Prior to beginning work on this assignment, all students are required to read Chapter 9 in the book, The Outsiders: Eight Unconventional CEOs and Their Rad

A Perpetual Motion Machine for Returns

Tom Murphy and Capital Cities Broadcasting

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.

—Warren Buffett

In speaking with business school classes, Warren Buffett often compares the rivalry between Tom Murphy’s company, Capital Cities Broadcasting, and CBS to a trans-Atlantic 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, run by the legendary Bill Paley, 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 smaller markets. CBS’s market capitalization was sixteen times the size of Capital Cities’. By the time Murphy sold his company to Disney thirty years later, however, Capital Cities was three times as valuable as CBS. In other words, the rowboat had won. Decisively.

So, how did the 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 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 structure with forty-two presidents and vice presidents, and generally displayed what Buffett’s partner, Charlie Munger, calls “a prosperity-blinded indifference to unnecessary costs.”1

Paley’s strategy at CBS was consistent with the conventional wisdom of the conglomerate era, which espoused the elusive benefits of “diversification” and “synergy” to justify the acquisition of unrelated businesses that, once combined with the parent company, would magically become both more profitable and less susceptible to the economic cycle. At its core, Paley’s strategy focused on making CBS larger.

In contrast, Murphy’s goal was to make his company more valuable. As he said to me, “The goal is not to have the longest train, but to arrive at the station first using the least fuel.”202 Under Murphy and his lieutenant, Dan Burke, Capital Cities rejected diversification and instead created an unusually streamlined conglomerate that focused laser-like on the media businesses it knew well. Murphy acquired more radio and TV stations, operated them superbly well, regularly repurchased his shares, and eventually acquired CBS’s rival broadcast network ABC. The relative results speak for themselves.

The formula that allowed Murphy to overtake Paley’s QE2 was deceptively simple: focus on industries with attractive economic characteristics, selectively use leverage to buy occasional large properties, improve operations, pay down debt, and repeat. As Murphy put it succinctly in an interview with Forbes, “We just kept opportunistically buying assets, intelligently leveraging the company, improving operations and then we’d . . . take a bite of something else.”3 What’s interesting, however, is that his peers at other media companies didn’t follow this path. Rather, they tended, like CBS, to follow fashion and diversify into unrelated businesses, build large corporate staffs, and overpay for marquee media properties.

Capital Cities under Murphy was an extremely successful example of what we would now call a roll-up. In a typical roll-up, 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. This concept came into vogue in the mid- to late 1990s and flamed out in the early 2000s as many of the leading companies collapsed under the burden of too much debt. These companies typically failed because they acquired too rapidly and underestimated the difficulty and importance of integrating acquisitions and improving operations.

Murphy’s approach to the roll-up was different. He moved slowly, developed real operational expertise, and focused on a small number of large acquisitions that he knew to be high-probability bets. Under Murphy, 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 few big decisions.”

. . .

Tom Murphy was born in 1925 in Brooklyn, New York. He served in the navy in World War II, graduated from Cornell on the GI Bill, and was a prominent member of the legendary Harvard Business School (HBS) class of 1949 (whose graduates included a future SEC chairman and numerous successful entrepreneurs and 21Fortune 500 CEOs). After graduation from HBS, Murphy worked as a product manager for consumer packaged goods giant Lever Brothers. Ironically (since he’s a teetotaler), his life changed irrevocably when he attended a summer cocktail party in 1954 at his parents’ home in Schenectady, New York. His father, a prominent local judge, had also invited a longtime friend, Frank Smith, the business manager for famed broadcast journalist Lowell Thomas and a serial entrepreneur.

Smith immediately pigeonholed Murphy and began to tell him about his latest venture—WTEN, a struggling UHF TV station in Albany that Smith had just purchased out of bankruptcy. The station was located in an abandoned former convent, and before the evening was over, young Murphy had agreed to leave his prestigious job in New York and relocate to Albany to run it. He had no broadcasting experience nor for that matter any relevant management experience of any kind.

From the outset, Smith managed the business from his office in downtown Manhattan, leaving day-to-day operations largely to Murphy. After a couple of years of operating losses, Murphy turned the station into a consistent cash generator by improving programming and aggressively managing costs, a formula that the company would apply repeatedly in the years ahead. In 1957, Smith and Murphy bought a second station, in Raleigh, North Carolina, this one located in a former sanitarium. After the addition of a third station, in Providence, Rhode Island, the company adopted the name Capital Cities.

