratio was two or above.
And the few buybacks that have happened,
have happened at lower valuations.
So the question is, these outsider CEOs,
they're all sort of following the similar framework of doing
buybacks or issuing stock managers,
increasing the intrinsic value for their shareholders.
But it doesn't sound like a very difficult thing to understand,
it sounds like a very simple thing.
And yet it's simple, but hard since you
said most of the corporate America is not doing that.
I want to get to know your thoughts on why that does not
happen more often.
WILLIAM THORNDIKE: Yes.
So it's this distinction Buffett has between something that's
simple, simple to understand, versus easy, easy to actually
implement or do.
I think you guys are old enough to remember the late '08 early
'09 period after Lehman Brothers failed.
Do you remember that period?
So that was a legitimately scary period.
And the stock market fell dramatically,
but there were active scenarios for the financial system going
into sort of a freeze.
Falling off a cliff was the analogy that was used.
And so corporate America, as a group,
reacted in a way that's not irrational to that.
They generally focused on paying down debt and husbanding
resources, given the uncertainty.
So not irrational at all.
But if you looked at the two outsiders CEOs, the two CEOs
from the book who are still active during that period
of time, their actions were entirely different
than that pattern.
And so the two CEOs that were still active
are Warren Buffett, at Berkshire Hathaway,
and a guy named John Malone, who runs
a complex of companies centered now around Liberty Media.
And for both of them, the 18 to 24 months
following the fall of Lehman was the most active period
in their career.
So while the rest of corporate America
was husbanding resources, and sort
of standing by the sidelines, and healing balance sheet,
they were aggressively deploying capital, buying companies,
repurchasing shares.
But that's easy to intellectually understand,
but it requires a certain temperament
to be able to actually implemented it
in the heat of really difficult times.
INTERVIEWER: Sure.
So picking up on what you said about John Malone.
And reading your book, I noticed this trend
with the [INAUDIBLE] and Tom Murphy
as well, where there was this idea of roll ups,
acquiring companies and then sort of improvising
their operating metrics.
And less in Tom Murphy's case, but more in John Malone's case,
debt has had to play a significant role.
My question to you is-- when the whole sector, media, was doing
well and you see a long runway, maybe one
can look at that and the long term value
it will bring to shareholders.
But do you think the same sort of philosophy,
and the same sort of valuations, and the same perspective
towards debt would make sense today when a lot of things
of changing in media for example?
WILLIAM THORNDIKE: I think that's a very good question.
With the exception of Warren Buffet,
although we can come back and talk about that,
all the CEOs in the book were users of debt
in some form or fashion.
Some of them quite aggressively.
But their use of debt and their degree
of aggressiveness in deploying debt,
was very much related to the underlying predictability
of their business models.
So the most active user of debt, by a wide margin in the book,
was John Malone.
But John Malone, over the course of the time that the book focus
on, was focused in the US cable industry
before the advent of satellite delivery of program.
So effectively, a regulated monopoly business
with very predictable, recurring revenues.
Utility like recurring revenues.
So Malone recognized that predictability.
So as an example, you could go back
and trace the severe economic downturns
while Malone was running TCI.
Cable subscribers grew throughout all of them
over his tenure.
So he's a bit of a different case
than Capital Cities, which was focused
on advertising supported media.
So their largest cash flow source
was TV stations at a time when network TV was much more
dominant than it is now.
I think, today, it's a very different situation.
And so, always, your lens, I think,
in using leverage has to be-- you
have to have a degree of confidence in your projections
for cash flows going forward, even
in times of economic stress.
And then you need to have an appropriate amount of leverage
for that perspective, that set of projections.
And so now you, I think, have a much harder time getting
comfortable with the sort of leverage
that Capital Cities used, occasionally,
to fund acquisitions for those sorts of businesses.
Today, it wouldn't sense.
INTERVIEWER: So you're basically saying
that what happened in hindsight, it's
the framework and principles that have to remain consistent,
it's not those specific actions that need to repeat themselves.
WILLIAM THORNDIKE: Exactly.
That's a fair characterization.
