[00:02:45] Kyle Grieve: A thousand shares of TCI stock bought by employees for 875 in 1976 were worth 450,000 by the end of the 1980s due to two spinoffs, 12 stock splits, and an ever-increasing share stock price. Because of this, in the first 16 years that John was in charge of TCI, not one executive left for another job. If you’ve ever read Outsiders or listened to We Study Billionaires, episode 555, You have heard of John Malone.

[00:03:13] Kyle Grieve: In case you need a quick refresher on the characteristics of William Thorndike’s outsider CEOs, they are intelligent capital allocation, focus on investing capital into high return opportunities, focusing on per share value creation, which means increasing revenues, earnings, or cash flows in an easy way.

[00:03:31] Kyle Grieve: These CEOs focus on per share value creation. Increasing revenues, earnings, or cash flow is pretty easy. Overspend and buy another business with your own shares, which is instantly accretive to these metrics. The best CEOs know this is not how you create value. You want per share earnings and cash flows to increase.

[00:03:50] Kyle Grieve: These CEOs were masters of decentralization. They delegated certain tasks to other people to allow them to allocate capital most intelligently. These CEOs skipped the limelight. The outsider CEOs preferred to be non-promotional and spent a lot less time attempting to impress Wall Street analysis compared to their peers.

[00:04:07] Kyle Grieve: The CEOs had patience. Only make deals that are also good capital allocation decisions. If it doesn’t make sense, skip it and wait until the opportunity comes up at a future date. The CEOs made very bold acquisitions. If the right acquisition targets come along with a large price tag, feel free to pull the trigger if it makes sense for value creation.

[00:04:26] Kyle Grieve: The CEOs stayed rational. They didn’t follow the industry if the industry was not aligned with creating shareholder value. And lastly, the CEOs focus on the long term. If a short term loss results in a long term gain, pull the trigger. Outsider CEOs rarely spent time thinking about how to impress shareholders in the next quarter.

[00:04:44] Kyle Grieve: They were thinking many years ahead. John Malone ticked many of these boxes. He never issued dividends. Capital will be put to better use inside of the business. He made several large acquisitions. He took advantage of a decentralized business structure and kept a lean work staff in place. He flew against traditional Wall Street dogma of focusing on earnings and instead focused on cash flows.

[00:05:06] Kyle Grieve: Which showed a more accurate economic reality for TCI. Since TCI rarely show profits, they barely pay taxes. Giving them more money to reinvest in more businesses. Today we’ll be going over a very good book, as I previously said, called Cable Cowboy, John Malone, and the Rise of the Modern TV Business by Mark Robichaux. To start, I want to give a quick backstory to the author and why he was the right person to write this book. Mark was, quote, fascinated by the cast of underfunded cowboys who had wanted merely to make a buck by building a rural antenna service.

[00:05:39] Kyle Grieve: Their vision always seemed just beyond their grasp, and they often stumbled in running to reach it. Now the same spider’s web of copper lines across the country was suddenly the single fastest route to the internet. promising a stunning array of services, it would be unmatched in capacity and speed, the most sophisticated wired system in the world.

[00:05:58] Kyle Grieve: The tapestry of events that led to cable’s dominance was connected by a single thread, John Malone. As impressive as a CEO as John Malone was to his shareholders, there was also a dark side to much of what he did and a negative perception to many of his tactics. Many saw him as a modern day robber baron who used his monopolistic power as a means to extract cash from customers while providing mediocre service.

[00:06:22] Kyle Grieve: This gave rise to many notorious nicknames for John such as Darth Vader, Genghis Khan, and The Godfather. Like many of the monopolistic titans that came before him, such as Andrew Carnegie, John D. Rockefeller, and JP Morgan, quick success requires paying a heavy toll. In John Malone’s case, this was being the center of regulation in his industry and personal vendettas against him from high ranking government officials.

[00:06:44] Kyle Grieve: I think Mark Robichaux did a great job in this book of giving an impartial view of John Malone. So hopefully, by the end of the episode, you can make your own informed decision. Before we get into the nitty gritty of John Malone’s time at TCI, I want to first discuss a little bit about his childhood, as I think it does have a large impact on his adult life.

[00:07:01] Kyle Grieve: John’s father was an engineer, and his mother a schoolteacher. As early as age 6, he could be found tinkering with radios and TVs, so his affinity for technology was quite high from a young age. At 15, John quote, bid for and won a bin of radios for a dollar apiece from a GE small appliance outlet in Bridgeport.

[00:07:18] Kyle Grieve: His father had told him about the radios, which had been returned to GE for malfunctions. Using his father’s test equipment out in the barn, Malone would repair and sell them for 3 each, unquote. As a young adult, he studied engineering and economics at Yale. While working at Bell Labs, he received an advanced degree in industrial management at Johns Hopkins University.

[00:07:37] Kyle Grieve: He eventually earned a PhD in operations research. Now before joining TCI, John Malone had two jobs that impacted how he would run TCI. Number one was working at Bell Labs at AT&T. He lasted only a few years. One of the primary reasons that he left was that he was fed up with the overly bureaucratic culture that they’d installed.

[00:07:56] Kyle Grieve: Number two was working as a consultant for McKinsey. While there, he learned how to identify an attractive industry. During this time, he was introduced to the cable industry and it captivated his attention. As William Thorndike points out in The Outsiders, Malone liked three primary characteristics of the cable industry.

[00:08:13] Kyle Grieve: Quote, the highly predictable utility like revenues, the favorable tax characteristics, and the fact that it was growing like a weed. Unquote. Another lesson John Malone learned from his time at McKinsey was his knowledge of corporate structures. He got the chance to speak to many large corporations, and he found patterns in the way corporations operated that he thought were subpar at best.

[00:08:34] Kyle Grieve: He used his background in engineering to use first principles to best understand how corporations could better be run. Quote, 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.

[00:08:55] Kyle Grieve: Let’s discuss the formulation of TCI to give you a bit of backstory to what John Malone was about to sign up for. Bob Magnus was the founder of Telecommunications Inc., which I’ll call TCI from here on out. For all intents and purposes, Bob was a cowboy. Robichaux writes, quote, TCI was born in the scrub land of western Texas in 1952, when Bob Magnus, a part time rancher with a weakness for whiskey and gambling, gleaned from a couple of hitchhikers a nifty investment idea that almost bankrupted him, unquote.

[00:09:25] Kyle Grieve: Bob had seeded TCI with proceeds from mortgaging his own home. The problem Bob Magnus was trying to solve was that rural and valley towns in America did not have access to big city broadcast signals. Entrepreneurs would run a wire through the towns called Community Antenna, CATV, and charge users 45 bucks a month for access to the CATV.

[00:09:45] Kyle Grieve: This was where Bob thought he could hit it big. Bob liked the business and found some interesting tax laws that would help him grow his business. Robichaux wrote, quote, Cable operators could gradually write off the costs of their systems over a number of years, allowing them to reduce the leftover profits they reported as earnings, and thereby sheltering a healthy cash flow from taxation.