In 1961, Murphy hired Dan Burke, a thirty-year-old Harvard MBA—also with no prior broadcast experience—as his replacement at the Albany station. Burke had been originally introduced to Murphy in the late 1950s by his older brother Jim, who was a classmate of Murphy’s at HBS and a rising young executive at Johnson & Johnson (he would eventually become CEO and win accolades for his handling of the Tylenol crisis in the mid-1980s). Dan Burke had served in the Korean War and then entered HBS, graduating in the class of 1955. He then joined General Foods as a product manager in the Jell-O division and, in 1961, signed on with Capital Cities, where Murphy quickly indoctrinated him into the company’s lean, decentralized operating philosophy, which he would come to exemplify.

Murphy then moved to New York to work with Smith to build the company through acquisition. Over the next four years, under Smith and Murphy’s direction, Capital Cities grew by selectively acquiring additional radio and television stations, until Smith’s death in 1966.

After Smith’s death, Murphy became CEO (at age forty). The company had finished the preceding year with revenue of just $28 million. Murphy’s first move was to elevate Burke to the role of president and chief operating officer. Theirs was an excellent partnership with a very clear division of labor: Burke was responsible for daily management of operations, and Murphy for acquisitions, capital allocation, and occasional interaction with Wall Street. 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 was to spend it.”224 He exemplifies the central role played in this book by exceptionally strong COOs whose close oversight of operations allowed their CEO partners to focus on longer-term strategic and capital allocation issues.

Once in the CEO seat, it did not take Murphy long to make his mark. In 1967, he bought KTRK, the Houston ABC affiliate, for $22 million—the largest acquisition in broadcast history up to that time. In 1968, Murphy bought Fairchild Communications, a leading publisher of trade magazines, for $42 million. And in 1970, he made his largest purchase yet with the acquisition of broadcaster Triangle Communications from Walter Annenberg for $120 million. After the Triangle transaction, Capital Cities owned five VHF TV stations, the maximum then allowed by the FCC.

Murphy next turned his attention to newspaper publishing, which, as an advertising-driven business with attractive margins and strong competitive barriers, had close similarities to the broadcasting business. After purchasing several small dailies in the early 1970s, he bought the Fort Worth Telegram for $75 million in 1974 and the Kansas City Star for $95 million in 1977. In 1980, looking for other growth avenues in related businesses, he entered the nascent cable television business with the purchase of Cablecom for $139 million.

During the extended bear market of the mid-1970s to early 1980s, Murphy became an aggressive purchaser of his own shares, eventually buying in close to 50 percent, most of it at single-digit price-to-earnings (P/E) multiples. In 1984, the FCC relaxed its station ownership rules, and in January 1986, Murphy, in his masterstroke, bought the ABC Network and its related broadcasting assets (including major-market TV stations in New York, Chicago, and Los Angeles) 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 and an enormous bet-the-company transaction for Murphy, representing over 100 percent of Capital Cities’ enterprise value. The acquisition stunned the media world and was greeted with the headline “Minnow Swallows Whale” in the Wall Street Journal. At closing, Burke said to media investor Gordon Crawford, “This is the acquisition I’ve been training for my whole life.”5

The core economic rationale for the deal was Murphy’s conviction that he could improve the margins for ABC’s TV stations from the low thirties up to Capital Cities’ industry-leading levels (50-plus percent). Under Burke’s oversight, the staff that oversaw ABC’s TV station group dropped from sixty to eight, the head 23count at the flagship WABC station in New York was reduced from six hundred to four hundred, and the margin gap was closed in just two years.

Burke and Murphy wasted little time in implementing Capital Cities’ lean, decentralized approach—immediately cutting unnecessary perks, such as the executive elevator and the private dining room, and moving quickly to eliminate redundant positions, laying off fifteen hundred employees in the first several months after the transaction closed. They also consolidated offices and sold off unnecessary real estate, collecting $175 million for the headquarters building in midtown Manhattan. As Bob Zelnick of ABC News said, “After the mid-80s, we stopped flying first class.”6

A story from this time demonstrates the culture clash between network executives and the leaner, more entrepreneurial acquirers. ABC, in fact the whole broadcasting industry, was a limousine culture—one of the most cherished perks for an industry executive was the ability to take a limo for even a few blocks to lunch. Murphy, however, was a cab man and from very early on showed up to all ABC meetings in cabs. Before long, this practice rippled through the ABC executive ranks, and the broader Capital Cities ethos slowly began to permeate the ABC culture. When asked whether this was a case of leading by example, Murphy responded, “Is there any other way?”