INTERVIEWER: So that leads me to my next question, which
is not only were these outsiders CEOs themselves, contrarians,
and they did remarkably well for their shareholders,
but along the way, that also, as you write in your book,
created a diaspora of alumni from these.
Can you talk more about that, and how you think about that,
and why that happened?
WILLIAM THORNDIKE: Yes.
So I think there's a bit of an analogy with ducklings.
So there's this concept with ducklings
that they imprint on the first thing
that they see when they're born, which, the vast majority
of the time, is their mother.
And they then follow that.
But every now and then, you'll read stories of a duckling
is born and a young girl happens to walk between the duckling
and the mother.
And the duckling will imprint on the mother
and follow her around.
So I think in business, there's a similar phenomenon where
people are unduly influenced by early mentors.
I should say disproportionately influenced by early mentors.
And so these companies had very strong cultures and people who
grew up in those cultures were sort of
indoctrinated into these frameworks,
these ways of thinking about capital allocation.
And those who subsequently left to run other businesses,
brought those frameworks with them.
And as an investor, it was a very productive thing,
to follow the alumni.
INTERVIEWER: So what are some names to that?
WILLIAM THORNDIKE: There's a company called General Cinema,
the only Boston based company.
I'm from Boston, so the only one for my local area.
The former CFO went to run an electric utility
in the Northeast, a totally different business,
and had extraordinary returns doing that, but in a very
different setting.
There are numerous along alumni who came out of Capital Cities
and went to run other businesses.
INTERVIEWER: Bob Iger.
WILLIAM THORNDIKE: The best known of which,
right now, is the current CEO of Disney Bob Iger.
He's a Capital Cities alum and is actually
still very close to Tom Murphy.
Tom Murphy, who's now in his early 90s,
is still an active mentor for Iger at Disney.
So it'd be any number of examples of that.
So that's a pattern that's definitely
proven to be fruitful over time for investors.
INTERVIEWER: So on that theme, if you take,
say, Danaher, as an example.
Even if it's an outsider CEO, but they find a company
that might be subjective to cyclical headwinds.
So I'm thinking of Colfax in my mind right now.
WILLIAM THORNDIKE: Yeah, yeah, yeah.
INTERVIEWER: Would it be fair to just pay a high multiple
or pay a high valuation even in a cyclical industry,
but generally, an outsider CEO.
So how should investors think about valuations
along with the characteristics of the industry
and the management?
WILLIAM THORNDIKE: Yes.
So interestingly, it would be logical to expect
that capital allocation ability would trade at a premium,
but it's interesting.
If you look at the actual data, often it doesn't.
And I think there are a couple reasons for that.
One is, this approach to thinking
about capital allocation, one of the hallmarks of it
is a focus on minimizing taxes.
Over long periods of time, optimizing around taxes
can have an enormous impact on shareholder value,
but optimizing around taxes often
correlates with complexity.
So it often makes those businesses harder
to understand.
Also, these CEOs generally did not spend a lot of time
on investor relations.
They didn't view that as a good use of their time.
So the combination of complex structures, use of leverage,
and not a lot of time explaining results to Wall Street,
occasionally produces inefficiency, even
in the best capital allocators.
[INAUDIBLE] and I were talking before about how
this would be true as recently as 2012 in the Berkshire
Hathaway stock.
And there would be other examples.
Colfax is an interesting case because it's a mini me, so
to speak, of Danaher, which is run by the Rales
brothers, Mitch and Steven Rales,
who have just an extraordinary record.
Clearly an outsider group, they're sort of
starting over again with a very similar approach
in this company Colfax.
The initial acquisitions there are in industrial businesses
which are cyclical.
And Colfax, in particular, has faced
sort of a perfect storm of issues
in some of their end markets and the stock as reacted
accordingly.
And so I think it's an interesting time
to be looking at a business like Colfax--
run by a proven outsider team like that
after the stock has been hit hard for what may or may not
be one time reasons.
I don't have a point of view.
But I would be studying it, if I was focused, full time,
on the public markets.
I think it's an interesting potential situation.
INTERVIEWER: Thanks.
And Will, I remember, your book, in one
of the first few chapters, profiled a CEO,
who, very soon after joining, shrunk the company
by about half.
They lost rights to their company jet
and they sold one of the biggest divisions of the company.
