This is part of my operating manual series opening up the playbook of private equity and company building luminaries. Check out past ones with Mark Leonard, Andrew Wilkinson, Robert F. Smith, ESW, Felix Dennis and Mike Speiser.
If you are interested in buying, growing, and selling small companies, check out my course & community on it at IndiePE.com.
Most of this comes from the book “Cable Cowboy: John Malone and the Rise of the Modern Cable Business” by Mark Robichaux and the book “The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success” by William Thorndike
Who is John Malone? What is TCI?
John Malone is the billionaire former CEO of Tele-Communications Inc. (TCI), a cable and media conglomerate from 1973 to 1996. Malone built TCI into a powerhouse through acquisitions of cable and media companies with exotic structures and financial engineering. At its peak, they were buying one business a day.
Today Malone is the largest private landowner in the United States with 2.2+ million acres, more than twice the size of Rhode Island.
How did TCI and John Malone perform?
At the end of his reign, TCI was the largest company in the cable industry and boasted the lowest programming cost, least maintained facilities, most complex structure, and by far the best returns.
If you would have invested $100 into TCI in 1973 when John Malone joined the company as CEO and shared in all the spin-offs and splits then your $100 would have appreciated to $181,200 when TCI was acquired by AT&T in 1999.
Another way of putting it is that a single share TCI, purchased at the 1974 low of 75 cents was worth $4,184 by the end of 1997 – a 5,578x increase.
Tracking the performance of TCI often confused Wall Street and investors. Malone was laser-focused on maximizing shareholder value. He did that through a flurry of complex mergers, acquisitions, stock dividends, and spin-offs that clouded the picture of the company’s true performance while minimizing taxes.
Every aspect of Malone’s empire was designed to optimize shareholder returns and minimize taxes through the active use of financial leverage.
Let’s dive into how John Malone achieved such performance.
What is the founding story of TCI & Bob Magnes?
Bob Magness is the Founder of TCI. John Malone was brought in later to be the CEO.
Bob Magnes was a cotton seed salesman and a cattle rancher. By chance in 1956, Magness gave two men a ride, who were stranded while installing a community antenna system.
At the time, there were only a few national television broadcasting networks in the US, NBC, ABC, and CBS. They were broadcasted over-the-air so many areas were out of reach for the broadcasts. Here was an opportunity for entrepreneurs. They started setting up antennas on high ground where the antennas could receive the broadcasts and then lay down cables from the antennas, all the way to the customer's homes to sell them services.
The chance encounter changed Bob Magness's life. He sold his cattle, took out a mortgage on his home, borrowed $2,500 from his father. and invested the proceeds into building a cable system in Memphis, Tennessee.
Bob worked tirelessly on the system for two years, laying the cables himself, while his wife covered the office, and eventually sold the cable network.
With the proceeds of the sale, Magness moved his family to Montana and became the main investor and operator of 6 cable systems, through two companies under overlapping ownership: Community Television Inc. and Western Microwave Inc.
In 1968, the two companies merged under the name Tele-Communications, Inc. (TCI) and in 1970 the company went public. At the time, it was the 10th largest cable company in the United States. The company had grown from 12,000 subscribers in 1958 to close to 100,000 subscribers in 1972.
Now the company was big enough that Magness needed someone with more business knowledge to run it.
Enter John Malone.
How did John Malone come to join TCI?
John Malone grew up in New Haven, Connecticut where his father was an engineer. He excelled in school, math especially, and, track and field.
His father always recommended “guessing at the answers” before he saw them. This was a way to develop an intuition and make split-second decisions, which was an important weapon of his – allowing him to “see” the answers before others did.
In 1963, John graduated from Yale with a bachelor's degree in electrical engineering and economics.
First Jobs
After graduating, Malone looked for a place where he would be able to continue his studies while getting paid. He found that opportunity at AT&T’s Bell Labs where he earned a Master’s and Doctorate’s degrees in Operational Research and Computer Science.
