“Tom Murphy has taught me more about running a business than any other person. We have been friends and mental partners for more than 50 years. My only regret is that I didn’t meet him earlier. Tom phoned me today and said that recovering from a recent bout with Covid convinced him that he would feel more comfortable ending his activities at Berkshire. I accepted his wish. He will continue as a major shareholder and friend.”
— Warren Buffett, February 14, 2022
In recent years, there have been many campaigns to increase the diversity of corporate boards. However, the core qualifications for a valuable board member must always include at least two key qualities: First, the member must have significant business acumen and the credibility to provide guidance to management. Second, the member must have a very meaningful ownership interest in the company.
Berkshire Hathaway’s Board of Directors has an unusual amount of skin in the game even if you exclude Warren Buffett’s interest in the company. However, Tom Murphy’s resignation from the board in February, at the age of 96, represents the departure of a very major shareholder. Mr. Murphy owned 695 Class A share and 1,489 Class B shares according to the company’s 2021 proxy statement which is worth nearly $370 million based on recent market quotes. Of the current board members, only Warren Buffett, Charlie Munger, and David Gottesman have larger interests.
It’s obvious that Tom Murphy satisfied the requirement of having a significant ownership interest in Berkshire, but I am sure that Warren Buffett valued Mr. Murphy’s business background even more highly.
We can learn a great deal about business and capital allocation by studying Tom Murphy’s long and successful career in broadcasting which culminated in the sale of Capital Cities/ABC to the Walt Disney Company in 1996. Over the years, I have read about Mr. Murphy from time to time, but I never attempted to form a composite picture. Let’s take a look at Tom Murphy’s long career and then examine his relationship with Warren Buffett and Berkshire Hathaway.
Decentralization, Frugality, and Capital Allocation
William Thorndike opens his widely acclaimed book, The Outsiders, with a study of Tom Murphy’s track record in a chapter named “A Perpetual Motion Machine for Returns”. The chapter title is no exaggeration. One dollar invested with Tom Murphy when he became CEO of Capital Cities Broadcasting in 1966 would grow to $204 by 1996 when he sold the company to Disney. This works out to a 19.9 percent annualized return over nearly three decades compared to 10.1 percent for the S&P 500 and 13.2 percent for an index of leading media companies.
This type of rapid compounding over a long period of time simply does not occur when you are starting out with a large capital base. Mr. Murphy’s start in the broadcasting industry could not have been more humble. After meeting Frank Smith in 1954, Mr. Murphy accepted a job offer to run a small television station in Albany that had recently emerged from bankruptcy.
Despite having no formal management experience at the time, Mr. Murphy took immediate control of the television station and improved its operations to the point where it was generating consistent cash flow. Cost cutting was an important part of the strategy, and Mr. Murphy was soon entrusted with the management of two additional stations, collectively called Capital Cities Broadcasting.
With the business expanding rapidly, Mr. Murphy hired Dan Burke in 1961 to take over management of the television station in Albany. Mr. Burke had consumer products experience but no background in broadcasting. However, he quickly learned all he needed to know from Mr. Murphy who was soon confident enough to focus on capital allocation issues knowing that the day-to-day operations were in good hands.
Mr. Murphy took over as CEO in 1966 when Frank Smith died. At that point, the company had revenue of $28 million and had grown through additional acquisitions over the preceding half decade. Mr. Murphy promoted Mr. Burke to President and Chief Operating Officer. Mr. Burke focused on ensuring that the company’s operating businesses operated at peak efficiency and Mr. Murphy dedicated his time to making capital allocation decisions.
Over the next four years, Mr. Murphy completed a series of acquisitions culminating in the $120 million purchase of Triangle Communications. At that point, Cap Cities owned the maximum number of television stations permitted by the FCC and Mr. Murphy turned his attention to newspapers which were still very attractive businesses in the 1970s. He purchased several small dailies as well as the Fort Worth Telegram for $75 million in 1974 and the Kansas City Star for $95 million in 1977.
Mr. Murphy clearly wanted to grow the size of Capital Cities, but he never lost sight of the fact that growth through acquisition only creates value if it can be accomplished at sensible prices, nicely encapsulated in this quote:
“The goal is not to have the longest train, but to arrive at the station first using the least fuel.”
