Direct Wisdom from John Malone


#1


“By 1970, John Malone had been at McKinsey long enough to know an attractive industry when he saw one, and the more Malone learned about the cable television business, the more he liked it. Three things in particular caught his attention: the highly predictable, utility-like revenues; the favorable tax characteristics; and the fact that it was growing like a weed. In his years at McKinsey, Malone had never before seen these characteristics in combination, and he quickly concluded that he wanted to build his career in cable.”

- The Outsiders by William Thorndike

In 1973, John Malone met Bob Magness, who offered him the job of CEO of his almost bankrupt cable company, Tele-Communications (TCI). From 1973 to 1998, Malone rolled up the cable industry and in the process made TCI shareholders a fortune, a 30.3% compounded annual return. What sets the intelligent fanatic John Malone apart from most is his incredible deal making ability, and structuring them in the most tax efficient way possible. He would say, “the whole process of building an industry, putting together the pieces, a lot of it was done through acquisition, merger, partnerships, and joint ventures.”

Malone’s quantitative minded discipline allowed him to understand the effectiveness of debt and use it to make numerous horizontal and vertical acquisitions. He would use all the tools available to him to reduce reported earnings and taxes. Ignoring EPS is something many are used to today (think Amazon), but back in the 1970’s and 1980’s this was new. Malone can be considered the father of EBITDA, which was the metric he introduced to the financial community on how to value TCI.

Malone’s creativity and vision allowed him to find, fund, and partner with young creative entrepreneurs and bring them into TCI so they could benefit from his scale.

In our latest book, Standing on the Shoulders of Giants, we talk about one of Malone’s most successful partnerships with Bob Johnson of Black Entertainment Television (BET) where his $500,000 investment turned into $805 million.

Today John Malone is chairman and majority owner of Liberty Media, Liberty Global, Liberty Interactive and is still doing deals. If you want to learn more about John Malone, read Cable Cowboy. Malone was also included in William Thorndike’s book, The Outsiders.

In 2012, John Malone spoke at the University of Denver for their Cable Mavericks series. The lecture is filled with stories of his business dealings as well as wisdom on due diligence, culture, synergies, horizontal vs vertical acquisitions, his use of tracking stocks, and avoidance of taxes. He also gives great detail into what went wrong when AT&T acquired TCI for $50 billion in 1999.

Below the video I’ve posted a short excerpt from the transcript.

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John Malone: The easiest deals are the ones where you’re buying another business, merging it in in the business you’re already in. Those are easy. They’re easy to figure out. They’re generally horizontal acquisition and you gain scale synergies.

The bulk of the ones that we’ve done over the years were what you call rolling up the cable industry. When the cable industry restarted, pretty much every community issued a franchise to operate in that community. Typically, they would issue the franchise to local people, usually politicians or their friends. The industry started 50 years ago, very, very Balkanized, thousands of individual cable franchises. Overtime, those congealed into the cable industry process, even continues to this day with a few larger transactions as the cosmology, the concentration of these assets grew in the US. That same process is going on around the world right now.

That is a horizontal integration process. It drives scale, size, balance sheet size, financial capability. Then you have the vertical type deals. I own a cable system. What am I going to carry on my cable system? If all I’m going to carry is the broadcasting programming, what am I really adding? Then the issue became and this is an issue in the early ‘80s. How do you create channels? How do you create programming that people are interested in enough that they will subscribe to your cable service and pay for the programming? That was the vertical phase. I’d say through the ‘80s, we probably invested in or acquired probably 30 different companies that were in the programming development and distribution business things like CNN or Discovery or Black Entertainment Television or Telemundo or Stars. There was that process of developing the programming and having the distribution.

Then we got into the technology areas as we had scale and we had a large budget to purchase and the deploy capital. We got into digital programming, digital set-tops. We were the first guys who created digital television, compressed digital television in the home. We created the thing called at-home which was the first high-speed broadband connectivity in North America using cable technology. Now, of course, that’s gone on to where the industry generally is deploying speeds up to 120 megabits capability of going faster.

It’s been an evolutionary process of identifying the need and then trying to build the technologies around it and the relationships you have with other providers whether they’re programmers put you in partnership with all kinds of people. I mentioned Ted Turner, News Corp, Rupert Murdoch who created the Fox News Network. Just in the technology area, we had long-standing partnerships with Microsoft when Bill Gates first started. He was a co-provider of the digital set- top when it started.

Just the whole process of building an industry, putting together the pieces, a lot of it was done through acquisition, merger, joint ventures, pretty much all the stuff you guys study in strategic finance, I guess, you call it.

Question: There is a lot of road kill in the M&A arena. What are the main ingredients on why acquisitions don’t work?