In 1967 John Malone stood in front of the AT&T boards and presented a mathematical economic treatise of his, somewhat prophetically named Profit Maximization in a Regulated Firm.
According to Malone, after the presentation, the Chairman of AT&T put his arm around his shoulder and said “Son, this was great, it gives you a lot to think about. But let me give you one word of advice. If there is anything you do in your career that changes the course of the Bell system, you will have really done something”. Realizing that AT&T was not the fast pace environment that he was looking for, Malone started looking for his next job.
Malone took a job at McKinsey. The main rule he learned was to listen intently.
When Malone moved to McKinsey, he started by interviewing everyone from the senior ranks to the new hires.
- What works?
- What doesn’t?
- How would you fix it?
Malone found that if he interviewed 30 people or so and listened intently, themes would emerge. The best ideas were sometimes hidden, or they were lost on senior executives. By laying the patterns bare, studying in detail the disparate parts – not unlike disassembling a radio – he learned how big corporations don’t work. It was not rocket science, Malone realized, you simply take the best ideas from anyone who has them, polish them, and serve them up to the chairperson.
Why did John Malone join TCI?
After a two-year stint at McKinsey & Company, Malone accepted a job proposal from one of his clients at McKinsey and went to work for General Instruments where he got his first brush with the cable industry.
After losing a fight for the vacant CEO position of GI, Malone moved to a subsidiary of GI, Jerrold Electronics, one of the biggest technical equipment suppliers to the growing cable industry at the time and the third-biggest owner of cable systems in the US.
Malone has joked that, at the time when he arrived, Jerrod’s accounts receivable to the cable companies were bigger than the cable industry’s entire market cap. What Jerrod was actually doing, was factoring the receivables to various financial discount houses.
Bob Magness was interested in acquiring Jerrod’s cable systems. The only problem was that he was severely cash-strapped.
When Malone told Moses Shapiro, the Chairman of General Instruments at the time, about TCI’s interest in acquiring Jerrod’s cable systems as well as his opinion that they could most likely squeeze a higher price out of “this guy Magness”, Shapiro retorted: “Yeah, but I don’t want any Portuguese Escudos. I want coin of the realm…cash.”
Investing in antennas and laying cables to customers’ homes requires capital expenditures and from the beginning, the cable industry has been reliant on funding through debt issuance. Cable subscriptions provided stable cash flows but growth required the consumption of significant capital.
By 1972, Bob Magness was exhausted. Creditors had become uneasy with the burgeoning debt load of the company and he realized that he might not be as well suited to the role of a CEO of a public company. It was time to find someone better.
After a few months of courtship, on April Fool’s Day in 1973, John Malone started working for TCI as President and CEO of the company. He took a 50% pay cut and committed himself to investing a significant amount of his net worth in TCI stock. “I can’t pay you very much, but you’ve got a great future here if you can create it,” Magness told Malone.
By the time John Malone took over, Bob Magness had built TCI into the fourth-largest cable provider in the US using a wobbly foundation of brinkmanship, bald-faced gambles, and abundant debt. TCI’s debt was equal to an impressive 15x revenue at the time.
Malone has joked that in the first two years at TCI, he spent half of his time in New York “getting beat up by the banks” and the other half of his time, meeting with city officials and reneging on commitments TCI had committed to for cable licenses.
Why was cable a compelling business?
“The sort of business that investors want today is predictable. It’s got glue, sustainable revenue streams, meaningful growth, and pricing power in parts of the business.”
- John Malone
Steady Cash Flow - Cable TV systems generated great cash flow from installation charges and recurring monthly service fees.
Most of the money was plowed back into the companies, avoiding dividends to shareholders which would be taxed.
This high cash flow could service an immense amount of debt, which was used to buy more systems.
Depreciation - The companies paid hardly any taxes because of the high depreciation on the equipment – the average cable system enjoyed a profit margin of 57%, far better than most businesses.
