Case study #2 - Henry Singleton and Teledyne Inc.These case studies are to show how a CEO produces incredible returns for its shareholders by allocating capital in a logical fashion.
Remember that there are only five ways capital can be allocated:
- Reinvest in the Company
- Make acquisitions
- Pay down debt
- Buy back stock
- Pay a dividend
There are no other choices than the above five and the CEO’s will produce radically different returns for investors depending on how and when they allocate capital.
In the first case study, I examined the incredible results that were achieved by a company that intelligently grew by acquisition.
This second case study will be divided into two parts. The first part will be growth by acquisition, also done in an intelligent fashion. The second part will touch upon a different capital allocation category that produced even more radical returns for investors.
I hope you enjoy!
Case study #2: Teledyne Inc. Teledyne was co-founded by Henry Singleton in 1961. He was the CEO and the brains behind the Company.
Singleton attended MIT and earned his bachelor’s, master’s, and PhD degrees in electrical engineering. He never studied finance or business.
In 1939, he won the Putnam medal as the top mathematics student in the U.S. Singleton was an avid chess player and was 100 points shy of the grandmaster level.
After graduating from MIT, Singleton worked for Hughes Aircraft, founded by Howard Hughes, as an engineer.
Litton Industries then hired Singleton away from Hughes Aircraft. This was a brilliant move on the part of Litton as Singleton invented the inertial guidance system – still in use today – for commercial and military aircraft.
In the late 1950’s, Singleton was promoted to General Manager and had aspirations for the CEO role. Over the next few years it became clear to him that he would never attain this position with Litton and so he left the Company in 1960 and co-founded Teledyne and became CEO.
In 1961, Teledyne went public.
Conglomerates In the 1960’s, the conglomerate business model - a company that owns a lot of unrelated businesses – was very popular. It was the fad of the decade and like with all other fads, it ended poorly for the majority of them. Today, investors dislike conglomerates as they are inefficient, not pure plays, have too many pieces, etc. but in they were really in back then.
In a nutshell, the conglomerate model was:
Use your higher multiple stock as currency to make an acquisition of a target company that has a lower multiple stock than your own - causing the new earnings generated from the acquisition to trade at your own higher multiple thereby increasing your stock price – then buy another lower multiple company using your higher priced stock as currency and keep repeating over and over.
The math used by conglomerates was the following:
Earnings Shares EPS P/E Stock
Conglomerate $100M 100M $1.00 25 $25
Target Company $10M 10M $1.00 8 $8
Now let’s say the conglomerate purchases the target for $10 per share – a 25% premium over the targets stock price. It would cost the conglomerate $100M and would be paid by issuing 4M shares at $25 each. Below is the result:
Earnings Shares EPS P/E Stock
Conglomerate $110M 104M $1.06 25 $26.50
Conglomerates would buy dozens and dozens of companies using the above strategy. Using this strategy, conglomerates could increase EPS every year irrespective of how well the businesses did for them – or so they thought. Wall Street loved this and the investors kept bidding up the prices of the conglomerates higher and higher allowing conglomerates to issue more and more stock, at higher prices, for more and more acquisitions.
The quality of the businesses acquired, were poor and as you guessed, it all ended very badly for the vast majority of conglomerates. If you don’t buy quality, it will bite you in the behind. In the late 1960’s, the biggest conglomerates like Litton Industries, ITT, etc. started to miss earnings estimates and the industry and their stock prices got killed. Investors lost a bundle.
Some conglomerates were top quality – Teledyne, Berkshire Hathaway – but most ended in disaster.
TLV’s Law You will do well as an investor if you abide by TLV’s law that states:
- Always buy good assets with a competitive advantage
- Never overpay
- Own for long periods of time
- Never make any exceptions to the above (if there is nothing to buy then don’t buy simply because you have cash – wait for a good opportunity)
Part 1 Teledyne Between 1961 and 1969, Henry Singleton – CEO of Teledyne – acquired 130 companies in various industries such as industrial products and services, insurance, specialty metals, electronics, aviation, and consumer items.
Unlike other conglomerate CEO’s who simply bought whatever they could, Singleton only bought companies that were profitable and growing, with leading market positions and usually in niche markets.
He avoided turnarounds and said “we specialize in high-margin products that are sold by the ounce, not the ton”.
Singleton was a very disciplined buyer, never paying more than 12X earnings and bought most companies at much lower multiples. He always paid in stock, which was the correct move as his tock had a P/E that ranged between 20 – 50 in the 1960’s.
In 1969, Singleton became the first conglomerate CEO to stop buying companies. The reason? Acquisition prices were rising and his stock’s P/E was falling. It no longer made sense for him to make acquisitions and pay in stock.
And then in 1971, Henry Singleton did something rather amazing: he got rid of his entire acquisition team.
How good was Singleton’s acquisition strategy?