[00:10:05] Kyle Grieve: And once they had 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, unquote. The simple way to understand the cable business back in the 1970s were that there were two primary segments. One was the operators, and two were the programmers.

[00:10:22] Kyle Grieve: TCI started as an operator, owning the back end of TV, but not the programming. Eventually, they made their way into programming. Now, TCI’s first attempt at programming was as entry level as you could possibly imagine. They aimed a TV camera at a news ticker service, another on a thermometer, and occasionally you’d have a camera focused on a goldfish bowl.

[00:10:42] Kyle Grieve: But cable TV was a profitable industry to be in during the early days. Cable TV systems, to every new owner’s delight, generated bundles of cash from installation charges. 100 to 300 a customer in the 1970s, and a monthly service fee of 5 to 20 dollars. The average cable system enjoyed a profit margin of 57%, far better than most other businesses. Unquote. Because Bob Magnus could continue his M&A spree while avoiding taxes due to the high depreciation cost of equipment, he utilized a ton of leverage. As time passed, lenders to TCI started to get an unsettling feeling about how much debt Bob had racked up expanding TCI. As his relationship with lenders worsened, he decided he’d had enough.

[00:11:24] Kyle Grieve: Quote, TCI and its subsidiaries were failing to meet critical financial benchmarks required by the terms of their loan agreements. Bankers wanted to know, why hadn’t TCI hit its cash flow projections? When did it expect to make its next payment? Why hadn’t TCI foreseen all this trouble? Magnus had simply run out of gas and many of his executives were burnt out too.

[00:11:44] Kyle Grieve: The complexities of running a public company and tracking the performance of more than 200 cable franchises in 21 states, all while fighting regulators and lawyers was becoming too much for the one time cottonseed salesman. And so one day in the fall of 1972, after he had spent hours toting up TCI’s financial position, Magnus finally and fully grasped just how terribly precarious the whole situation had become.

[00:12:07] Kyle Grieve: He skimmed the numbers, looked at Betsy, his wife, and blurted out, I’m going to hire the smartest [Redacted] I can find. Unquote. John Malone was his guy. But Malone was taking a gamble on this job. Before taking over as CEO of TCI at the age of 31, John was offered a great deal by Steve Ross, the chairman of Warner Communications. Steve was prepared to pay John 150, 000 a year, access to a limo, and even willing to move Warner’s headquarters a short distance from where John lived in Connecticut. Rather than having him relocate to New York. Bob Magnus offer on the other hand, was only 60,000. Bob told John quote, I can’t pay very much, but you’ve got a great future here. If you can create it. Unquote. John, like many other great CEOs, chose a position at TCI where he knew he would have a lot of control to run the business in the best way that he saw fit.

[00:13:00] Kyle Grieve: Quote. Malone believed in him. Bob Magnus and I’d staked everything on this job. and then some. Upon shaking hands, Magnus had agreed to a salary of just 60,000. Malone had also seen fit to buy 7,500 shares of TCI stock, which he helped to pay for with a 60,000 personal loan from a local bank. Unquote. So when we look at management in a business that we’re looking to invest in, we often look for businesses with high insider ownership.

[00:13:26] Kyle Grieve: I couldn’t find what percent this stake represented, either as a percent of his total ownership of TCI or as a percent of John’s total wealth. But I can imagine it was probably a decent chunk of change for John at this time. We can also assume that TCI was a microcap, so a 60, 000 investment could have meant he still owned a reasonably sized portion of the company.

[00:13:44] Kyle Grieve: So, one of Malone’s first moves as CEO was to try and convince Bob Magnus to sell one of TCI’s prized possessions. TCI owned 75 percent of National Telefilm Associates, NTA, which was a programmer. It was run by one of Bob’s good friends, George Hatch. NTA was piled with debt, and much of that debt had been obtained by using TCI as a guarantor of loans.

[00:14:07] Kyle Grieve: The problem was that TCI was a guarantor debt, but only had a few million in revenues at the time, and it had its own debt to service. If the bankers wanted, they could theoretically have bankrupted TCI. John did not like how NTA was run. Quote, Many of NTA’s problems were a direct result of poor choices George Hatch had made, and his ideas to save the company were no better.

[00:14:29] Kyle Grieve: In one meeting, Hatch had proposed purchasing a company that bought old black and white negatives from studios and salvaged the silver. Another idea involved buying a shopping mall. Malone sat in quiet rage wondering what incredulous thoughts must be going through the minds of the Citibank official who had flown out to Denver from New York just to hear this gibberish.

[00:14:49] Kyle Grieve: The whole thing was just insulting, Malone had felt, unquote, but Malone had used his negotiating skills with bankers to give TCI more time to figure out how they could deal with the problems NTA was generating, and it was eventually resolved. John Malone would have numerous fights in his day as the head of TCI.

[00:15:05] Kyle Grieve: One of his first big ones was with the city of Vail, Colorado. The city council had voted to end TCI’s franchise to operate in the city. They declined to allow TCI to rewire the system and refused to renew TCI’s contract with the city. Malone’s response was priceless and showed the power that he wielded. Quote.

[00:15:24] Kyle Grieve: At 6:35pm on November 1st, 1973, the TV screen of every TCI customer in Vail went dark. TCI had pulled all programming, substituting it with the names and home phone numbers of top city officials, including the mayor. The blackout lasted through a Sunday Denver Broncos game against the St. Louis Cardinals, and the phones lit up.

[00:15:45] Kyle Grieve: By Tuesday, the crisis was settled. Unquote. John understood that TCI had a lot of power that it could wield, and a product that its customers wanted. He was not afraid to ruffle feathers if it meant keeping the cash flows coming in. He was afraid that if he bent to the whims of certain jurisdictions, it would set a precedent of TCI showing weakness.

[00:16:04] Kyle Grieve: He didn’t want to be squeezed on renewals, and this was a great warning sign to anybody who was thinking of doing just that. These are the types of stories that are hard for investors to get a grasp of. They might see the products of these decisions, such as increased revenues, higher retention rates, increased earnings, and free cash flow, but it can often be hard to see all the narratives that create this value.

[00:16:24] Kyle Grieve: But if you spoke to any of the giants in the industry, they realized John Malone’s brilliance. Mike Freese, the CEO of Liberty Global, said, quote, John’s genius in growing and consolidating the cable industry in America revolved around a couple of key principles. The first was scale. When you’re bigger in a common industry, in a common market, you can drive efficiencies.

[00:16:44] Kyle Grieve: You can negotiate better programming and supply agreements. You have more clout. You can shape markets. Secondly, he understood early on the power of leverage in a balance sheet and cash flow. And, if you can generate cash flow and show the market that you are generating cash, that’s going to allow you to drive that value creation story into more and more businesses. Unquote.

[00:17:03] Kyle Grieve: Without understanding scale, leverage, capital markets, and relationships, John would never have gotten to where he was. A great example of his understanding of capital markets and leverage was in how he could grow TCI while lowering debt. This was important because at the time TCI was frequently mentioned as a takeover candidate.