“The fiber business is a good business—for one or two providers—but for thirty? All funded with borrowed money? …(I’ll repeat,) great business for one or two providers. Questionable business for six, especially when it’s financed with a bunch of bonds.”
- John Malone
Debt - Tax laws made it attractive to reinvest as cable operators could gradually write off the cost of their systems over many years, allowing them to reduce the leftover profits they reported as earnings and thereby sheltering a healthy cash flow from taxation.
After cable systems were written off most of the value of a cable system’s assets, they could sell it to a new owner, who could begin the tax-eluding depreciation cycle all over again.
Because of the structure and the tax incentives, TCI had to keep expanding, buying up new cable companies to start the write-off process anew and build new cash flows.
Debt interest payments could also be written off as an expense for taxes. Malone targeted ratio of five times debt to EBITDA and kept it for most of the 1980s and 1990s. Malone was careful not to cross-collateralize so if one defaulted, it wouldn’t impact the others. Debt also had the nice added benefit of magnifying financial returns. Very little upfront equity was required to purchase new systems.
How did TCI fund acquisitions?
A mountain of debt. Malone played in a regulated industry that was very stable and focused on cash flow so he knew what he could afford.
In the early days, TCI was struggling financially and Malone met with the main lenders to ask them to bring down the interest rates because of the healthy cash flows. They countered instead by proposing to raise the rates. Malone told them they could have the keys and raise the interest rates if they thought they could run the company better than him. They backed down and gave TCI some room to breathe.
To fund TCI’s expansion, Malone courted companies with capital to invest and an interest in cable, but no expertise.
What does TCI look for in businesses to buy?
Simple Math Deals
Malone looked for obvious deals. He didn’t use fancy spreadsheets to model out deals. He wanted deals that could be justified with simple math. He once said “I’m a mathematician, not a programmer. I may be accurate, but I’m not precise.”
Malone would only buy businesses when the purchase price was below five times cash flow after obvious benefits from programming discounts and overhead elimination were taken into account. Malone could do this math on a napkin. No fancy modeling is needed. The basic assumptions and operational expertise were what mattered. This simple approach allowed him to move quickly when deals came up. He would strike deals within an hour even for million subscriber systems.
Horizontal Integration
The cable business had obvious scale advantages. With scale, the unit economics improved as TCI could buy programming and equipment for lower costs than their smaller competitors.
The synergies were also real in horizontal acquisitions. He could cut overhead on new acquisitions and estimate it reasonably well before closing.
Avoid Competition
TCI focused on rural areas and smaller cities where there was less competition for cable licenses and city officials had lower expectations required for their licenses.
Many competitors were overbidding for cable licenses in large cities while TCI continued to grow in the shadows. At its peak, TCI was doing an acquisition a day. Quietly consolidating the industry across smaller cities.
Vertical Integration
Malone preferred to scale horizontally, but once it got large enough it made sense to also scale vertically.
“The question is: Is the cable business going be a great business; who is going to make the money? It may well be that the Disneys of the world make the money and cable and video continue to get squeezed. But I think at least for now they’ve got enough pricing power in broadband to make up for that.” “The key to future profitability and success in the cable business will be the ability to control programming costs through the leverage of size.”
- John Malone
The next step from owning cable that delivered the programming, was to own a piece of the cable channels themselves, thereby sharing in a whole extra upside. This way, TCI could own both the pipe and the water flowing through it. Vertical integration of companies would become an awesomely powerful and controversial tool in building TCI. TCI came to own parts of BET, MTV, the Discovery Channel, and many more
Bet on Up-And-Comers
Malone realized early on the value of betting on young and talented entrepreneurs. He could use the size and scale of TCI to get equity interests in up-and-coming content providers and cable companies. Then he could turn around and add significant value to them. This cost very little in upfront capital. By the time of the AT&T sale, the company had 41 separate partnerships like this.
When he saw an idea or founder he liked, he would act quickly. He famously wrote Bob Johnson, the founder of BET, a $500,000 check during their first meeting. By the end of the 1980s, TCI owned a piece of BET, Turner Broadcasting, Discovery, Encore, QVC, and many other cable companies.