The downfall of many capital allocators is their desire to grow their empires at nearly any cost. Few hard charging executives are willing to shrink their companies. By repurchasing shares, a capital allocator relinquishes cash that might otherwise be used to expand his empire in exchange for shrinking the share count. Of course, doing so can make a great deal of sense in terms of per share value.
During the bear market of the mid-1970s, Mr. Murphy began an aggressive repurchase program because he was able to acquire shares mostly at single-digit P/E multiples. Eventually, he would repurchase close to fifty percent of Capital Cities shares.
There’s a lesson to be learned by comparing Mr. Murphy’s attitude toward acquisitions and repurchases with the record of CBS. When Mr. Murphy became CEO of Capital Cities in 1966, CBS had a market capitalization that was sixteen times as large as Capital Cities. However, Capital Cities was three times as valuable as CBS when it was sold to Disney in 1996.
How did this happen?
Thorndike explains that CBS had a very different attitude toward acquisitions:
“CBS spent much of the 1960s and 1970s taking the enormous cash flow generated by its network and broadcast operations and funding an aggressive acquisition program that led it into entirely new fields, including the purchase of a toy business and the New York Yankees baseball team. CBS issued stock to fund some of these acquisitions, built a landmark office building in midtown Manhattan at enormous expense, developed a corporate culture with forty-two presidents and Vice Presidents, and generally displayed what Buffett’s partner, Charlie Munger, calls “a prosperity-blinded indifference to unnecessary costs.”
CBS focused on building the longest train, justifying expensive acquisitions and expansion that ended up not paying off nearly as well as Mr. Murphy’s strategic acquisitions, zealous expense controls, and share repurchase programs.
In 1986, Capital Cities acquired ABC for close to $3.5 billion, a massive acquisition both in absolute and relative terms. It was clearly a bet on the future of the company. Warren Buffett provided financing for the deal through Berkshire Hathaway which represented an important vote of confidence. The team of Murphy and Burke set about to improve ABC’s margins through a combination of cost cutting and adopting the same business practices and efficiencies that had produced much higher margins at Cap Cities. First class airfare and limousines, par for the course at the old ABC, were out in favor of taxicabs.
Tom Murphy and Dan Burke did not take a totally hands-off approach after acquiring a business. They sought to put in place operating efficiencies and a culture of thrift, but once this was established, they did not micromanage local operations. Executives from subsidiaries would meet with Cap Cities management for budgeting and capital allocation planning, but would otherwise run their businesses on their own.
In 1996, Cap Cities/ABC was sold to Disney for $19 billion which represented a multiple of 13.5x cash flow and 28x net income. Mr. Murphy was willing to repurchase shares like crazy in the 1970s when he could do so at single digit multiples of earnings and finally sold out at what can only be described as a very fancy multiple.
Shortly after the deal was announced in the summer of 1995, Tom Murphy was interviewed by Charlie Rose regarding the rationale for selling to Disney and his thoughts on the future of broadcasting and entertainment. It is interesting to note that Disney originally wanted to purchase Cap Cities in a 100 percent cash transaction. However, Mr. Murphy insisted on a significant stock component, both to shield Cap Cities shareholders from taxes and to provide ongoing upside.
Berkshire’s Cap Cities Investment
When you read about Warren Buffett’s financial ties to Tom Murphy, the story typically starts in 1985 when Mr. Buffett participated in the financing for the Cap Cities/ABC deal. However, the two men had known each other for well over a decade before the ABC deal took place. It is easy to see why there was a natural affinity when you read about Tom Murphy being so frugal that he only painted the two sides of the Albany television station’s headquarters that faced the road!
As Roger Lowenstein describes in Buffett: The Making of an American Capitalist, Mr. Buffett actually owned shares of Cap Cities in the 1970s:
Buffett, who had met Murphy in the early seventies, knew that anyone who didn’t waste paint on his headquarters was his sort of guy. He bought 3 percent of Cap Cities for Berkshire in 1977, but after a run-up in the stock he sold — a decision Buffett would later attribute to “temporary insanity.”
Since both Berkshire Hathaway and Cap Cities were in the newspaper business in the 1970s, their paths often crossed, and Mr. Buffett became one of Mr. Murphy’s close confidants. When Cap Cities moved to acquire ABC in 1985, Berkshire Hathaway already owned 2.5 percent of ABC’s stock. Mr. Buffett was perceptive enough to know that if Cap Cities bought ABC, Cap Cities itself might soon be in play.