[00:17:22] Kyle Grieve: John said quote, we are worth more dead than alive and we’re living on borrowed time, unquote. To combat these takeover attempts, John had to use complex financial engineering to grow the business and allow it to pay down debt. One strategy to fund TCI’s expansion plans was to attract businesses with capital to invest, but a limited expertise in cable.

[00:17:42] Kyle Grieve: One such investor in TCI was Kauffman and Broad, who owned 14 percent of TCI at the time. But they wanted out. With the stock price dwindling around the dollar mark in the mid-1970s, their block of shares was ripe for the taking from a corporate raider. To keep the stock held by friendly investors, John devised a plan.

[00:17:59] Kyle Grieve: Bob Magnus and John Malone didn’t have the money to buy this large block of shares. So they loaned the money to a quote unrestricted off balance sheet subsidiary Bob asked John, John who do you know who you would absolutely? Trust your wife with it took a while for them to come up with a name when Bob came up with an idea quote Can we trust Tiger Magnus asked Malone grinned by God.

[00:18:20] Kyle Grieve: I think we can trust Tiger. He replied It started out as a joke, but the two men created a holding company called Tiger Incorporated, a company that would become one of TCI’s largest shareholders over the next few years, owning at one point more than one third of the company, including the stock of Golf Western and Kauffman Broad.

[00:18:37] Kyle Grieve: Magnuson Malone never told a soul that TCI’s largest block of stock was parked with a dog, covenants. Tiger would evolve into two firms, including one known as TCI Investments, 50 percent owned by an unrestricted subsidiary of TCI and 50 percent owned by Kaufman and Broad. To Malone and Magnus, the idea of Tiger served a higher purpose, allowing TCI to keep shares out of hostile shareholders hands, while giving TCI the chance to buy back its own shares from a subsidiary.

[00:19:08] Kyle Grieve: As the fear of a takeover showed, TCI was having some problems with getting the market to see the value of their business. But John came up with a plan to help try and get Wall Street to better understand the true value of TCI. As I previously mentioned, TCI pretty much never turned a profit on its income statement.

[00:19:24] Kyle Grieve: Wall Street did not like this and therefore didn’t pay much attention to the business. But as John gained experience, he realized TCI was creating shareholder value, but traditional accounting standards weren’t adequately displaying that value creation. So John came up with a financial metric which accounted for earnings before interest, taxes, and depreciation.

[00:19:43] Kyle Grieve: Yeah, EBITDA minus the amortization expense. Robichaux wrote, quote, through a combination of logic, job owning, and sheer force of presence, Malone persuaded Wall Street to take a second look at the cable industry, long shunned because of its non-existent earnings and heavy debt addiction. Malone argued, successfully, that after tax earnings didn’t count.

[00:20:03] Kyle Grieve: What counted was a cable’s prodigious cash flow, funding TCI’s continued expansion. Buying cable was like buying real estate. As the value of TCI’s franchise rose, so would the value of its stock. Net income was an invention of accountants, he declared, unquote. So here are the facts for TCI at the time.

[00:20:20] Kyle Grieve: One, they had high interest expense payments. Two, they had high levels of depreciation. Three, they showed accounting losses. And four, they had negligible tax bills. So even though the net income statement said TCI was a crappy business, The cash flow statement said otherwise. John Malone would have said as long as TCI collected on its rents from his customers, met its interest expense payments, and could continue growing from acquisitions, then why should investors have anything to worry about?

[00:20:46] Kyle Grieve: Robichaux writes, quote, Malone liked the mathematics of it. Tax sheltered cash flow would be leveraged to land more loans to create more tax sheltered cash flow. A standing joke around TCI was that if TCI ever did report a large profit, Malone would fire the accountants. Unquote. A lot of this makes me think of the early days of Amazon.

[00:21:06] Kyle Grieve: In 100 Beggars, by Chris Mayer, he discussed the case study of Amazon with an analyst named Thompson Clark. Quote, looking at Amazon’s reported operating income, it doesn’t look profitable, Thompson continues. On 88 billion in 2014 sales, Amazon earned a measly 178 million in operating income. That’s a razor thin 0.2 percent operating margin. Adding back R&D, however, paints a completely different picture. In 2014, Amazon spent 9.2 billion on R&D. Adding that back to operating income, Amazon generated adjusted operating income of 9.4 million in 2014. That’s an operating margin of 10.6%. Unquote. Thompson goes on to say, quote, my higher level point is simply that Amazon would have been profitable if it wanted to.

[00:21:51] Kyle Grieve: Thompson writes, if it wanted to show earnings, it could have. It didn’t. The layman, who may be interested in buying Amazon stock, would certainly be turned off by its lack of ever being profitable. Well, if you back out R&D, effectively backing out CapEx, you see how profitable the business really had been.

[00:22:07] Kyle Grieve: Unquote. Now, I realize this isn’t an apples to apples comparison. TCI could not have shown a profit, even if it wanted to, unlike Amazon. But the point remains that traditional accounting standards do sometimes miss the value creation a business is going through, and I think TCI was a great example.

[00:22:22] Kyle Grieve: Another strength of John Malone’s was to make sure that he was getting the right shareholders on board. At a shareholder meeting, John said, quote, if you’re going to ask about quarterly earnings, you’re at the wrong meeting, and you probably shouldn’t own the stock. What we care about is value. We want to create value for our shareholders, and I think the best way to create value is to have a very long view.

[00:22:41] Kyle Grieve: So that’s what we do. So when we have the opportunity to expand into an area, we think is going to have a long term value, we do it. We don’t have to worry about the impact on earnings, so it makes a different kind of organization. Unquote. He wanted shareholders to know that using traditional accounting standards would be like sticking a square cube into a round hole.

[00:22:59] Kyle Grieve: It just wouldn’t work. To understand TCI and its strategy, you had to use the unorthodox methods that he outlined. But if you could understand the methods behind his madness, you opened yourself up to one of the best performing stocks that ever existed. Let’s break this quote above down even more. John said a few things that stood out to me as a long term investor.

[00:23:18] Kyle Grieve: Quote, what we care about is value. Unquote. From reading his book and researching John, I think this comes down to three primary points. Number one, he wanted to create shareholder value. Number two, he wanted to buy acquisitions that were value accretive to shareholders. And number three, he thought about capital allocation in terms of creating shareholder value and not necessarily how to appease Wall Street.

[00:23:40] Kyle Grieve: The next interesting part of this quote is his emphasis on having a long view of things. John had an epic run of mergers and acquisitions. Between 1973 and 1989, John made 482 acquisitions. On average, one acquisition every two weeks. How could someone make that many acquisitions at that rate and still be creating so much value? But John did it.

[00:24:01] Kyle Grieve: And he did it masterfully. Robichaux wrote about an example of serendipitous value creation. One day in the fall of 1978, Don Fisher’s secretary received a phone call from a woman at Gulf and Western who wanted to know did TCI plan to sell its resorts international stock. It must be a mistake, Fisher told the secretary.

