American cable company Tele-Communications Inc. (TCI) never turned a profit … not even in the industry’s heyday in the 1970s. Yet, it was acquired by AT&T in 1998 for $48 billion, making it one of the largest media mergers in history at the time. The compound annual return to TCI shareholders after the acquisition was an incredible 30.3%, as compared to 20.4% for its peers in the industry and 14.3% for the S&P 500 over the same time period.
But this unprofitability was a mirage. TCI was endlessly cash generative throughout its entire life. There’s an old finance nut that goes “cash flow is a fact, profit is an opinion.” This is perhaps never more true than with TCI’s longterm CEO John Malone, who took it to its logical extreme.
John Malone was born in Connecticut in 1941. From a young age, Malone had a knack for mechanical engineering, coupled with an entrepreneurial spirit. He made his pocket money selling used radios that he refurbished himself. Fittingly, Malone pursued a combined degree in economics and electrical engineering from Yale. He also earned a masters and PhD in operations research from Johns Hopkins. Malone’s formal education cemented in him a quantitative bent, which would prove critical to his leadership of TCI.
Malone started his career at AT&T’s respected research arm, Bell Labs, in 1963. His job was to study optimal strategies in monopoly markets and make recommendations accordingly. Malone’s analysis led him to conclude that AT&T should borrow more and repurchase its shares, unorthodox advice for the time. The advice was delivered to AT&T’s board … and then promptly ignored.
Malone quickly became disillusioned with the bureaucratic culture at AT&T, and he grappled with a lingering sense of mediocrity. In 1968, Malone quit for a job at McKinsey & Company, which planned to start a special department for technology companies. At McKinsey, Malone found himself working on the problems of Fortune 500 companies, taking them apart just like he did radios as a teenager. This helped Malone understand why big corporations didn’t work.
One of Malone’s clients, General Instrument, was having trouble with their latest acquisition, Jerrold Electronics, a company which built and financed cable systems for potential owners. While studying Jerrold for his client, Malone paid attention to the cable industry for the first time. He found a number of things about the industry very interesting. Malone noticed the highly predictable revenues that providers enjoyed, because subscribers paid monthly fees and rarely disconnected. There was also little competition because cable franchises essentially granted companies the right to a local monopoly. The industry also enjoyed favourable tax characteristics: operators could shelter their cash flow by using debt to expand and then aggressively depreciate the costs of construction. Once depreciation ran out, they could sell the asset to another operator, at which point the depreciation clock on the same assets would reset. Last but definitely not least, cable was having a moment. Malone learnt that subscriber numbers had increased over twentyfold in the decade from the 60s to the 70s, with no sign of slowing down. A growing industry seemed like a good place to be.
When Malone presented a plan to the client to turn Jerrold around, they offered him a job as CEO. Malone accepted. He then proceeded to clean Jerrold up. To reduce manufacturing costs, Malone shifted assembly from Philadelphia to Mexico and started sourcing raw materials from Asia. He also always bought at scale, driving prices down even further. To increase cash flow, Malone devised a new system called key account management, where he and two other executives would personally check-in on the customers who owed them money.
Malone was by all accounts General Instrument’s rising star. However, he also knew that the board would never make him CEO of t ...
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