John Malone, one of the eight CEOs mentioned in my post about the Outsiders book, is featured in Cable Cowboy, a book that tries to describe how he built his cable empire and, in the process, compounded the stock of his cable company TCI by an astounding 30.3% per year for over 25 years.

Written by Mark Robichaux, a Wall Street journalist who covered several of Malone’s deals over the years, the book provides some behind-the-scenes color around his myriad cable and content deals.

But it does not, at least to my satisfaction, explain exactly what did Malone did that was so different from other CEOs.  He was clearly very smart and well educated – he graduated from Yale University with a B.A. in Electrical Engineering and Economics as a Phi Beta Kappa and National Merit scholar, and obtained an M.S in Electrical Engineering from an NYU program at Bell Labs as well as a Ph.D. in Operations Research from Johns Hopkins.

And the book describes how Malone learned about cable directly from some of its early pioneers. He was clearly good at financial engineering and pioneered many of the techniques used by private equity firms today (aggressive use of debt leverage). He could do this because he was early in realizing that cable revenues were reliably recurring, like a utility (but unregulated!), so it could be used to raise a lot of debt inexpensively. He also systematically maximized the tax benefits of financing his cable assets in this manner. I think he may have been somewhat lucky to not get wiped out at various points in his career while operating with a high level of leverage.

But beyond these operational strengths, I think he was particularly good at multiplying value via his deal-making. He was perpetually buying and selling various cable and content assets but its not obvious how all that wheeling and dealing actually creates value.

An analogy struck me while reading about some of his deals: the concept of trading small advantages in chess.

Lets say you start with a pawn sacrifice in the opening to get a move advantage. As time passes, unless one plays forcefully, this temporal advantage can quickly dissipate. So good players often convert this into a positional advantage if the opportunity presents itself. Positional advantage is more structural and hence robust. Later in the end-game it can, in turn, be converted into another kind of advantage – a passed pawn or perhaps a sacrifice to get an attack on the opponent’s king, etc. Thus there is a constant trading of advantages, from transient to permanent ones, depending upon the board situation. And a skilled player can usually translate this kind of trading of small advantages into a win.

I get the sense that Malone was very good at doing something equivalent in his business deals.

Using his deep knowledge of the cable industry, he could sense when a cable asset became available at an attractive price. He had a good sense of the intrinsic value of the cash-flows of cable assets. He would opportunistically buy such a mispriced asset even if it was not what he ultimately wanted (e.g. not in a region where he was building a roll-up of cable assets). Just like in chess you collect a small advantage when you can, even when its not a mating attack on the opposite king. You do that to get something to trade with.

Then he would patiently wait, sometimes for years, before an opportunity came to sell this asset, which would usually have appreciated by then (since he bought it when it was distressed). He would use the cash from this sale to then turn around and buy an asset that he really wanted all along. Or buy back shares in TCI if they were undervalued.

Thus he avoided overpaying for premium assets – the downfall of many of his competitors who were pursuing so-called “strategic M&A”on the advice of their investment bankers.

An example of his patience was evident in how he waited to but content assets (programming) until he had enough scale from his rolling up a bunch of regional cable providers. Once he had enough scale in cable distribution, he was in a strong negotiating position to acquire content assets on favorable terms.

And, since he could distribute the content to more subscribers than his competition, he was able to net more cash flow from his content assets. He would then leverage this additional cash-flow by raising more debt and buying more cable subscribers. And so on. This kind of virtuous cycle (more subscribers -> more content -> more subscribers) with increasing returns to scale can indeed explain compounded returns of 30% per year for more than two decades.

He was able to get to this point by systematically trading one advantageous deal into another, like a master chess player, thus multiplying overall value (in other words, by multiplying what economists call gains from trade).

The book triumphantly ends by describing how he is crowned his career by finally selling TCI to AT&T, once again opportunistically, when he judged that they were paying an attractive price for it.

And then he is supposed to have retired. 

Except he did not!

I think Malone is still playing this game, only this time in Europe, even in his seventies!

A company he chairs and controls, Liberty Global, is well along the way to owning a cable franchise that dominates Europe. There are significant economies of scale in doing so in such a dense and contiguous geographical area – just think of a cable truck being able to efficiently serve neighboring regions vs. one that services installations scattered all over the map.

And yet Liberty Global also owns some assets in Chile, completely disconnected from Europe! This fact was puzzling me when I was initially analyzing the company until the chess analogy came to mind. I now suspect Malone bought the Chilean cable opportunistically, when they were available for cheap, knowing full well that he will trade them later for what he really wanted – assets in the dense areas of Europe.

Indeed, recently the Liberty CEO is now talking about selling the Chilean cable assets and is in the process of buying more cable in Netherlands that is contiguous with their other European cable units.

In another repeat of the TCI playbook, Liberty Global is only now going about acquiring content in Europe. They have begun by making some small investments recently (e.g. a small position in ITV), but clearly waited until they had rolled up enough distribution muscle before they did so. At this point they are already the largest cable company (by number of subscribers) in Europe and thus clearly can get very attractive terms from any content producer there. And just like TCI, they can then monetize the acquired content better than others since they have the largest number of subscribers.

As Yogi Berra said, its deja vu all over again.

 

Disclosure: I am long Liberty Global (LBTYA) in various personal and professional portfolios.