[00:24:20] Kyle Grieve: TCI didn’t own any resorts international stock. But the woman insisted that TCI did own the stock through a company called Athena. Amused, Fisher asked for a copy of the document to prove it. Five years earlier, when TCI had paid 4 million in 1973 to Gulf and Western GNW for control of Athena, among the hodgepodge of holdings that GNW sold to TCI were warrants to buy 463, 000 shares of Resorts International at 39 a share.

[00:24:48] Kyle Grieve: Until 1978, the warrants were practically worthless. Indeed, TCI’s Athena was losing money and was 40 million in debt, but in 1978, when Resorts International opened the first casino in Atlantic City, the stock shot to as high as 96 a share. After converting the warrants and selling shares at a high, TCI made 31 million, a fortune for a company whose market cap was only 100 million at the time. Unquote.

[00:25:12] Kyle Grieve: A few of his best deals were made later on in life. For instance, he took TCI Music from 1 billion in price to over 10 billion in only a few days. Robichaux wrote that he did this by quote, taking a tiny near worthless stock, fill it with small stakes in several companies, watch them grow, then trade them for stakes in even bigger more secure companies, unquote.

[00:25:34] Kyle Grieve: Keep in mind that this was in 1999 during the height of the internet bubble. Another deal was in 1999 that displayed his ability to value assets. He paid 280 million dollars to buy a 5 percent stake in General Instrument. Shortly after, Motorola bought out GI, and that stake was then worth 1.8 billion dollars.

[00:25:51] Kyle Grieve: Oh! and he didn’t pay a dime of tax on this deal due to it being a share swap. And John had other ways to create value as well in his earlier years. Part of the beauty of his acquisition strategy was that his name would be mentioned by a lot of very wealthy people associated with the cable industry. He leveraged this to his advantage in 1997.

[00:26:10] Kyle Grieve: He was able to form a consortium of seven insurers to refinance TCI debt of 77.5 million, which seems small now, but was unheard of at the time. The best part of this deal. Wasn’t that it was a large amount of money. It wasn’t the nuances of the deal. John secured the loan at quote fixed rates and cheaper and more flexible than the banks.

[00:26:30] Kyle Grieve: It was without a doubt the happiest day of Malone’s career with TCI, unquote. After making this deal, John made sure to let the previous owners of TCI’s debt know their services were no longer needed. At a meeting that he organized, he excitedly said, quote, thank you all for coming. From time to time, various lenders to the company have expressed an interest in reducing their exposure to the company.

[00:26:51] Kyle Grieve: I’m happy to announce we have arranged for alternate financing. It’s going to be possible for any bank that wants to reduce their exposure to do so in a timely basis. In other words, if you want out, you can get out. Now, unquote. Robichaux added, quote, He savored the blank faces on the hushed audience fanned out before him.

[00:27:08] Kyle Grieve: Incredibly, TCI could pay them off up to the last red cent. Then, as if delivering the second half of a one two punch, Malone let the bankers know that TCI had found cheaper money. From this day forward, the company is a prime rate borrower, he said. Putting all banks on notice that the interest rate was coming down.

[00:27:25] Kyle Grieve: Two of the banks were paid off in full, five banks wanted to stay in, and re wrote their covenants, to allow TCI more flexibility through unrestricted subsidiaries. A year later, institutional investors discovered the company’s stock and started to take up the price. TCI was able to go to the equity markets to raise capital.

[00:27:43] Kyle Grieve: From that point forward, Malone never looked back, unquote. Since John used debt to add rocket fuel to the TCI business model, paying lower interest rates meant he could produce higher cash flows, which meant he could spend more money and keep the flywheel going for TCI. Let’s get into some of the basis of TCI’s business model, as it really took off and intelligently expanded over the years.

[00:28:03] Kyle Grieve: Bob Magnus built up the operator side of the business and dabbled in the programming side. John kept growing both sides of the business and made sure to take advantage of the fact that he could control who saw the programming. This was part of why TCI had such monopolistic control over the industry.

[00:28:18] Kyle Grieve: TCI could threaten to remove the programming from one of its programmers if it didn’t like a deal that was proposed or, given TCI’s scale, they could secure deals with major programmers at much better prices than a competitor could get. For instance, in 1977, John wanted to add HBO to its cable systems.

[00:28:34] Kyle Grieve: John observed that Showtime was also planning to launch, and John saw an opportunity to act as a puppet master of these two rivals. He ended up signing a sweetheart deal from HBO at far superior terms compared to competitors. This was where problems with regulators started to become an issue. By 1981, TCI was the largest cable operator in the US, with 2 million viewers.

[00:28:54] Kyle Grieve: If John Malone called up a programmer, he had a lot of bargaining power on what he would pay. If the programmer didn’t like it, John would just choose not to deal with them, and the programmer would be at a major disadvantage. John structured these deals very well. He’d often acquire equity in the programming company as part of the deal.

[00:29:12] Kyle Grieve: This allowed him to own equity stakes in many different programmers and helped align the programmer with the operator. Because of this anti-competitive behavior, he would start drawing the ire of regulators. More on that in a bit. In the early 80s, it was becoming obvious that cable franchises were an attractive investment.

[00:29:28] Kyle Grieve: If a cable operator wished to increase rates, the only thing that stood in their way was getting approval from local governments. And in the Vale case study, you can see how much power the cable operators had in winning these types of concessions. Because of this, there was a whirlwind of deals that grew higher and higher in size.

[00:29:44] Kyle Grieve: But since John was focused on value, he began getting priced out of many of these deals as he understood that many of these deals were too rich for TCI’s pockets or were being done at too high of a purchase price. John thought that once some of the allure of buying cable systems washed off, some of these businesses would come crawling to TCI asking to be bought at sale prices.

[00:30:05] Kyle Grieve: During this time, another problem arose for TCI. This was the problem of service. Primarily, that the service was not good. Part of the problem with monopolies is that they are rent seekers. This means they can just indiscriminately charge rents to their customers, and since there is no competition, they don’t have to spend money on upkeep.

[00:30:21] Kyle Grieve: Which usually means that the service is mediocre and the prices are high. I think this was part of the downfall of cable TV and part of why streaming has taken so much market share. Streaming services like Netflix, Disney Amazon Prime Video, and Apple TV were all created because they saw an angle in the TV business.

[00:30:38] Kyle Grieve: Maybe this isn’t so much of a strength now, but you could get these streaming services on demand with no advertisements. The beautiful part about streaming from the consumer’s point of view is that they’re all competing against each other to create better and better products. If there was only one of them, they could primarily focus on extracting as much money as possible out of their customers.

[00:30:57] Kyle Grieve: Let’s get back to TCI. In the 1980s, they almost lost a franchise in Jefferson City. The primary reason was that TCI had raised the prices by 186 percent in 3 years. The price increase wasn’t even the primary issue. During this price increase, the service was abysmal. This particular TCI franchise was very lean, and not well funded.