And yet you profile this person as one of the most successful
CEOs ever.
Can you share with us your thinking
around that a little bit more for the benefit
of the audience?
WILLIAM THORNDIKE: Yes.
So that CEO is a guy named Bill Anders.
He's interesting because he has an unusual background.
So he was trained as an engineer, also,
he was then a test pilot in the Navy, and an astronaut.
And he flew an Apollo mission.
And, in fact, there's a very famous picture
that I'm sure you've all seen of the Earth from space.
It's sort of this iconic image from the 1960s.
And Anders actually took that picture
out the window of the Apollo capsule.
So he had this interesting career.
He didn't enter the private sector until is mid 40s
and then he went to work at GE.
He went through the GE training program,
was a contemporary of contemporary Welch's, and then
he was eventually hired to run a defense oriented conglomerate
called General Dynamics.
And he was hired to run General Dynamics in the 12
months following the fall of the Berlin Wall.
So fall of the Berlin Wall the early 1990s
threw the entire defense industry into chaos.
The traditional model of building a large weapon systems
to deter a Soviet threat was, all of a sudden,
out the window.
So very unclear what those businesses
are going to look like.
And Anders came in and did a fair amount of analytical work,
working with Bain & Company actually,
and determined that defense businesses,
to survive and thrive in this new environment,
were going to have to either build on market leading
positions or sell businesses that did not
have market leading positions.
So he began to aggressively divest those businesses that
had weaker positions.
So he ended up selling off a large chunk of the company.
He then went out to try to build around the company's
core franchises, one of which was its fighter plane business.
So General Dynamics made the F15, which is a long time--
and he went to the number two player
in that market, Lockheed, to see if you
could buy Lockheed's business.
And he went to sit down with the Lockheed CEO.
And the Lockheed CEO says, we're not for sale,
but we'd love to buy your business.
We'll pay you.
And he named an extraordinary price.
And Anders, without blinking an eye,
moved forward to sell their largest business
because he just saw that there was no-- he had done
all the math, all the work.
He knew, exactly, what the cash generated by that business
would look like.
And when he was paid enough of a premium,
he was willing to sell it.
And so he end selling that business.
So the company, at the end of this series of divestitures,
was less than half its size.
And meanwhile, he'd been optimizing the businesses,
so he generated enormous cash from improved operations
and from these assets sales.
And he then did two interesting things.
He had a very savvy tax adviser who
helped him design a series of special dividends
that were characterized as return of capital.
So they were shielded from any capital gains tax
so that he was able to distribute a lot of proceeds
directly out to shareholders in a tax advantaged fashion.
And he used the balance of the excess cash
to repurchase 30% of shares.
So the net of all that was just extraordinary value creation
for the shareholders, but in a situation
where the company itself, by any metric, revenues, cash flow,
employees, shrunk very dramatically.
So it's an interesting case.
INTERVIEWER: I want you to say more
about that from an institutional imperative point of view.
CEOs generally want their company revenues
to grow, they want their own influence to grow,
they want to have a good sort of corporate office, and so on.
And here's someone sort of doing that in the opposite direction
almost, at the surface level.
And this is a theme that I find comes up
again and again in your book.
Tom Murphy left a prestigious job
to go and start a radio station.
He had no experience there.
Warren Buffett, himself, he left Wharton to study
in The University of Nebraska.
And one could argue that a lot of what Singleton did also
seemed counter intuitive.
So there's a contrarian, almost rebellious streak
that one sort of senses in these CEOs.
What do you think gives them the strength
to act the way they do?
WILLIAM THORNDIKE: It's a good question.
So the word I would use to characterize
that sort of strain of independence is iconoclastic.
So these guys were iconoclasts.
They were intentionally-- comfortable
doing things different than the peer group.
And what drove their confidence, their ability
to have these contrary positions,
was that it was rooted in deep, analytically based conviction.
So as a group, the group is very quantitatively oriented.
As I said, four engineers, two MBAs.
They did their own analytical work
around major corporate decisions,
including acquisitions and buybacks.
They did not rely on an internal finance
team or external advisers, bankers, and consultants.
And they were solving for the problem of value per share.