In the nine years after the transaction, revenues and cash flows grew significantly in every major ABC business line, including the TV stations, the publishing assets, and ESPN. Even the network, which had been in last place at the time of the acquisition, was ranked number one in prime time ratings and was more profitable than either CBS or NBC.

Capital Cities never made another large-scale acquisition after the ABC deal, focusing instead on integration, smaller acquisitions, and continued stock repurchases. In 1993, immediately after his sixty-fifth birthday, Burke retired from Capital Cities, surprising even Murphy. (Burke subsequently bought the Portland Sea Dogs baseball team, where he oversaw the rebirth of that franchise, now one of the most respected in the minor leagues.)

In the summer of 1995, Buffett suggested to Murphy that he sit down with Michael Eisner, the CEO of Disney, at the annual Allen & Company gathering of media nabobs in Sun Valley, Idaho. Murphy, who was seventy years old and without an apparent successor, agreed to meet Eisner, who had expressed an interest in buying the company. Over several days, Murphy negotiated an extraordinary $19 billion price for his shareholders, a multiple of 13.5 times cash flow and 28 times net income. Murphy took a seat on Disney’s board and subsequently retired from active management.

24He 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 the company to Disney. That’s a remarkable 19.9 percent internal rate of return over twenty-nine years, significantly outpacing the 10.1 percent return for the S&P 500 and 13.2 percent return for an index of leading media companies over the same period. (The investment also proved lucrative for Warren Buffett, generating a compound annual return of greater than 20 percent for Berkshire Hathaway over a ten-year holding period.) As figure 1-1 shows, in his twenty-nine years at Capital Cities, Murphy outperformed the S&P by a phenomenal 16.7 times and his peers by almost fourfold.

FIGURE 1-1

Capital Cities’ stock performance

Note: Media basket includes Taft Communications (September 1966–April 1986), Metromedia (September 1966–August 1980), Times Mirror (August 1966–January 1995), Cox Communications (September 1966–August 1985), Gannett (March 1969–January 1996), Knight Ridder (August 1969–January 1996), Harte-Hanks (February 1973–September 1984), and Dow Jones (December 1972–January 1996).

The Nuts and Bolts

One of the major themes in this book is resource allocation.

There are two basic types of resources that any CEO needs to allocate: financial and human. We’ve touched on the former already. The latter is, however, also critically important, and here again the outsider CEOs shared an unconventional approach, one that emphasized flat organizations and dehydrated corporate staffs.

There is a fundamental humility to decentralization, an admission that headquarters does not have all the answers and that much of the real value is created by local managers in the field. At no company was decentralization more central to the corporate ethos than at Capital Cities.

The hallmark of the company’s culture—extraordinary autonomy for operating managers—was stated succinctly in a single paragraph on the inside cover of every Capital Cities 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. All decisions are made at the local level. . . . We expect our managers . . . to be forever cost conscious and to recognize and exploit sales potential.”

25Headquarters staff was anorexic, and its primary purpose was to support the general managers of operating units. There were no vice presidents in functional areas like marketing, strategic planning, or human resources; no corporate counsel and no public relations department (Murphy’s secretary fielded all calls from the media). In the Capital Cities culture, the publishers and station managers had the power and prestige internally, and they almost never heard from New York if they were hitting their numbers. It was an environment that selected for and promoted independent, entrepreneurial general managers. The company’s guiding human resource philosophy, repeated ad infinitum by Murphy, was to “hire the best people you can and leave them alone.” As Burke told me, the company’s extreme decentralized approach “kept both costs and rancor down.”

The guinea pig in the development of this philosophy was Dan Burke himself. In 1961, after he took over as general manager at WTEN, Burke began sending weekly memos to Murphy as he had 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 on reporting to headquarters. As Burke said in describing his early years in Albany, “Murphy delegates to the point of anarchy.”7

Frugality was also central to the ethos. Murphy and Burke realized early on that while you couldn’t control your revenues at a TV station, you could control your costs. They believed that 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’s culture.

In fact, in one of the earliest and most often told corporate legends, Murphy even scrutinized the company’s expenditures on paint. Shortly after Murphy arrived in Albany, Smith asked him to paint the dilapidated former convent that housed the studio to project a more professional image to advertisers. Murphy’s immediate response was to paint the two sides facing the road leaving the other sides untouched (“forever cost conscious”). A picture of WTEN still hangs in Murphy’s New York office.