[00:31:17] Kyle Grieve: So during this time, TCI made very few improvements. There were numerous complaints of a fuzzy picture, and service calls were excruciatingly long. During this time, TCI was not the only cable business going to war with specific cities. All their competitors were going through similar growing pains. The fact that these issues were so widespread drew the attention of Congress.

[00:31:36] Kyle Grieve: Part of the issue from John Malone’s perspective was that the government was essentially stealing TCI’s infrastructure and allowing competitors to use it and collect their revenues from TCI’s assets. But from a government perspective, they saw TCI as delivering poor service and gouging their constituents.

[00:31:52] Kyle Grieve: To give an idea of how the cable industry had grown from 1976 to 1987, the number of networks grew from 4 to 76, the number of cable systems more than doubled all the way up to 7, 900, and revenue expanded from 900 million to nearly 12 billion dollars. Before the boom of the 1980s, John Malone would take advantage of TCI’s underpriced shares to consolidate their control in the industry.

[00:32:14] Kyle Grieve: I mentioned that corporate takeovers were a constant threat that TCI had to deal with. One of John’s finest moves was to opportunistically buy back stock which would increase their ownership stakes of the business and make it harder for corporate raiders to organize a takeover. What we show breaks it down here very well.

[00:32:29] Kyle Grieve: Quote, in 1978, they created a super voting class of B shares, and through a complex series of repurchases and trades, were able to secure what longtime executive John Sy refers to as hard control of TCI by 1979, when their combined ownership of B shares reached 56%. Unquote. John understood capital allocation well.

[00:32:49] Kyle Grieve: William Thorndike noted that John Malone told David Wargo that it would make sense to sell some of their cable systems at 10 times cash flow to buy back their own stock at 7 times cash flow. And when TCI was trading for a premium, John would use TCI’s equity to fund purchases. Both of these attributes, one, buying back shares when the market undervalues them, and two, issuing stock for acquisitions only when your stock is overvalued, are two attributes that are rare to find in managers.

[00:33:14] Kyle Grieve: And John Malone did an excellent job of not succumbing to industry norms just to please Wall Street. Now remember how I discussed how John decided to stay away from buying overpriced cable assets in the early 1980s? This was a period where businesses like American Express and even Coca Cola were purchasing stakes in cable systems and programming.

[00:33:31] Kyle Grieve: So John had a very good insight that it was probably not the best time to deploy capital. But he knew his time would come. Mid 80s would signal the time was right to get back in. His play was to move into some of the larger urban markets that had previously been overpriced. Pittsburgh was a good example, when TCI purchased Warner Amex for 94.5 million. Just to understand how good of a deal this was, just a few years earlier, Amex invested 175 million for 50 percent of Warner’s cable properties. This new venture secured an 800 million loan to bid on more franchises. The problem that Warner Amex had gotten into was that they were over promising and under delivering.

[00:34:07] Kyle Grieve: To solve this problem and prevent rate increases for the new franchise, quote, TCI promised a system with 44 channels instead of 63. It ripped out expensive equipment and sold interactive boxes back to Warner for 30 each. Malone cut payrolls by nearly half, closed the elaborate studios promised to local officials, and moved the extravagant downtown headquarters to a tire warehouse.

[00:34:29] Kyle Grieve: Pittsburgh was a steal for TCI because within two years, TCI had lowered its debt and improved finances enough to begin paying back banks using the system’s own improved cash flow. Keep in mind that TCI had grown a lot by this point. But John kept the business very lean. TCI only had a dozen senior executives at the time.

[00:34:48] Kyle Grieve: When they needed to go to New York, they’d pile into the company’s two bedroom apartment with multiple people sleeping in the same room. Robichaux writes of the TCI headquarters at the time, quote, TCI was a square, flat, one story brown building on the outskirts of Denver. Faux wood paneling lined the offices, which were furnished with brown plaid chairs and couches that looked as if they had been lifted from the lobby of a Motel 6. Unquote.

[00:35:10] Kyle Grieve: Another interesting piece of information I came across that reminded me of many of the great serial quires of today was how decentralized TCI became. I think John’s previous experience with seeing the downside of bureaucracy helped him develop TCI into a more decentralized organization. By the late 1980s, TCI had six operating divisions operating nearly autonomously.

[00:35:30] Kyle Grieve: John said, quote, when you’ve got it running right, when you’ve got it decentralized, when you’ve got it structured properly, it’s like flying the most powerful fighter jet in the world, unquote. You probably know I’m a big fan of serial acquirers. As I discussed with Chris Mayer on Millennial Investing episode 310, decentralization is a big factor in many of today’s successful serial acquirers.

[00:35:49] Kyle Grieve: Another important part of a good serial acquirer is the ability to trust the people you give responsibility to. as well as your partners in any joint venture that you decide to take part in. John, like Warren Buffett, was very skilled at identifying talented managers and then allowing them to do whatever they were doing to impress in the first place.

[00:36:07] Kyle Grieve: For instance, Malone had plenty of partnerships with other cable operators who would own and operate their own systems. Because he was hands off in certain situations, he would make a point to invest in talent when he saw it. In 1987, Malone merged a TCI spinoff with a cable operator called Marcus Communications.

[00:36:23] Kyle Grieve: John would leave the business in the hands to Jeffrey Marcus to operate. This was not unusual for John to do. And to do it successfully, he had to have a high degree of trust in the managers that he gave responsibility to. Let’s get back to some of the monopoly like characteristics that John had created for TCI through scale.

[00:36:39] Kyle Grieve: One of the biggest programmers in the 80s was HBO. Due to the sheer scale and power of TCI, they only paid HBO 0.90 per subscriber for access to HBO. However, smaller cable operators had to pay HBO 5 dollars for the same service. John engineered TCI to have bargaining power that was unmatched by the majority of his peers.

[00:36:59] Kyle Grieve: Al Gore targeted TCI and John Malone for a number of years, and John Malone developed a hatred for him. Quote. Gore’s comments fueled the image of Malone as a rapacious monopolist. Malone had ignored the court of public opinion but at his own peril. Malone and his family began getting threats. At first, they were intermittent, the same kind received by any big CEO with thousands of shareholders to satisfy.

[00:37:22] Kyle Grieve: But later, they became more frequent, some written, some by phone, most of them from crazies and cranks. One person threatened to burn his house down and kill his kids. Unquote. Malone’s daughter fully moved to the east coast out of fear, and Malone never forgave Gore for creating the environment that he and his family had to live through.

[00:37:39] Kyle Grieve: By the early 90s, Malone was using marketing tactics that listeners will be familiar with today. In 1991, TSI launched a pay movie channel, Encore. To increase the amount of users out there to try this new service, they gave the service away to the users for free for a month. After that month, subscribers would automatically be charged for the service unless they notified TCI to cancel.

[00:37:59] Kyle Grieve: The result was that quote, customers screamed when they received their bills. And after 10 state attorney generals sued, TCI retreated and dropped the practice around the country. Unquote. I don’t know about you, but I’ve noticed nearly every web based subscription service today uses a somewhat similar strategy to sign up new customers.