They were very, very focused on optimizing value per share.
And so, occasionally, that mindset
would give them conviction around some sort of an action.
It could be stock repurchase, a large acquisition,
or a large divestiture.
And when they had that, they were
prepared to move forward because they, themselves,
had the conviction coming out of their own thinking,
their own work.
INTERVIEWER: Sure.
Thanks.
And finally, I'm sure the question
about who are the modern outsider CEOs
is going to come up.
So I'm going to pause myself on that
and it'll come up during our discussion.
But before we open it up to the audience, I wanted to ask you,
if you look at a CEO who wants to improve
the intrinsic value per share, but let's say their horizon
of doing this is not a few years,
but maybe decades or even centuries.
And I'm thinking of someone like Jeff Bezos.
A comment that's been attributed to him
is he's sort of said your margin is my lunch.
How does one think about a CEO like that
in the context of outsiders?
WILLIAM THORNDIKE: Yes.
So I think a common trait across this whole group
was optimizing for long term value per share.
I should have emphasized that, [INAUDIBLE].
That's very true.
Long term, I would define in the context of sort of from today
looking forward three to five years.
I think that's really kind of the visible business future.
I think decades and centuries is harder, at least
in most businesses.
Particularly in your business, it
would be hard to look out that far
and make decisions accordingly, I think,
in most of your business lines.
So I think that's a more realistic time frame.
I think Amazon is a fascinating case
and Bezos is a fascinating case.
So if you said-- So you guys have an exceptional business.
It's been extraordinarily well lead.
But if I was put on the spot and asked to name an outsider
CEO among the traditional-- the technology CEOs in the last 25
years, Bezos would be the first choice for me.
And it would be because-- and I can't
say that I've studied the company in great detail,
but I have read annual reports.
And I believe he's optimizing for per share values
5 to 10 years out.
And he can afford that time frame
because he owns such a large percentage of the company
himself.
So he has the ability to tune out the noise
by virtue of having so much ownership
concentrated his own hands.
So I think he's an interesting case.
INTERVIEWER: And who are the other CEOs
in today's market or today's businesses that seem
like the outsider CEOs to you?
WILLIAM THORNDIKE: So you mentioned the Rales brothers
at Danaher and Colfax.
I think they very definitely fit the model.
There's a wonderful CEO named Nick Howley who
runs a business called TransDigm that focuses on specialized
aircraft components.
And he's done an extraordinary job building value there.
There is a CEO name Mark Leonard who
runs a very interesting software business in Canada
called Constellation Software using many of these principles.
I believe, controversial as it is at the moment,
that Mike Pearson at Valeant, although it's still early days,
has many of these traits.
And this is a very interesting case to watch unfold.
There's a reinsurer called Arch Re that
runs its business very much along these lines, I think.
There are a series of sort of mini Berkshire insurance
companies, Markel Insurance, Fairfax,
White Mountains, Allegheny.
They are built along similar lines.
There's a home builder, of all things, called MVR.
So I could go on, but there are current, contemporary examples
that I think embody these traits very well
across a variety of industries.
INTERVIEWER: Sure.
So maybe along the lines of that,
for the individual investor on average,
if they are willing to put in the time
to study-- additional time than it would take to just invest
in an index fund, let's say, what
would be your advice in how to approach investing, in general?
And from a spin on the outsider's perspective,
how could they go on identifying these in foresight
rather than hindsight?
WILLIAM THORNDIKE: Yes.
So I think your first qualifier, [INAUDIBLE], is very important.
So I think if you're going to actively manage
your own retirement portfolio, you
have to be committed to putting in the time to do that.
And it has to be something that, intellectually, you
enjoy doing because otherwise, you're
going to be better off with index fund type solutions,
I think, longer term.
But if that does fit for you, then I
think you have a question around portfolio construction, which
is, I think, a very personal, temperamental thing.
Are you going to be concentrated or are you
going to be diversified?
There are sort of arguments for both.
So I think those are things that you just
have to sort out for yourself with advice
from people you respect.
As to identifying-- so there are two ways
to invest in outsider CEOs.
One is to keep a list of the proven outsider CEOs, some
of whom we've talked about.