How did Malone manage TCI?
John Malone simplified playbook:
1. Identify a market opportunity
2. Hire good people & pay them well
3. Focus on doing the same deal over and over again for years
4. Payout with tax-friendly structures
Focus on Being a Capital Allocator
Malone saw himself as being a capital allocator first, and manager second. He delegated most of the day-to-day responsibilities to his COO, J.C. Sparkman, who managed with rigorous budgeting.
Sparkman was a former air force officer and ran the company with strict discipline. Managers were expected to stick to a budget and hit their cash flow targets. If they did, they were left on their own to operate how they saw fit. If they didn’t, they were quickly visited by upper management and replaced if things didn’t improve.
Focus on Cash Flow
Malone realized quickly that maximizing earnings per share didn’t work with the pursuit of scale. Higher net income meant higher taxes which was a waste of money.
Malone basically invented the focus on cash flow. Most companies at the time ran their companies on EPS, earnings per share. Malone ignored that and focused on EBITDA (earnings before interest, taxes, depreciation, and amortization) which wasn’t a thing back then.
He was alone at the time in emphasizing cash flow to lenders and investors. It was an entirely new vocabulary. Many of his competitors adopted it over the years and we all use it today. At the time it stumped analysts and TCI’s stock was punished in the short-term for it.
Don’t Fear Complexity
With all the joint ventures and spin-offs, TCI was notoriously difficult to value. It was often sold at a discount to peers and its true value for this reason.
The complexity was worth it for all the extra value from the different projects.
Strong Culture
Incentives and autonomy create a strong culture.
The company was known as a place for frugal, action-oriented cowboys. They were the counterpoint to the more conservative and bureaucratic east-coasters who ran most other large cable companies.
TCI’s aggressive employee stock purchase program made many millionaires down to his secretary. The company would match employee contributions and everyone was invited to participate. In Malone’s first 16 years, not a single senior executive left.
In 1995 with 12 million subscribers, the company had only 17 employees at the head office. Malone would say “We don’t believe in staff. Staff are people who second-guess people.”
The company had no human resources and didn’t hire a PR person until the late 1980s.
Avoid Taxes at All Costs
Malone hated taxes. They offended his libertarian leanings. Even as TCI grew its cash flow 20x, he never paid any real taxes.
He never paid dividends and rarely paid down debt. All extra cash flow was reinvested in more acquisitions to grow the company.
His only splurge in the head office was on tax experts who he met with monthly.
Virtually all his sales we in equity as well to avoid taxes.
Frugality
Malone was famously frugal at TCI. The large amount of debt they used forced operational discipline. The company’s office was spartan with few employees, one receptionist, and an automated service that answered the phone. They shared hotel rooms on the road and Holiday Inns were a rare luxury.
With its frugality, TCI had the highest margins in the industry and consistently outperformed its projections.
They were the last adopter of new technologies. They would only invest in their aging cable systems when absolutely necessary.
No memos
Malone, like Magness, didn’t believe in memos. No paper passed from his desk to his underlings. Politicians didn’t excel at TCI. Communication was direct, effective, and efficient. Every Monday morning, Malone sat with his closest executives at a broad round table, to figure out a way to squeeze more out of TCI’s growing cable kingdom.
Confidence
After TCI had a good amount of success, there's a point where Malone looks at Brian Roberts, Murdoch, etc. being billionaires while he was worth a paltry $50m and goes "I'm smarter than all of them so I need to get mine" and he did exactly that. He doubled down on a bunch of specialized transactions designed to enrich himself.
Tax-Friendly Share Price Growth
“It’s not about earnings, it’s about wealth creation and levered cash-flow growth. Tell them you don’t care about earnings..” “The first thing you do is make sure you have enough juice to survive and you don’t have any credit issues that are going to bite you in the near term, and that you’ve thought about how you manage your way through those issues.”
