William Thorndike is the author of my favourite investing book, The Outsiders. And so I was thrilled to speak with him recently on subjects ranging from how to find the market's best CEO's to capital allocation to one of our investments at Motley Fool Pro, Sky Network Television (ASX:SKT). I hope you enjoy the interview as much as I did! — Joe Magyer
JOE MAGYER:
Hi, Fools. This is Joe Magyer and I'm here today with Will Thorndike, the founder of Housatonic Partners and the author of The Outsiders. The Outsiders is a book that all the cool investing kids are talking about and in all seriousness, it's the best and most original investing book I've read in years.
Unlike most investing books that focus on either how to get rich quick or how to pick stocks, The Outsiders is more focused on a group of super successful, iconoclastic CEOs that delivered huge returns, not just over one, three, five years … but over a span of decades. And for a sense of the scale of research that went into this book, Will's team did more than 100 interviews and studied more than 1,000 company years' worth of financial data while researching this book. So, thanks very much for joining me and talking to us about the book, today, Will.
WILL THORNDIKE:
Thanks, Joe, for having me.
JOE MAGYER:
I appreciate your taking the time. I guess a logical place to start would be to talk about Henry Singleton — who the guy is and why he's the best CEO of the past century.
WILL THORNDIKE:
Yes. Henry Singleton had a unique background for a CEO. He was trained as an engineer and scientist. He got his undergraduate degree, masters, and a PhD from MIT in electrical engineering and for his doctoral thesis, he programmed the first computer at MIT. He subsequently went on to develop a degaussing technology that allowed naval ships to avoid radar detection during the Second World War. He ended up working for one of the pioneering conglomerates in the 1950s, Litton Industries. While he was there, he developed an inertial guidance system that's still in use in military and commercial aircraft.
He was a super talented engineer. When he was an undergraduate, he won something called the Putnam Medal which is awarded to the top mathematician in the country. Later in his career, at the age of 43, he founded his own company, Teledyne, which grew to be one of the most successful of the sixties-era conglomerates and in running that business over almost 30 years, he generated exceptional returns … 20% compounded over 28 years.
It roughly doubled the rate of return for his conglomerate peers. In doing that, he developed a whole range of varied, unusual, [and] idiosyncratic practices, including pioneering stock buybacks, never selling his stock, and doing a whole range of things that were unheard of at the time. He was a remarkable figure and the first in this series of chapters in the research project.
JOE MAGYER:
Why is it that despite what is an incredible track record, only a small group of investing nerds actually know who this guy is?
WILL THORNDIKE:
Yes, it is remarkable. He is still relatively unknown. Part of that stemmed from his personality type. He disdained the limelight and was very reticent to spend time with the business press and with Wall Street analysts. In his day he gave no earnings guidance. He never appeared in Wall Street sell-side conferences and that sort of thing. He preferred to stay apart and focus on building value in his company over time.
JOE MAGYER:
Yes. A pretty big contrast to the CEOs that most people could name.
WILL THORNDIKE:
He would not have been on Squawk Box.
JOE MAGYER:
Yes. How did you go about choosing this group? Part of the reason I ask is I know the obvious answer might be the equity returns over a long time horizon, but you're careful to point out, early in the book, that you're focused on folks who were, through the different processes, citizens of Graham and Doddsville, and not ideally just being the levered-up survivors of a series of coin flips.
WILL THORNDIKE:
Yes, that's right. Each of the CEOs had to meet two classes. There's an absolute returns test, which says they had to have better returns relative to the S&P over their tenure than Jack Welch had during his 20 years at General Electric (NYSE:GE) at the helm. And then they had to materially outperform their peer group.
And in looking at the specific actions that led to that higher performance, by definition, these CEOs were doing things very differently than their peers, but it turned out that the specific actions were remarkably similar across the group. They centered around things relating to capital allocation and more broadly resource allocation.
JOE MAGYER:
I see a lot of Outsider tools being used today — share buybacks. All sorts of creative tax minimization or deferment. One thing I feel I don't see a lot of — but I'm curious about your thoughts on this — is a lot of the underlying principles that made some of these folks so successful. Two of the big ones that spring to mind are frugality and decentralization. Is that just because frugality isn't fun as a CEO?