And you can start with Buffett and Malone.
And then systematically track the value of their stocks
and have some parameters around when you might buy it.
I mean, Buffett has given you parameters
about when he'd by Berkshire, so you can start there.
But you guys create algorithms-- if Berkshire is ever
trading at 1.2 times, it ought to flash red on your screen,
and you ought to put some in your personal account.
That's easy.
So I think there's some things like that
with existing, known outsiders.
You ought to have them on a watch list.
And as I say, from time to time, they systematically
trade at discounts to their peers, crazy as that is.
So you ought to be set up to wait for those opportunities.
In terms of recognizing new outsider CEOs,
I think that's a hard thing to do.
I think they need to have been in the seat
for at least five years to have enough in the way of actions
taken to be able to have a point of view on whether they're
really outsiders.
So in the first five years, you just
don't have enough data to go on.
Pearson's right around-- it's interesting,
he's right around five years.
I think in those five years, the early markers
are interestingly qualitative.
I think vocabulary means a lot.
So I think it's very interesting to hear
how a CEO talks about their business
or how they write about it in their annual report.
And so I think you get extra credit if you use the words per
and share consecutively a lot.
That's just starting there.
If you're optimizing things per share as opposed to just,
we're going to grow revenue, we're going to grow profits.
Every time someone says that, picking the word-- connection
with profits, you'd like to hear them say per share immediately
afterwards.
Because just growing profits, you
can actually destroy lot of value
growing the business, growing profits, growing revenues.
And I think a focus on the use of the word cash
gets extra credit.
So people who are optimizing around free cash
flow instead of net income.
And if people talk about their unit economics
and they use words like internal rate of return
when they're justifying investment decisions,
extra credit, I think.
So I think there's some things that you
can pick up about-- I'll give you an example.
So we invest in the cell tower business,
which is an excellent business.
And there are two, dominant public companies-- American
Tower and Crown Castle.
And I have years of going to investment conferences
and hearing those two companies present.
Both have been great, great stocks
over a long period of time.
But their approaches to capital allocation
and to running their businesses are very different.
American Tower is the largest player
and, historically, if you sit at one of their presentations,
they'll talk about number of towers, revenue,
what they call tower cash flow, and EBITDA,
which is the use of the metric of cash flow
that they talk about.
And they've done a great job building their business.
If you then sat in on Crown Castle's presentations
over time, you'd see that they evolved over time
under a CEO who was an engineer at a different metric.
And evolved over time, but eventually,
they would just say, we're running our business
to optimize for one thing and that's recurring
free cash flow per share.
And so they had moved to a single metric that
was differentiated from what others in the industry
were doing.
And if you really understood the business,
you'd see the power of that.
Every piece of that would give you
an indication of how they would behave if their stock was
trading at a high multiple, a low multiple, how they'd
think about new builds, how they'd
think about acquisitions.
So I think you can learn a lot from metrics and vocabulary.
INTERVIEWER: And do you think one also
has stuff to learn from how they structure their capital
allocations structure?
For example, becoming a REIT, R-E-I-T, for example,
versus not.
WILLIAM THORNDIKE: I think so.
I think, potentially, yes.
Again, I think it comes down to how they talk about that.
I think the REIT structure can make a lot of sense,
but you'd love to hear them justifying
that in quantitative, per share terms.
What exactly are the benefits of that
for shareholders, longer term?
Why is that going to produce higher per share values
than a non REIT format?
INTERVIEWER: I was hoping you would
share your opinion on that.
WILLIAM THORNDIKE: I think it varies by industry, honestly.
INTERVIEWER: No, in the examples-- American Tower
and Crown.
WILLIAM THORNDIKE: They're all REITS now,
so they've all made that decision.
And I think it's a very rational decision
for that kind of a business.
It wouldn't have been as rational earlier on, when
they were growing more rapidly.
INTERVIEWER: Because they had to reinvest.
WILLIAM THORNDIKE: Yes.
It's just the dynamics of those recurring,
capital intensive businesses, I think.
But I think at this stage, for both of them, that's
a very rational decision.
INTERVIEWER: Great.
So I have a bunch of audience questions for you.
WILLIAM THORNDIKE: Great.