“I used to go to shareholder meetings and someone would ask about earnings, and I’d say, ‘I think you’re in the wrong meeting.’ That’s the wrong metric. In fact, in the cable industry, if you start generating earnings that means you’ve stopped growing and the government is now participating in what otherwise should be your growth metric.”
- John Malone
Malone used different classes of shares with different voting rights. A standing joke around TCI was that if TCI ever did report a large profit, Malone would fire the accountants.
“[Taxes are] a leakage of economic value. And, to the degree it can be deferred, you get to continue to invest that component on behalf of the government. There’s an old saying that the government is your partner from birth, but they don’t get to come to all the meetings.” “Better to pay interest than taxes.”
- John Malone
Malone had to “teach” the street what was really important – there is a big difference between creating wealth and reporting income. A focus on cash flow rather than reported income was hard for most to accept and was controversial for decades but those who invested alongside Malone would benefit greatly. He always pushed a long-term mindset and time horizon.
Risk Minimization
“Don’t expose yourself to one financial source.. diversification of every kind is the goal. Isolate financial risk.”
- John Malone
The cable industry would never rely on a single supplier of a hardware component for that reason.
Malone liked to use naval metaphors, such as bulkheads, to describe the setup. Large ships are designed to withstand battle damage because they have watertight bulkheads and separate and self-contained compartments that can be sealed off to prevent an injured vessel from capsizing. You can take a torpedo in any one part and still stay afloat.
With each new system he bought, the debt was secured by a TCI subsidiary, not by the parent company. So, if the cable system defaulted on a loan, only one subsidiary would be threatened.
Another way Malone eased risk was to spread it out among an ever-broadening array of partners, thereby protecting TCI and enhancing its influence in the industry simultaneously. Aside from the cable systems that were wholly owned by TCI, the company was a minority partner in more than 35 cable companies, all of which got the same price breaks in programming that TCI got – which amounted to as much as a 30% discount.
“Our skills here, internally, are very much in financial engineering.” “Entrepreneurs will always be able to take an asset, leverage it up, operate it tightly and make it worth money to them and get good equity returns.” “You can borrow money against a growing cash-flow stream, and as long as your growth rate’s faster than your cost of money it’s a wonderful business.”
“The cable industry created so many rich guys. It was the combination of tax-sheltered cash-flow growth that was, in effect, growing faster than the interest rate under which you could borrow money.” “Inflation lets you raise your rates and devalue your liabilities.”
- John Malone
What does TCI do after a sale? How do they operate?
TCI was highly efficient at cutting costs after acquisition.
With one unprofitable Pittsburgh acquisition, they were able to immediately cut payroll in half, and moved their fancy offices from a downtown skyscraper to a tire warehouse. Within months, the unprofitable company started generating significant cash flow.
They put their resources into hanging cable, getting new markets, and then ignoring subscribers. You can do that with mini monopolies, not much else. Terrible customer service was part of the business plan.
He was working in a regulated monopoly and behaved differently because of it. Those were just the incentives in the space.
When did John Malone buy businesses?
“Recently somebody said, ‘Hey, you lost weight,’ and I said, ‘Yeah, thirty-five pounds and three and a half-billion dollars.” “I’ve done lots of bad deals… Yeah, I’ve done some horrific deals.” “When I stick to my knitting I do okay. It’s – it’s when I listen to some pied piper.”
- John Malone on the internet bubble
Malone was patient when things got too expensive. He built up cash reserves, made smaller acquisitions, and waited for prices to normalize after the buying frenzy was over.
Once bubbles burst, Malone sprang into action. He made his most significant gains in downturns. Malone relished the role of bargain hunter amid the spoils of bad deals made by his competitors.
A superpower: He was able to wait without tiring of waiting.
If you are interested in buying, growing, and selling small companies, check out my course & community on it at IndiePE.com.
If you know of anything I should add to this please reach out @ColinKeeley or Colin@ColinKeeley.com. I’ll continue updating as I learn more.