WILL THORNDIKE:
Yes, and I think those two things, honestly, go together. I think an ethos of frugality in a corporation — usually stemming from a CEO at the top — it infuses a culture and it naturally leads to a bias towards decentralization … the hallmark of decentralization being lean, corporate headquarters staffing and often, relatedly, non-fancy corporate headquarters buildings.
I think that in corporate America, there is a natural tendency to want to grow your business. Have the business be bigger. More prestigious. Have a larger corporate headquarters building. Have it designed by a leading architect. Surround yourself by MBAs and generally engage in the behavior that's commonly associated with CEO-ness. This group pretty actively disdained that.
JOE MAGYER:
We have something I jokingly call the Lobby Test where we'll go into the office of a new company we're researching, and if there is a waterfront view from the lobby, we're immediately concerned about the cost management. And it's a surprising number of companies.
In contrast, we're invested in Sky Network Television, which is the dominant pay-TV company in New Zealand, and it's run by John Fellet, who formerly worked with John Malone. And when we went out to visit with them, we took a cab and keep driving and driving and driving.
We're out in the suburbs and we're surrounded by houses. I'm starting to get angry with the cab driver. We finally stopped and turned into what looked like a driveway. It turns out Fellet built this office and these massive satellite dishes right out in suburbia, surrounded by homes sitting right next to these massive dishes.
WILL THORNDIKE:
Oh, that's great. I love that. I have a similar story. I grew up around Boston. Of all the CEOs in the book, only one of them is from Boston. It's a guy named Dick Smith who ran a company called General Cinema. And when I grew up as a kid, I went to the movies at one of his movie theatres in a local suburban strip mall.
I went in and out of that movie theatre probably 100 times in my youth, and I never realized that the nondescript door to a back office to the right of the theatre I used to go to was actually the door to the corporate headquarters for General Cinema. And General Cinema, at that point in time … behind that nondescript door … was the headquarters for a company that controlled the largest Pepsi-Cola bottler in the country, the Neiman Marcus legion of retail stores, and Harcourt Brace, the largest educational publisher in the U.S. The same thing — just extraordinarily nondescript was the headquarters. So, yes. I love that.
JOE MAGYER:
Who are the younger CEOs you see out there today who are succeeding with outsider-style leadership and capital allocation?
WILL THORNDIKE:
I think there are a number of CEOs who are currently following this path. It would include the Rales brothers of Danaher and Colfax. Nick Howley of TransDigm, which is a wonderful aviation components company that I know you guys are familiar with. The guy who runs a software company in Canada called Constellation Software. The CEO's name is Mark Leonard.
I know you know a group of insurance companies that follow these sort of Buffett principles and are very close to this whole approach — Markel (NYSE:MKL) and Fairfax and White Mountains. There's a home builder called NVR. I recently came across a utility business called Calpine (NYSE:CPN)that's doing some interesting things. There are definitely current exemplars out there. We were following this to different degrees. It's been fun to watch that.
By the way, Valeant Pharmaceuticals (NYSE:VRX) is a really interesting case as to whether or not the CEO there, Mike Pearson, is an outsider. Of course, being very much in the news with the Allergan bid.
JOE MAGYER:
One of the funny things about the style of management is that it's easy to look back at a single instance and say, "Well, this was clearly brilliant and it clearly worked." But at the time, these guys were totally either ignored or they were ignoring other people. As you look at some of these, like the Valeant situation today, there are a lot of people who have strong opinions about whether or not its approach is working. I think you could look at other names like Jeff Bezos of Amazon (Nasdaq:AMZN), which a lot of value investors wouldn't consider, but there's a lot of Sam Walton and John Malone there.
I guess what I'm getting at is if you're in the moment of looking for the qualities that you have as an outsider CEO, how do everyday investors go about identifying those kinds of CEO leaders in the here and now? A lot of times they're off the grid or their style is so unconventional that they'd never show up on a screen and you wouldn't see them on television.
WILL THORNDIKE:
That's a good question. And by the way, I do think that the current reaction to the Valeant-Allergan side and sort of the bear case is very similar to concerns that were heard across John Malone's entire career at TCI. There are very interesting similarities there, I think, to the reactions and concerns being raised.
I think, over time, you can assess a CEO's fit with this approach by their actions. By the acquisitions they make. By the stock repurchases. And I think over time what they do, ultimately, is sort of the key guide to whether or not they're following this approach and whether or not they're CEOs that you want to invest with. A marker of this that could be quite predictive is the way they describe — or they think about and describe — their business I think can be very revealing.