INTERVIEWER: The first one, you shouldn't be surprised.
You're at Google.
The question is, how do you think
about Larry Page, and Alphabet, and the framework of outsiders?
WILLIAM THORNDIKE: Yes.
So I admit, I'm a little embarrassed.
I don't really know all the details of Alphabet.
So I'm very intrigued.
Obviously, thinking about Google more generally--
it's just an extraordinary company that you guys work for,
an extraordinary business.
And phenomenal value has been created
and I think you guys seem very well positioned
in your major business lines going forward.
I think the issue for Google is--
so I'll give you an analogy.
Charlie Munger once wrote about the difference
between CBS and Capital Cities in the heyday of the TV station
business, 1960s and 70s, when those
were basically incredibly profitable,
oligopoly businesses.
And Capital Cities ran this very lean, frugal, optimizing sort
of a structure around those businesses
while maintaining leadership positions
for its news broadcast.
So investing in the product.
But CBS divested outside of the core business,
it bought The New York Yankees baseball team,
it bought a toy business, it built
this landmark headquarters building called
Black Rock, you can still see it in New York,
had a corporate structure with tons of presidents, and vice
presidents, and co presidents.
And Munger referred to CBS as of prosperity blinded indifference
to costs and he contrasted that with-- so
I think the issue for Google is, you guys are so incredibly
profitable that you don't have to make capital allocation
trade offs.
You can kind of do it all.
You can sort of try things.
And so I think the issue is that as the business inevitably
matures, all businesses mature, even yours,
that may be a decade down the road,
will you be able to think analytically
about optimizing across a scarcer opportunity set?
Because the problem with technology companies,
historically, is that they don't stop investing in R&D,
even after the returns from those investments
are very poor because the founders just
have that in their DNA.
So I think the test will be for Larry--
those investments are still very productive for you guys.
The YouTube acquisition was an excellent acquisition.
So I think it's early to tell and the conundrum
is that there will be challenges posed by your very success
today as to whether-- I think we'll learn a lot about Larry
in the next decade as capital allocator.
He's done an extraordinary job getting the business
to this point in time and it will be interesting to see.
INTERVIEWER: Sure.
So the next question.
He wants you to discuss the lack of a control group.
Or flipping it around, discussing the survivorship
bias displayed in "The Outsiders."
WILLIAM THORNDIKE: Yes.
The lack of a control group.
So is a question that's come up from time to time.
And so the question is, are there examples
of CEOs who have pursued these strategies and not
been successful?
Is there a survivorship bias-- they sort of
got knocked out early.
And the reality is, we weren't able to find any in our work.
We weren't able to find any.
But listen, I think it's a valid question.
What's striking is that-- so one of the investors who
I've gotten to know, after the book came out,
about working on this project has a high level stats degree.
And I raised this question with him
and he said it that, for him, the strength of the correlation
was such that he was very comfortable with the value
of the findings of the data.
But I think it's a valid questions.
I think it's a valid question.
INTERVIEWER: Fair enough.
And is there any opportunity for activist
investors to motivate non outsider CEOs to behave
in an outsider like behavior?
WILLIAM THORNDIKE: The short answer is yes, but sort of a
qualified yes.
I think that activism is very popular at the moment,
but there are very different approaches to activism.
And the world of activists divides into two camps--
those who are sort of optimizing around short term outcomes
and those who are more focused on longer term outcomes.
So ValueAct and [INAUDIBLE] would
be examples of the latter.
And there would be plenty examples of the former.
And I think that group of activists, the longer term
group of activists, has had a very positive impact on capital
allocation trends over time.
And they have been able to demonstrate
that they can come in and, working productively
with the management team, make changes that are very
beneficial for shareholders.
I think the shorter term group, the data is much more mixed.
I think it's very dependent on-- and its
very dependent on the CEO and the board in any given case.
But generally, I think activism is
a positive for more rational capital allocation.
INTERVIEWER: Sure.
And I have to ask for those of us in the room--
and actually, you're going to have a much wider audience
even on YouTube.
For the folks who are not necessarily
professional investors, who are not finance majors,
but who are maybe students or individual investors--
so this is a continuation of my previous question.