[00:38:17] Kyle Grieve: As TCI continued jumping over regulatory hurdles, John realized that TCI’s power was getting too large for the government to allow. After talking with his inner circle, he determined that the government would end up splitting TCI in two, with a cable system and a content company. Instead of waiting for regulators to force them to do it on their terms, he preempted their move and just did it on his own.

[00:38:37] Kyle Grieve: This was where Liberty Media, which he shares to this day, was born. As you’re now aware of, John was improving more and more and making incredible deals that created shareholder value. But a lot of that value wasn’t showing up in Malone’s net worth. Ted Turner once joked to John, quote, Gee, John, I’m getting rich, and Bob’s getting rich, and the only one that’s not getting rich is you, unquote.

[00:38:57] Kyle Grieve: John said before the Liberty Media deal quote up until then I had been more focused on TCI, I was going to have the biggest and best company and it was making Bob very rich and Bob wasn’t reciprocating and that was just Bob. He would never do anything unless you pushed him into a decision That’s what created Liberty.

[00:39:15] Kyle Grieve: It was a little schemey, very tax efficient, and it worked. Unquote. With the Liberty Media spinoff, John realized that this was his chance to add a few zeros to his net worth. Now, I’m going to attempt to explain this offer to you, but it’s incredibly complicated. I had to read it multiple times to try to make sense of it.

[00:39:30] Kyle Grieve: The deal was written down in a 345 page prospectus, so it was hard to understand on purpose. The deal was called an exchange offer, and TCI shareholders got the right to take part in it. Now, here are some of the details of the deal. For every 200 shares of TCI stock shareholders owned, they would get one right to buy a Liberty share.

[00:39:49] Kyle Grieve: Each right, in turn, allowed shareholders to swap 16 shares for a single share of Liberty Media. This rights offering valued Liberty Media at approximately 300 per share, implying an 18. 75 value for each TCI share. This put Liberty Media at a market value of 600 million, which was the amount of assets that John had allocated to the spinoff company.

[00:40:09] Kyle Grieve: The deal left analysts perplexed. Liberty had posted a loss on revenue of 52 million for the pro forma nine months, but John didn’t make deals that were easy for the lay person to understand. And even Bob Magnus understood this. Bob told John that nobody would understand the deal and therefore it was unlikely to realize value.

[00:40:28] Kyle Grieve: John replied, that was the point of the deal. I had a real hard time understanding the mechanics of this exact part of the deal. The fewer investors who participated in the deal, the larger the stakes would accrue to the owners. Here’s what Robichaux writes on the deal, quote, while fewer than half of TCI’s shareholders took part in this Liberty spin off, Malone bet as heavily as he possibly could and commanded a disproportionately larger share of equity being handed out.

[00:40:52] Kyle Grieve: 20 percent of all Liberty shares and 40 percent of voting control. Yet to get it, he would reduce his TCI holdings by more than one third. Malone got 8.7 percent of Liberty shares in return, three times more than he would have been able to claim had all shareholders participated. Here are some of the details of how he ended up with so much stock.

[00:41:10] Kyle Grieve: So Malone exercised 25.6 million of options. He was given instead of salary, but only had to put up a hundred K in cash. He gave Liberty a note for the remaining 25.5 million. He later paid off a part of the debt with TCI stock. Next, he got to work increasing the value of Liberty’s shares to fund more acquisitions.

[00:41:30] Kyle Grieve: In only two years, he did three splits. Note that at this time, Liberty was not a public company. He took it public shortly after and the stock skyrocketed. Quote, in less than a year of trading, the shares more than tripled to 770 a share. By the summer of 1993, shares that initially sold for 256 apiece were now worth 3,700 unadjusted for splits.

[00:41:52] Kyle Grieve: Sending Malone’s investment of 42.1 million. Mostly it borrowed from Liberty on a personal note climbing to more than $600 million unquote. So just think about this, in a few short years, John had used a hundred K of his cash and 25.5 million of debt from Liberty to add $600 million to his net worth.

[00:42:12] Kyle Grieve: That is a truly incredible deal, and one that John manufactured for himself, all while enriching shareholders in the process. When Rupert Murdoch, the chairman and CEO of News Corp, was asked what it was like to do with John Malone, he said, quote, John’s deals are nearly always very complex, unquote. His complex deals kept competitors and partners awake at night as well.

[00:42:31] Kyle Grieve: Greg Maffee, the CEO and president of Liberty Media, said about John, quote, When I was still at Microsoft, I can remember Bill Gates had such respect for John, staying up until 11, 1130, 12 at night for the next meeting, thinking that What are we going to do with John? What is the doctor thinking? What’s he maneuvering on?

[00:42:48] Kyle Grieve: And how much time and effort Bill Gates and his team had spent trying to figure out exactly what does John Malone want? Unquote. In the early 90s, John could see the writing on the wall for the cable industry. The new regulation was crippling the industry. Phone monopolies, like the Baby Bells, were preparing to enter the industry and offer their own packaged services.

[00:43:07] Kyle Grieve: So John had to innovate and think fast. His major innovation was to have 500 channels to view. In his early years, this was impossible, the technology just wasn’t there. However, engineers had figured out how to increase efficiency and add an unprecedented amount of channels to TCI’s product offerings. 50 channels was the norm at this time.

[00:43:26] Kyle Grieve: Just after two weeks that John Malone had made this bold claim, Bell Atlantic partnered with an operator to offer multiple services such as the ability to transmit hundreds of channels, two way communication, video phone calls, and on demand services. The synergies between telcos and cables were obvious to John.

[00:43:41] Kyle Grieve: Although John knew the telcos didn’t have the experience and the talent of the cable industry mavericks like himself, he realized they did have one very big advantage. Deep pockets. For example, Bell Atlantic was three times the size of TCI. So telcos and the cable businesses began buying each other and joining up.

[00:43:58] Kyle Grieve: But this had some pretty severe second order effects. The common theme that I’ve spoken about today is that of regulations. The already powerful telcos were partnering with the already powerful cable operators. You know what that means. More regulation. In 1993, the Federal Communications Commission, FCC, froze rates on cable in order to rate rollback of up to 10%.

[00:44:19] Kyle Grieve: But as is common in the free market, companies will do whatever is possible to protect their profits. Here’s what Robichaux said about their user experience after these new regulations were introduced. Quote. Many systems created new packaging schemes to avoid regulation. Most have been charging higher rates than the FCC benchmarks would allow for the most popular expanded tiers of service.

[00:44:40] Kyle Grieve: But their prices were far below the FCC limits for basic cable packages. So the cable operators reduced charges for the costlier packages and recouped the money by raising basic cable rates to the cap now set by the law. That shift defied a major goal of the new law to safeguard the affordability of basic TV services for low income people.

[00:44:59] Kyle Grieve: Other cable companies began slicing channels out of the basic lineups and offering them a la carte, for about a dollar each. As a result, customers who wanted the same service as before regulation were now paying more. Unquote. John Malone was very opinionated on this and did not like how much meddling the government was doing in his industry.