Murphy and Burke believed that even the smallest operating decisions, particularly those relating to head count, could have unforeseen long-term costs and needed to be watched constantly. Phil Meek, head of the publishing division, took this message to heart and ran the entire publishing operation (six daily newspapers, several magazine groups, and a stable of weekly shoppers) with only three people at headquarters, including an administrative assistant.

26Burke pursued economic efficiency with a zeal that earned him the nickname “The Cardinal.” To run the company’s dispersed operations, he developed a legendarily detailed annual budgeting process. Each year, every general manager came to New York for extensive budget meetings. In these sessions, management presented operating and capital budgets for the coming year, and Burke and his CFO, Ron Doerfler, went through them in line-by-line detail (interestingly, Burke could be as tough on minority hiring shortfalls as on excessive costs).

The budget sessions were not perfunctory and almost always produced material changes. Particular attention was paid to capital expenditures and expenses. Managers were expected to outperform their peers, and great attention was paid to margins, which Burke viewed as “a form of report card.” Outside of these meetings, managers were left alone and sometimes went months without hearing from corporate.

The company did not simply cut its way to high margins, however. It also emphasized investing in its businesses for longterm growth. Murphy and Burke realized that 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.

For example, Murphy and Burke realized early on that the TV station that was number one in local news ended up with a disproportionate share of the market’s advertising revenue. As a result, Capital Cities stations always invested heavily in news talent and technology, and remarkably, virtually every one of its stations led in its local market. In another example, Burke insisted on spending substantially more money to upgrade the Fort Worth printing plant than Phil Meek had requested, realizing the importance of color printing in maintaining the Telegram’s longterm competitive position. As Phil Beuth, an early employee, told me, “The company was careful, not just cheap.”8

The company’s hiring practices were equally unconventional. With no prior broadcasting experience themselves before joining Capital Cities, Murphy and Burke shared a clear preference for intelligence, ability, and drive over direct industry experience. They were looking for talented, younger foxes with fresh perspectives. When the company made an acquisition or entered a new industry, it inevitably designated a top Capital Cities executive, often from an unrelated division, to oversee the new property. In this vein, Bill James, who had been running the flagship radio property, WJR in Detroit, was tapped to run the cable division, and John Sias, previously head of the publishing division, took over the ABC Network. Neither had any prior industry experience; both produced excellent results.

27Murphy and Burke were also comfortable giving responsibility to promising young managers. As Murphy described it to me, “We’d been fortunate enough to have it ourselves and knew it could work.” Bill James was thirty-five and had no radio experience when he took over WJR; Phil Meek came over from the Ford Motor Company at thirty-two with no publishing experience to run the Pontiac Press; and Bob Iger was thirty-seven and had spent his career in broadcast sports when he moved from New York to Hollywood to assume responsibility for ABC Entertainment.

The company also had exceptionally low turnover. As Robert Price, a rival broadcaster, once remarked, “We always see lots of résumés but we never see any from Capital Cities.” 9 Dan Burke related to me a conversation with Frank Smith on the effectiveness of this philosophy. Burke recalls Smith saying, “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 de minimis dividends, rarely issued stock, made active use of leverage, regularly repurchased shares, and between long periods of inactivity, made the occasional very large acquisition.

The two primary sources of capital for Capital Cities were internal operating cash flow and debt. As we’ve seen, the company produced consistently high, industry-leading levels of operating cash flow, providing Murphy with a reliable source of capital to allocate to acquisitions, buybacks, debt repayment, and other investment options.

Murphy also frequently used debt to fund acquisitions, once summarizing his approach as “always, we’ve . . . taken the assets once we’ve paid them off and leveraged them again to buy other assets.”10 After closing an acquisition, Murphy actively deployed free cash flow to reduce debt levels, and these loans were typically paid down ahead of schedule. The bulk of the ABC debt was retired within three years of the transaction. Interestingly, Murphy never borrowed money to fund a share repurchase, preferring to utilize leverage for the purchase of operating businesses.

28Murphy and Burke actively avoided dilution from equity offerings. Other than the sale of stock to Berkshire Hathaway to help finance the ABC acquisition, the company did not issue new stock over the twenty years prior to the Disney sale, and over this period total shares outstanding shrank by 47 percent as a result of repeated repurchases.

Acquisitions were far and away the largest outlet for the company’s capital during Murphy’s tenure. According to recent studies, somewhere around two-thirds of all acquisitions actually destroy value for shareholders. How then was such enormous value created by acquisitions at Capital Cities? Acquisitions were Murphy’s bailiwick and where he spent the majority of his time. He did not delegate acquisition decisions, never used investment bankers, and over time, evolved an idiosyncratic approach that was both effective and different in significant and important ways from his competitors’.