What is your general advice to them
about how to invest and be successful in long term
investing horizons?
WILLIAM THORNDIKE: Yes.
So that's a good question.
So I think a lot of it comes back to that
question I asked earlier.
[INAUDIBLE], you enjoy investing.
Intellectually, it's something that obviously is stimulating
and engaging for you.
That's not true for everybody.
So I think if you're going to manage your own account, which
is, I think, a wonderful thing to do,
you have to really enjoy that activity
and be interested in putting in the time to do that well.
I think, otherwise, you should look
at more passive alternatives for managing your assets.
And it's really hard, long term, to beat intelligent indexing.
Just from a cost efficiency perspective.
The other alternative, which can be indexed investing,
is if you can find a very good manager with a very
good long term record.
And if you can identify a manager like and stick
with them, you can earn significant returns over time.
It's hard to do that.
It's hard to find them.
It's hard to stick with them when they under perform
because even the best managers will have
periods of under performance.
And the worst time to leave them is
when they're under performing, but every fiber
of human instinct is to leave them at that exact juncture.
So it's hard to resist that.
The third alternative is to manage the account yourself.
And that can be the most rewarding,
both in terms of returns and personally, but you really
have to be wired, I think, in a certain way to want to do that.
And people in this room maybe self selected a bit for that.
INTERVIEWER: Sure.
Any other questions?
AUDIENCE: Is there any advice to suggest you hire Madoff?
Long term, leading the market.
WILLIAM THORNDIKE: Not long enough term, clearly.
And I think you need to understand the strategy
and make sure it resonates for you.
I think there were questions about the strategy there.
Lots of sophisticated investors looked at Madoff over the years
and didn't participate, so I think
there were worrying signals.
But that would argue for a portfolio of managers.
AUDIENCE: Should I grab a mic or something?
AUDIENCE: Or you can just repeat the question.
INTERVIEWER: Yes.
I'll repeat the question.
AUDIENCE: So your work share focuses,
very narrowly, on sort of increasing value per share,
which is the game as it's played today.
I'm just curious on your thoughts--
there's a growing amount of people talking
and many point at Robert Reich's new book about how it's sort
of missing this larger dynamic.
That when you focus so narrowly on that,
it's caused a lot of political distortions
and it's caused a lot rent-seeking behavior
in various cases that actually is making capitalism, overall,
less efficient.
So in some ways, your book could be a handbook
for driving the helm in the fast lane, if you by that argument.
I'm just kind of curious of how you think about that larger
balancing act and what responsibility, if any,
those CEOs should be taking about that?
AUDIENCE: It was loud.
You don't need to repeat it.
INTERVIEWER: Great.
WILLIAM THORNDIKE: So first of all, I
think that's a great question.
So I think there's an important distinction between optimizing
per share value in the short term, which I would define
is 24 to 36 months in the public market,
versus longer periods of time.
So the average tenure of the CEOs in this book
is over 20 years.
I believe that over longer periods
of time, that one metric captures a lot
of other important things, including
some things that Reich should be focused on.
So you cannot have exceptional, long term per share performance
unless you are delighting your customers,
you have an employee base that's loyal and fulfilled,
and you're not treading outside of societal norms
and parameters around environmental behavior--
realizing those are going change over time.
So what was acceptable in the '60s and '70s
would be different now, but you've
got to play within those rules.
So I think as a long term, as a single metric,
it's pretty good at picking up all of those things.
And I think it's hard to measure performance in some
of these other areas precisely.
So are you environmentally sensitive?
Are you really taking care of your employees,
both while they're employed for you,
and afterwards in the retirement programs, and health programs,
the other benefits you're providing?
Are there other ways of being a good corporate citizen?
So I think it works pretty well, long term, across those
dimensions.
Short term, it can be the antithesis of that.
If you're optimizing short term cash flow per share,
benefits plans are one of the first places you would look.
You would look at raising your prices aggressively
to existing, loyal customers because they're not
going to turn immediately and you
can get 12 to 24 months of-- there
are a lot of things you would do,
if your goal is just to optimize 24 month out cash flow.
But that's a way of thinking about that.
INTERVIEWER: So questions?