[00:45:17] Kyle Grieve: Malone felt the government was pandering to consumers by lowering the price of cable services, by robbing the shareholders of the businesses that paid for the infrastructure of these systems. Robichaux wrote, quote, if they can do this to us, Malone believed, they can do it to other businesses anywhere.

[00:45:32] Kyle Grieve: It’s about the most un-American thing I’ve ever experienced, he told a reporter at the time, unquote. As John got more and more agitated by the hindrance of regulation, he thought a larger move was going to be the best course of action. He began talks with Bell Atlantic. After a long period of haggling with Bell Atlantic’s CEO, Raymond Smith, they finally agreed on a price that made sense for both of them.

[00:45:51] Kyle Grieve: Bell Atlantic would merge with TCI in a deal worth 33 billion. This deal would put John Malone into the crosshairs of regulators once again, as many felt this merger would further cement TCI’s monopoly like power. After the deal was set, John was summoned to defend the merger to the U. S. Senate Antitrust Committee.

[00:46:08] Kyle Grieve: His primary strategy seemed to be to minimize TCI’s apparent power in the eyes of the committee. This reminded me of Monish Pabrai discussing a very interesting point about how monopolies prefer to attempt to stay hidden. Great businesses are all around us. It is not that hard to be able to tell that a business is great.

[00:46:26] Kyle Grieve: That is another point that Peter Thiel makes up in his talk. He says that monopolies go through extreme lengths to convince you that they are not a monopoly. That they exist in very competitive spaces because they know that if they are a monopoly, and beat their chest about it, they will attract unwanted attention.

[00:46:42] Kyle Grieve: Like, Facebook doesn’t really want the U. S. government to think it is a monopoly, and Google doesn’t want anyone to think it is a monopoly. So the monopolies try very hard to convince us, Oh, poor me, I’m not a monopoly. And the loser, 99 percent of comparative businesses go through extreme lengths to convince you that they are a monopoly.

[00:47:00] Kyle Grieve: They try to convince you that, I got the secret sauce, look at me, I am awesome. The monopolies basically are telling you, I am just Joe Public, man. I got nothing going on. Don’t look here, just keep walking. The competitive ones are beating their chest saying, no, come to me. I have this awesome business and let me tell you why.

[00:47:15] Kyle Grieve: Unquote. So I think at the time, TCI was still a good business, but its power was weakening, and John wanted to strategize an exit for him and Bob Agnes. But there were a few problems with the proposed Bell Atlantic TCI merger deal. John started noticing a few things that were causing him concern. For one thing, TCI was optimized for cash flow, Bell Atlantic was optimized for earnings.

[00:47:35] Kyle Grieve: The merger would not do any favors for Bell Atlantic in terms of making the income statement look better. It would make it look worse. Bell Atlantic would dilute its shares as part of the TCI deal. This meant that Bell Atlantic would have 220 million more shares outstanding to buy a business that didn’t earn any profits.

[00:47:51] Kyle Grieve: Meaning that Bell Atlantic’s EPS would decrease. Bell predicted a decrease of around 35 percent in per share earnings. Bell thought TCI shares were worth 20. John Malone thought they were worth 35. Part of the reason for this discrepancy was due to a second round of rate cuts by the FCC, further reducing the cash flows to TCI.

[00:48:09] Kyle Grieve: Here are some of the details of how big of an effect these rate cuts would be on the effects of TCI. Quote. The second round of effects would pinch TCI’s cash flow and hurt its stock price more than Smith or anyone in the cable industry had bargained for. TCI would suspend half of its 1.1 billion capital budget pending clarification of the FCC’s rate rules.

[00:48:30] Kyle Grieve: which sent the stock price of the industry’s major equipment supplier into a free fall. Malone called the additional 7 percent increase a club in the side of the head and figured that the new round of cuts shaved off approximately 1. 8 billion off the original price offered for TCI. Yet, he felt it was wrong to accept it.

[00:48:47] Kyle Grieve: I won’t sell my company at the bottom of the market, Malone told Smith, and you’d be crazy to pay more than top dollar with this level of uncertainty. Unquote. Neither side could make a way for the deal to work, so the merger was called off. The falling apart of this deal had a big impact on John Malone. After the merger was called off, he ceded control of TCI to his second in command, Brandon Clauston.

[00:49:07] Kyle Grieve: Part of the allure of Bell Atlantic merger was that John could focus all of his attention on the things that he loved, strategy and deals, while handing off some of his most hated tasks such as dealing with regulators and public relations to Raymond Smith. He ended up coming into the office less and the media took notice.

[00:49:23] Kyle Grieve: Shareholders were also taking notice at the time. In 1996, the stock hit a 52 week low and shaved 50 percent off its price on TCI’s latest earnings release. This was during a time when TCI increased rates by 13%, lost 70, 000 base subscribers, and 308, 000 pay TV subscribers. To make matters worse, cash flow increased at a disappointing 3 percent growth rate, much lower than investors had expected.

[00:49:47] Kyle Grieve: TCI also had an all-time high that was not held in high regard. They had a total debt of 15 billion dollars and were on a massive spending spree as Clauston attempted to bring TCI into the future a little too quickly. Malone wasn’t happy with these results and took the reins back from Clauston. But it was an uphill battle.

[00:50:04] Kyle Grieve: John first had to remove Clauston from his position of power, a move he did reluctantly. One of Malone’s faults, according to Robichaux, was that he was very loyal. The man he decided to replace him with was Leo Hindery. One of John’s greatest deals was in the making after his good friend and TCI founder Bob Magnus passed away.

[00:50:20] Kyle Grieve: Bob’s sons had control of a large block of Bob’s shares and were not particularly interested in keeping their shares. The problem was that TCI’s shares had recovered somewhat after John came back to be more assertive, but it was still underpriced in John’s view. A raider had come in offering the Magnus sons a 25 percent premium for their 32 million shares.

[00:50:38] Kyle Grieve: A transaction like this would have put the power into someone else’s hands. John would later find out that it was Comcast and Bill Gates who attempted to purchase the shares. But Malone was able to thwart the plan. He could see Microsoft was attempting to move into the cable industry with their Comcast partnership.

[00:50:53] Kyle Grieve: Gates already had monopoly like power in the PC market, and he was coming for the set top market next. John’s strategy was to inform the cable industry about the dangers of giving Microsoft too much power. His rallying cry worked, and during the summer of 1997, Malone and Hindrey would continue improving TCI by lowering expenses and growing simultaneously.

[00:51:12] Kyle Grieve: They did this by quote, allying with other major cable operators to close ranks, swap systems, and take its overall debt leverage down. His top lieutenant, Leo Hendry, built on an idea that Malone had pushed, putting clusters of cable systems, i.e. contiguous cable systems that had a large footprint and that could be operated together at lower cost, together, with rival companies.

[00:51:33] Kyle Grieve: If another cable operator could run a cable system more cheaply than TCI, Malone figured, then let’s make a deal. Hindery quickly set about striking joint ventures with other companies, usually those that had better profit margins and leaner operations. It was a quick and effective way to improve TCI’s wobbly balance sheet and anemic stock price. Unquote.

