Cable Cowboy
“Recently somebody said, ‘Hey, you lost weight,’ and I said, ‘Yeah, thirty-five pounds and three and a half billion dollars’.”
Capital Thinking · Issue #795 · View online
“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 is talking about the Internet bubble in this quote, when he refers to the money he lost. It was a very crazy time.
The level of fear of missing out (FOMO) is hard to convey to someone who did not go through it.
A Dozen Things I’ve Learned from John Malone
1. “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.” “They key to future profitability and success in the cable business will be the ability to control programming costs through the leverage of size.”
No one has taught me more about transfer pricing than John Malone and the people who work for him. I was lucky enough to work for Craig McCaw who started in the cable TV business before he became a pioneer in cellular communications and interacted with John Malone, TCI and Liberty over the years.
The takeaway from this quote is simple:
every business has a value chain and profit pools.
How profit is allocated between the layers in the value chain is determined by the relative transfer pricing power of the layers.
Lots of businesses create value, but no profit. This fact is poorly understood. The profitability of an industry not the same issues as its importance.
As an example, airlines create huge value for society (consumer surplus) but generate very little profit (producer surplus).
2. “[Don’t] expose yourself to one financial source.. diversification of every kind.. isolation of financial risk..”
The best way to combat the wholesale pricing power of a supplier or customer is to have alternatives.
As an example, the cable industry would never rely on a single supplier of a hardware component for that reason. The second point John Malone makes is that creating watertight compartments in a ship (and in a business) to isolate risk is just good engineering.
3. “[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 likes a strong economic moat. The test for whether a moat exists is whether the business has “pricing power.”
Warren Buffett puts it this way:
If you must hold a prayer meeting to raise prices, you don’t have much of a moat.
What happens when you don’t have a moat?
Here’s John Malone with an example:
“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.”
I lived this one up close and personal with a portfolio company known as NextLink/XO and know all too well that huge increases in supply when there are many providers is not good for profits. Some people during the bubble thought the Internet had suspended the laws of supply and demand, but they were proven wrong.
4. The concept that cable television looked more like real estate than it did manufacturing was always obvious, … to me, anyway. And I think the financial markets really didn’t have a model for cable, because the industry was a small, startup industry with no real following.
Coming out of that period of the ’70s, the industry needed some model, some metric how the market could value us. We decided out …to go on a cash flow metric very much like real estate.
Levered cash flow growth became the mantra out here. A number of our eastern competitors early on were still large industrial companies — Westinghouse, GE, — and they were on an earnings metric.”
“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.”
Among the many lessons I have learned about finance are as follows:
(1) accounting earnings are an opinion;
(2) free cash flow is a fact; and
(3) the only unforgivable sin in business is to run out of cash.
A key figure for John Malone in terms of raising the necessary cash was Michael Milken, who was also a key figure for many other people in this business world like Bill McGowan (MCI Communications), Bob Toll (Toll Brothers), Steve Wynn (Wynn Resorts), Steve Ross (Time Warner), Rupert Murdoch (News Corporation), Craig McCaw (McCaw Cellular, Nextel), and Ted Turner (CNN).
5. “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.”
How can I say this better than John Malone?
I can’t. So I will leave it at that.
Photo credit: Boston Public Library on Unsplash