AUDIENCE: At the time of Henry Singleton,
it was very rare for a company to buyback stocks.
Right now, almost every company would buyback stocks.
Another example, 3G capital.
They are using like a zero based budget.
And I read that other food companies,
they are doing roughly the same thing.
So does that mean that, in the long time,
this outsider technique is going to be used everybody,
so that this outsider mentality would not be that valuable?
WILLIAM THORNDIKE: That's a great question.
That's a great question.
So I think the answer goes back-- so both of those pieces.
So let's look at the buybacks first.
So we talked earlier about buybacks.
So buybacks are very popular right now.
But because of the way they're being implemented,
I think it's unlikely they're going
to create significant value, generally,
across corporate America.
I think those who are more targeted and bolder
in their approach to buybacks, are
going to continue to be able to create value that way.
So I think a lot of it has to do with your approach to that.
So that's in the case of buybacks.
3G is just fascinating.
It's just fascinating to see what they're
doing across these industries.
And I don't know-- I'm curious to see what that's
going to look like five years from now,
but have proven, across a range of businesses now,
the ability to grow cash flow, increase margins through zero
based budgeting, reducing costs without material
declines in revenues.
In many cases, they haven't shown the ability
to grow revenues, but they were in business
that were pretty mature anyway.
So I think it's early days still in seeing how that's
going to play out over time, but the early data
is very interesting.
And I think it's an interesting question.
I think it's an ethical question.
Because a company may have been very prosperous
over a long period of time, like CBS in the example
I talked about before, and it's created a corporate structure
that just grew organically over time, like Kudzu,
but isn't necessarily rational relative
to the business itself, and sort of grew
because of institutional momentums,
is it ethical to streamline those businesses so that they
run more efficiently, if it doesn't change the customer
experience?
I don't know.
I think that's a really interesting, ethical question.
I think you could certainly make an argument that you're not
necessarily doing a favor for those in bloated hierarchies
to protect their jobs at ad infinitum.
I'm not sure that's better for society.
I'm not sure that what 3G is doing isn't
the right long term-- even though it causes dislocation,
it's very unfortunate for those who lose their jobs,
it's unclear to me that that's not
good for society, longer term.
I don't know.
I think it's an interesting question.
INTERVIEWER: So the question has gone into more specifics.
Let me just repeat it.
The question is, how do you characterize Facebook
and Oracle in the framework?
WILLIAM THORNDIKE: I just don't really
have enough knowledge of either company,
honestly, to answer that question intelligently.
I know that Oracle has been acquisitive
over a long period of time.
And I believe, although I haven't studied the data,
that that's been a very accretive activity
for shareholders.
So that would argue that they've been effective in acquisitions,
which is a major potential conduit for capital allocation.
Facebook, it's extraordinary what's
gone on in that business.
And their primary capital allocation channel
has been internal growth.
They've been funding internal growth.
That's a very prudent thing to do.
That's been true for Google.
Impossible to argue that that hasn't been a great high IRR
activity for-- but at some point, the growth levels out.
And the question then becomes, what
do you do with the excess cash?
And I think it's early to tell, but the WhatsApp acquisition--
You guys would be better able to evaluate that to me.
I mean, that seems completely insane to me
on normal financial metrics, but I
don't think normal financial metrics necessarily apply.
But we'll be able to calculate the IRR on that three years
from now.
It'll be very interesting to see.
When you guys did the YouTube acquisition, by the way,
it was also a possible to justify it.
That's been a phenomenal acquisition.
So I think the world that you guys
play in is a little bit different,
the metrics need to be different.
AUDIENCE: That was also long term.
It lost money for a long time.
WILLIAM THORNDIKE: It did.
It did, but ultimately-- I mean, I give a lot of credit
to Eric Schmidt and Larry.
Whoever was involved in that, I think
they were thinking about that very analytically.
They had a longer term-- they had a point of view on that.
They had conviction, and they acted on it,
and it created a lot of value.
It's different than what I'm really able to evaluate though.
INTERVIEWER: So with that, thank you so much for being here
and for taking our questions.
Please to have you.
WILLIAM THORNDIKE: Thank you, [INAUDIBLE].
Nice to be here.
[APPLAUSE]