To Murphy, as a capital allocator, the company’s extreme decentralization had important benefits: it allowed the company to operate more profitably than its peers (Capital Cities had the highest margins in each of its business lines), which in turn gave the company an advantage in acquisitions by allowing Murphy to buy properties and know that under Burke, they would quickly be made more profitable, lowering the effective price paid. In other words, the company’s operating and integration expertise occasionally gave Murphy that scarcest of business commodities: conviction.

And when he had conviction, Murphy was prepared to act aggressively. Under his leadership, Capital Cities was extremely acquisitive, three separate times doing the largest deal in the history of the broadcast industry, culminating in the massive ABC transaction. Over this time period, the company was also involved with several of the largest newspaper acquisitions in the country, as well as transactions in the radio, cable TV, and magazine publishing industries.

Murphy was willing to wait a long time for an attractive acquisition. He once said, “I get paid not just to make deals, but to make good deals.”11 When he saw something that he liked, however, Murphy was prepared to make a very large bet, and much of the value created during his nearly thirty-year tenure as CEO was the result of a handful of large acquisition decisions, each of which produced excellent long-terms returns. These acquisitions each represented 25 percent or more of the company’s market capitalization at the time they were made.

Murphy was a master at prospecting for deals. He was known for his sense of humor and for his honesty and integrity. Unlike other media company CEOs, he stayed out of the public eye (although this became more difficult after the ABC acquisition). These traits helped him as he prospected for potential acquisitions. Murphy knew what he wanted to buy, and he spent years developing relationships with the owners of desirable properties. He never participated in a hostile takeover situation, and 29every major transaction that the company completed was sourced via direct contact with sellers, such as Walter Annenberg of Triangle and Leonard Goldenson of ABC.

He worked hard to become a preferred buyer by treating employees fairly and running properties that were consistent leaders in their markets. This reputation helped him enormously when he approached Goldenson about buying ABC in 1984 (in his typical self-deprecating style, Murphy began his pitch with “Leonard, please don’t throw me out the window, but I’d like to buy your company.”)

Beneath this avuncular, outgoing exterior, however, lurked a razor-sharp business mind. Murphy was a highly disciplined buyer who had strict return requirements and did not stretch for acquisitions—once missing a very large newspaper transaction involving three Texas properties over a $5 million difference in price. Like others in this book, he relied on simple but powerful rules in evaluating transactions. For Murphy, that benchmark was a double-digit after-tax return over ten years without leverage. As a result of this pricing discipline, he never prevailed in an auction, although he participated in many. Murphy told me that his auction bids consistently ended up at only 60 to 70 percent of the eventual transaction price.

Murphy had an unusual negotiating style. He believed in “leaving something on the table” for the seller and said that in the best transactions, everyone came away happy. He would often ask the seller what they thought their property was worth, and if he thought their offer was fair he’d take it (as he did when Annenberg told him the Triangle stations were worth ten times pretax profits). 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 believed this straightforward approach saved time and avoided unnecessary acrimony.

Share repurchases were another important outlet for Murphy, providing him with an important capital allocation benchmark, and he made frequent use of them over the years. When the company’s multiple was low relative to private market comparables, Murphy bought back stock. Over the years, Murphy devoted over $1.8 billion to buybacks, mostly at single-digit multiples of cash flow. Collectively, these repurchases represented a very large bet for the company, second in size only to the ABC transaction, and they generated excellent returns for shareholders, with a cumulative compound return of 22.4 percent over nineteen years. As Murphy says today, “I only wished I’d bought more.”

30The Publishing Division

After the Triangle transaction in 1970, Capital Cities was prevented from owning additional TV stations by FCC regulations. As a result, Murphy turned his attention to newspapers and, between 1974 and 1978, initiated the two largest transactions in the industry’s history to that time—the acquisition of the Fort Worth Telegram and the Kansas City Star—as well as the purchase of several smaller daily and weekly newspapers across the United States.

The company’s performance in its newspaper publishing division provides an interesting litmus test of its operating skills. Under the leadership of Jim Hale and Phil Meek, Capital Cities evolved an approach to the newspaper business that grew out of its experience in operating TV stations, with an emphasis on careful cost control and maximizing advertising market share.

What is remarkable in looking at the company’s four major newspaper operations is the consistent year-after-year-after-year growth in revenues and operating cash flow. Amazingly, these properties, which were sold to Knight Ridder in 1997, collectively produced a 25 percent compound rate of return over an ave