[00:51:51] Kyle Grieve: This consolidation would result in a massive consolidation of the industry. Hindery said, quote, once there were a hundred of us cable operators, then there were fifty of us, then there were twenty of us, and then there were ten of us, and then there were only six of us, unquote. As for the proposed takeover, John also fixed that.

[00:52:08] Kyle Grieve: During the 14 months that Bob Magnus had passed away, John took TCI’s share price from 10 to 28. He got a deal for the Magnus sons that would add 200 million to their net worth over the Comcast Microsoft deal. John made sure he came on top as well, nearly doubling his voting shares to 40 percent without putting up any of his own money.

[00:52:27] Kyle Grieve: Once the estate problem was dealt with, John would turn his attention back to finding someone who could buy TCI. In the summer of 1998, the cable market was really heating up. The markets were euphoric and the internet craze was approaching its peak. Microsoft was making all sorts of deals with cable companies, and by proxy, TCI’s share price was appreciating.

[00:52:46] Kyle Grieve: By this time, TCI shares were trading around 40, and John Malone was getting a little nervous. John Malone and Leo Hindery knew that Wall Street was running cash flow models that included cash from some of TCI’s interactive products that were still in the production phase. So that meant that, you know, these weren’t guaranteed cash flows.

[00:53:04] Kyle Grieve: And just like John knew a good deal when he saw it, I think he knew a bad deal as well. So I believe he began to see that the timing was going to work out well for TCI shareholders to continue making value accretive moves. And one of those moves would be selling TCI shares to a bidder at an inflated price.

[00:53:19] Kyle Grieve: Malone and Henry settled on AT& T. You’ll recall that the deal with Bell Atlantic fell through a few years earlier, but management had changed and the old guard was being replaced by newer and younger faces. AT& T was offering high speed internet access and had many synergies with TCI. AT& T had a problem that TCI could solve.

[00:53:37] Kyle Grieve: Robichaux writes, quote, AT& T’s biggest weakness? It didn’t own the last mile. The wire going inside each home and business. Only the local phone monopolies had control of the ubiquitous copper wires that linked millions of customers to service providers. To complete a long distance call, for instance, from New York to LA, AT& T had to pay a toll to the local bell at each end, totaling up to 40 percent of what AT& T was able to charge for the call.

[00:54:03] Kyle Grieve: Laying its own new wires would be prohibitively expensive, requiring 100 billion or more by most estimates. AT& T could lease local lines from the Bells and resell local services, but there is no profit in that. A takeover of a big local phone company might help, but it would probably get scuttled in Washington given AT& T’s monopoly past.

[00:54:23] Kyle Grieve: This is a great example of a corner resource that Hamilton Helmer and I discussed on We Study Billionaires episode 600. Hamilton Helmer defines a corner resource as quote, preferential access at attractive terms to a coveted asset that can independently enhance value. Unquote. In TCI’s case, this was their cabling system that was going directly into their customers’ homes.

[00:54:43] Kyle Grieve: Sure, AT&T could have built it out themselves, but that would have been ridiculously expensive. Doing a deal with TCI for the infrastructure that they had built would make a lot of sense, and from a strategic point of view, it would keep them out of Washington’s crosshairs. The deal was struck, and AT&T paid 48.3 billion in cash, stock, and the assumption of debt. AT&T paid a 30 percent premium over the value of shares, 50 dollars and 71 cents. This was an incredible deal. You’ll recall TCI’s share price was in the pits at around 10 dollars per share in 1997, so Malone created nearly 500 percent of value for TCI in two short years.

[00:55:18] Kyle Grieve: Looking back at John’s career at TCI is to examine one of the greatest CEOs to ever do it. It’s hard to see exactly what the results were just for TCI stock. After all, with the use of equity and buybacks, it’s not easy to figure out exactly what TCI shares compounded at. But here’s what we do know, as explained by Robichaux.

[00:55:36] Kyle Grieve: Quote, if an investor bought 100 of TCI stock in 1973, Participated in the spinoffs and splits, mimicking Malone’s trades, he would have 181,200 by late 1999, unquote. If we compound this over John Malone’s career at TCI, he compounded that capital at 33.44 percent annually over those 26 years. Now I’ve spent some time thinking about TCI as an investment during my research process for this episode.

[00:56:03] Kyle Grieve: And even though he had an epic track record, the business was not easy to understand. You couldn’t use traditional quantitative metrics to value the company. You had to implicitly trust Malone’s capital allocation skills. You need to understand the cable industry, its regulations, and how partnerships were playing out.

[00:56:19] Kyle Grieve: The industry was fast paced and exposed to high levels of painful regulation. And you had to contend with chronically high debt levels. The people who would have gotten the most out of TCI stock appreciation were those who put their undying trust into John Malone. Hypothetically speaking, I’m not sure I would have ever invested in TCI.

[00:56:37] Kyle Grieve: The debt load alone would have scared the hell out of me. Additionally, the two big rate cuts from the FCC would have been crippling blows to the intrinsic value of TCI shares. But, if investors had trusted John Malone to overcome those hurdles as he had throughout his career, perhaps they would have stuck around long enough to reap the rewards that John Malone had created.

[00:56:53] Kyle Grieve: I had many takeaways from reading Cable Cowboy and researching John Malone. Here are my six primary ones. One. Much of his ability to create value was based on the fact that he didn’t pay taxes. This was a double edged sword. As it made the income statement look ugly, but also allowed him to spend money, he would have forked over to the government to buy more companies.

[00:57:12] Kyle Grieve: Two. He was willing to part ways with acquisitions if the deal was right. Yes, I like serial acquirers that are permanent owners of subsidiaries. But I think given the industry John was playing in at the time, it made a lot of sense. It allowed him to buy underpriced assets when the industry was going through problems as well as buy back his stock.

[00:57:29] Kyle Grieve: And it allowed him to divest during the more euphoric times when less experienced companies were looking to get a piece of the action. Three. My dislike for highly regulated industries was cemented in my research of John Malone. He despised dealing with it. He made numerous attempts to exit TCI and place a burden of responsibility on the shoulders of others so he wouldn’t have to bother with it.

[00:57:49] Kyle Grieve: Four. John showed how important it was to have a manager who was truly a steward of shareholders capital. He cared deeply about creating value and he properly aligned himself with shareholders by being one of the largest shareholders in both TCI and Liberty Media. Five. John did not care about what Wall Street thought about him and TCI.

[00:58:07] Kyle Grieve: He had to train Wall Street to understand his unique ways of seeing value. Six. He thought long term and made moves that would benefit TCI and Liberty for many years into the future. He headed much of the innovation in the cable industry and wasn’t fearful of dipping his toes into adjacent industries.

[00:58:24] Kyle Grieve: That concludes this episode of the book Cable Cowboy and John Malone. If you’ve read this book or have any thoughts on John Malone, I’d love to hear from you. Feel free to reach out to me on X under the handle @Irrationalmrkts, email me at kyle@theinvestorspodcast.com or look me up on LinkedIn.

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