And specifically, if they have developed idiosyncratic metrics that they are optimizing the business around, I think that can be a very strong signal of the presence of this sort of world view, specifically to the degree they're talking about the cash economics of the business as opposed to the broader accounting conventions and expressing those on a per-share basis. Those are the two key hallmarks, I think.
JOE MAGYER:
I love a good, clear, intrinsic value-oriented shareholder letter. They're few and far between, but they're nice to find.
WILL THORNDIKE:
Yes, and I would agree with you. I think Bezos is a very interesting case. I think he is the most outsider-like by a wide margin of the sort of visionary tech CEO. His letters are great reading and they are very revealing of a highly rational, analytical mind-set.
JOE MAGYER:
Well, as an Amazon shareholder, I love hearing your confirmation.
WILL THORNDIKE:
Yes.
JOE MAGYER:
I have a screen that I run looking for Outsider companies. In a way, it's a waste of time, because the qualities that you're looking for don't as readily show up on the screen. I don't know if TCI would have shown up on the screen. But anyway, we're typically looking for something like shrinking share count and growth in book value per share, just as a rough guide. In the U.S., I'll find 200-plus names and that's great, but when I do the same screen in Australia, I get zero names.
It's not that there aren't any savvy capital allocators in Australia, just that different tax laws have a big impact on how companies go about returning cash to shareholders. Adding the local layer of complexity makes screening for Outsiders feel that much more futile. This all leads to my noticing that there are no international CEOs featured in the book. Was the difficulty in identifying some of these Outsiders who were success locally but less known in the States part of the reason there weren't any international CEOs featured in the book?
WILL THORNDIKE:
It's a good question, Joe. I would love to include an international name in the book. The reason that I didn't is just data availability. I worked with a group of HBS students in researching the book, and through them I had access to the incredible Baker Library of the Harvard Business School. Unfortunately, the databases there are heavily focused on the domestic U.S. market. So, I think it's something that would be a very interesting exercise. I do think there are examples internationally and I also think these ideas are much less developed outside the U.S. So there's an even greater, longer-term opportunity over time. I think that's exciting.
JOE MAGYER:
Thinking about either an international version or a second edition where we might see an international name leader pop up, one group that springs to mind is 3G Capital. They've done amazing work with some of their acquisitions. Organic growth, cost cutting, incredibly smart use of leverage. I've really been impressed by those. I'm curious if you've spent any time studying 3G and have any thoughts on them.
WILL THORNDIKE:
Yes. I have spent a little bit of time studying them and I agree that they share these traits. They remind me a lot of, from the book, Capital Cities. I think there are some very interesting similarities there and it will be interesting to see, over long periods of time, whether they add the share repurchase arrow to their quiver the way Capital Cities did. But I think they're a very interesting international example. Yes.
JOE MAGYER:
I'm curious. There are Buffett, Malone and Stiritz who are also out there applying their trade. I'm curious. Do you have any money with the three of them?
WILL THORNDIKE:
I own a bunch of the Malone entities and have for some time. Then I do own Berkshire Hathaway (NYSE:BRK-B) shares. I do not own any of Bill Stiritz's shares currently, although I have enormous regard for him. But two out of the three I do own actively.
JOE MAGYER:
Got you. Last one. I noticed in the epilogue that you thanked Charlie Munger for his early encouragement and insights. How much fun was it talking shop and old stories with Uncle Charlie?
WILL THORNDIKE:
Oh, my gosh. That was great. Charlie Munger is such an amazing individual and unbelievably insightful. He was very supportive of this project from very early on. I spent a fair amount of time with him — all of the chapters where he had first-hand experience with the companies. That was really fun. And then after the book came out, I had a chance to breakfast with him in L.A. What a wonderful, gracious, and talented man. That was a really fun part of the project.
JOE MAGYER:
Well, going to the Berkshire meeting every year is a favorite pastime of mine, so I can only imagine sitting down with him. We'll call it there. Will, I really appreciate your taking the time and I encourage everybody reading and listening to simply check out the book. It's a wonderful read. It's the first investing book I nudge people to read these days. Thanks again, Will, and thanks everybody for listening. Fool on!
WILL THORNDIKE:
Thank you, Joe. Take care.
[End]