“What do we do about that, pal”?” Murphy asked.
Buffett said, “You better have a nine-hundred-pound gorilla. Somebody who owns a significant amount of shares who will not sell regardless of price.” Obviously that somebody would have to be very rich, and totally loyal.
“How about you being the gorilla, pal?”
Berkshire ended up buying three million shares at the current market price of $172.50, which amounted to 18 percent of Cap Cities for a total investment of slightly more than $500 million. This might seem like a tiny deal from the perspective of 2022, but it was a huge deal for Berkshire at the time. As Lowenstein points out, the Cap Cities stock purchase was eight times as big as Berkshire’s recent purchase of Nebraska Furniture Mart.
By the mid-1980s, Mr. Buffett was already more willing to pay up for higher quality businesses run by management teams that he had confidence in. The price of the transaction was 16 times earnings and justified based on the assumption that Mr. Murphy and Mr. Burke would be able to cut costs at ABC and make the deal pay off.
That played out, eventually. But not without unpleasant bumps along the way.
A Seamless Web of Deserved Trust
“The highest form a civilization can reach is a seamless web of deserved trust. Not much procedure, just totally reliable people correctly trusting one another.”
— Charlie Munger, USC Law School Commencement, May 13, 2007
Berkshire Hathaway proved not only to be a 900-pound-gorilla for Cap Cities, but a very friendly gorilla. In an unusual move, Mr. Buffett gave Mr. Murphy proxy power over Berkshire’s Cap Cities stock as well as legal authority over Berkshire’s ability to sell. Lowenstein quotes Buffett making the following extraordinary statement:
“I will be in Cap Cities as long as I live. It’s like if you have a kid that has problems — it’s not something we’re going to sell in five years. We’re partners in it.”
Well, it might not sound extraordinary to close followers of Warren Buffett’s career, but it was extraordinary in the heated environment of the 1980s. Before the deal closed, ABC began having trouble with declining advertising revenue and ratings were falling. ABC turned out to be even more profligate than expected, and the network had a $70 million loss in the first year after the acquisition. But the Murphy/Burke duo quickly took a scalpel to costs, and they made good progress.
As cable television gained momentum, competitive threats to traditional networks intensified. Lowenstein notes that a couple of years after the ABC purchase, Cap Cities stock had soared to $630 at which point Mr. Buffett could have sold. The stock soon fell to $360, but Mr. Buffett was in it for the long haul. Berkshire had a reputation to protect as a stable owner. This was a competitive advantage when buying family businesses such as Nebraska Furniture Mart and it apparently extended to publicly traded securities where Berkshire was serving as the cornerstone of a stable shareholder base.
Patience paid off handsomely. In 1994, Cap Cities/ABC split its stock 10-for-1. In July 1995, Disney agreed to acquire Cap Cities/ABC for $19 billion. Each share of Cap Cities/ABC was entitled to one share of Disney which traded at $58 5/8 on the day of the announcement, plus $65 of cash, an implied valuation of $123 5/8 for each Cap Cities share on the date of the announcement.
Two Sides of the Same Coin
Many business executives are operational specialists. They understand how to optimize a business in terms of maximizing long term profitability and customer satisfaction.
A much smaller number of executives are excellent capital allocators. They understand when it makes sense to reinvest in the business, when acquisitions might be fruitful, and when funds are best returned to shareholders.
It is exceedingly rare to find both talents — operational and capital allocation excellence — in one executive.
Tom Murphy got his start optimizing the business performance of a small television station in Albany and quickly perfected his methodology. He was able to pass on this knowledge to a younger executive when he hired Dan Burke and then he delegated operational responsibilities while he focused on capital allocation.
Warren Buffett is not exaggerating when he extols Tom Murphy’s stellar track record.
All too often, corporate boards are merely window dressing, selected to satisfy various constituencies that have nothing to do with shareholder interests and failing to provide meaningful guidance to management.
Obviously, Berkshire’s board has historically been very different. Tom Murphy’s resignation from Berkshire’s board is clearly a loss for the company and I’m sure Warren Buffett will miss his wise counsel.