John Malone: There’s lots of reasons. A lot of it is cultural. You’re trying to blend … Our experience was we were headquartered out here in the Denver area. Our guys were all cowboys, and we learned pretty quickly in our acquisitions we had to pretty much kill the leadership in anything we bought. You could call it the Roman-Empire approach what you would basically … Let’s call it retire to be kind. You would retire the guys who you made rich when you bought their company because culturally, they don’t work hard anymore. Probably the reason they sold the company to you was their wife was nagging them to take it easy. They’re working too hard.

The first thing you learn is, once you make a guy rich, don’t expect them to work hard. Very unusual people do that. Even if they say they’re going to, they’ve ran their own company. They’re not going to work very hard working within your company so that was one lesson. You pick the brightest guys you find in the company you’ve acquired who weren’t running it and you make them the new management, and you built horizontally that way, and you avoid this cultural clash that, I think, really hurts a lot of companies. If you try and blend cultures that are two different, it’s very hard and disruptive; it takes years. Usually, it doesn’t work. That’s lesson number one in the merger and acquisition area.

The other is plain and simple vertical acquisitions are much tougher than horizontal ones because you’re essentially buying a business you don’t know and you don’t understand, whereas buying one like yours, you’re already in it. You understand it, you know the people, you know the economics, much simpler.

A lot of vertical acquisitions don’t work. If you’re looking for an example, say the acquisition of AOL with Time Warner which was probably the biggest disaster in merger history. The cultures were completely different. The Time Warner people were traditional media people. The AOL people were go-go Internet people. AOL was frankly just a big puff bag, didn’t have any real assets. It had grown so fast that it’s accounting was, let’s say, inaccurate to be kind, and the people at Time Warner did no diligence. They put the two companies together and basically the value collapsed shortly thereafter. That’s a huge one that didn’t work. We’re lucky none of our … In growing the company, we didn’t have any really bad experiences with value destruction.

Probably the biggest destructive merger that I’ve been involved in was when we sold our big cable company, TCI, to AT&T. At the time it happened, they agreed to in 1999. It was the largest merger in the US business history up to that point in time. It was about 60 billion.

Unfortunately, the AT&T people got into the cable business for the wrong reason. They didn’t really understand it. They thought it was going to be a solution to their problem of connecting the last mile in their telephony network. They were a little bit naïve about that.

To give you rough numbers, in 1999, AT&T had a cash flow EBITDA of 16 billion, and they owed no net debt. By 2001, AT&T owed 78 billion and had an EBITDA of nine. The destruction of value that is kind of monumental, and you can’t sleep and make that happen. You have to do a bunch of bad deals in order to bury your company that fast, that deep, and destroy the momentum of a business. That was a disaster. It was a disaster for the shareholders. It was a disaster for me personally because I was the largest shareholder. I watched three and a half billion of personal net worth to about 500 million, and I could not sell it because I was an insider. I was blocked from selling it. That was a disaster.

On paper, it looked terrific. My shareholders were getting AT&T stock, a company that has been around for 100 years, very liquid stock, AAA credit rating, and they were getting it at a big premium. They were paying a 40% premium in stock for our company. Everybody thought this is wonderful, a big price, a big premium, and a liquid stock, and it was for those who were smart enough to sell. Unfortunately, some of us couldn’t or wouldn’t or didn’t. The residue of that company got acquired by Comcast for pennies on the dollar a few years later. The Comcast that you see around today, those trucks running around, are most of the assets where the old AT&T-TCI assets. That’s one run that didn’t work. I think there’s certainly plenty of examples of disastrous combinations.

Usually, it has to do with the merger is being made for the wrong reason or it’s complete lacking of understanding of what the other business, the acquired business, is really all about.

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#2

I love the transcripts on these great investor videos and the google talks.


#3

I really wish there was a cast study on Malone, leverage, and taxes. The GOAT right there.


#4

One of the few true greats. When I listen to him, I always know what he thinks and where he stands. That’s not that common. For instance, with Buffett, I never know if he is talking about what he thinks is best practice or what he actually does. The most interesting thing about Buffett is the contradiction between what he says and what he does.

However, if Malone is (actually) responsible for the wide use of EBITDA that’s not good. EBITDA means a lot in a cable business where the upfront costs are high and the maintenance costs minimal. In 90% or probably much more, EBITDA is meaningless or worse, misleading. Do a Google search of Buffett and Seth Klarman on the subject if you’re curious what I’m talking about. Basically, EBITDA works if capital expenditures are not necessary for the business to continue at its current level of profitability, which is almost never the case.

Anyway, thanks for highlighting Malone. He knows more about business strategy than just about anyone. Every time I listen to him I learn something important, including this time when I’d already listened to that talk.


#5

Thanks, great hear anything about John Malone.

He seems quite humble.