Acquisition strategy results 1961 1971 Change
Sales $4.5M $1.1B +2,344%
Earnings $0.1M $32M +31,900%
EPS $0.13 $8.55 +6,477%
Shares 0.4M 6.6M +1,550%
Incredible results!
While the shares outstanding increased by 1,550%, the EPS increased by 6,477%. If you were a shareholder you did not mind Singleton issuing stock for acquisitions.
Singleton emphasized extreme decentralization in the management of these business units. H drove accountability and managerial responsibility as far down into the organization as possible.
Singleton focused on optimizing free cash flow and not earnings. He quickly improved margins and radically reduced working capital at Teledyne’s operations, which generated significant cash.
Singleton had a consistently high ROA of over 20% throughout the 1970’s and 1980’s. Charlie Munger said: “Singleton is miles higher than anybody else, utterly ridiculous”.
With all of this, cash rose dramatically for Teledyne.
Part 2 Teledyne – stock buyback years In 1972, Teledyne’s stock got way too cheap and so Singleton thought that buying it back would create more shareholder value than paying a large dividend.
From 1972 and continuing for the next 12 years to 1984, Singleton bought back his stock in a
big way.
He has been called the Babe Ruth of the stock buyback.
Prior to Singleton using the stock buyback tool as a way to create value for shareholders, stock buybacks were very rarely done and were regarded as a sign of weakness by Wall Street.
Singleton preferred the Substantial Issuer Bid (SIB) tool as opposed to the Normal Course Issuer Bid (NCIB) we more commonly see.
In 8 separate tenders from 1972 – 1984, Singleton bought back almost
90% of all of Teledyne stock.
What effect did the stock buybacks have on Teledyne’s stock prices between 1972 – 1984? The stock
compounded at a rate of
42%. This number is so big that it is absurd!
To put it in perspective, at 42% your money doubles every 1.7 years.
This was kept up for a period of 12 years!
Yes, shareholders were very happy to have learned about stock buybacks.
The strategy was very successful because Teledyne’s stock was very cheap and the Company was able to continue to increase revenues and earnings.
The average P/E that Singleton used his stock as currency for acquisitions was >25.
The average P/E that Singleton used to buy back his stock was <8.
Stock buyback results 1971 1984 Change
Sales $1.1B $3.5B +218%
Earnings $32M $261M +708%
EPS $8.55 $353.34 +4,033%
Shares 6.6M 0.9M - 86%
The above earnings per share of $353.34 in 1984 takes into account the increase in earnings and the effect of the stock buybacks.
We need to split the two to see what was the effect of the stock buybacks alone.
Had Singleton not bought back any stock at all, Teledyne’s EPS in 1984 would have been $39.54 ($261M / 6.6M).
So the stock buybacks were responsible for $313.80 in EPS. Incredible!
Stated another way, you have a company that in a 12-year span, grew its sales by 218% (this is 10.1% compounded per year), grew its earnings by 708% (this is 19.1% compounded per year), grew its EPS by 4,033% (this is 36.4% compounded per year)
and 88.8% of all of the growth in EPS came
solely from stock buybacks!
Stock buybacks alone were responsible for the stock compounding at 37.3% a year for 12 years and the other 4.7% in the yearly compounding of the stock (remember the stock compounded this 12 year period at a rate of 42%) is explained by Teledyne’s operating businesses increasing their profits.
Stock buybacks, when purchased below intrinsic value, do phenomenal things to shareholder value.
This is why I keep saying GH should be buying back its stock instead of paying a dividend.
Today, GH stock is trading at a discount of 37% - 45% to intrinsic value.
Why is GH paying a dividend and not buying back its stock, via an SIB, in a very big way?
I cannot rationally answer this question. It just makes no sense!
Two approaches to stock buybacks There really are two approaches to buying back stock:
These days it is very common for companies to buy back stock but virtually all of the time the NCIB is used.
This is more of a hindrance in creating value that anything else. I say this because the NCIB has some severe limitations. You have to state in advance the percentage of stock you want to buy, but are not obligated to do so, per 12-month period, such as 5% or 10% (most companies do 5%, surprise surprise).
Then based on your average daily weighted number of shares traded over a prior period, a daily maximum is calculated and is based on 25% of the daily weighted number of shares purchased. There are ways to buy more than the average daily weighted number but you get the picture.
Most companies come out with a yearly NCIB (some actually buy back stock and some don’t). It comes out in a press release. It looks good to investors and it sounds good when the CEO says they are returning capital to shareholders by having this NCIB.
However, it is only good to use an NCIB is the Company is buying back its stock below its intrinsic value. Remember, you create shareholder value when you buy back stock below intrinsic value but you
destroy shareholder value when you buy back stock above intrinsic value.
Example:
Assume that Jane and Frank each have $2.00 in their pocket:
If Jane buys an item that is worth $1.25 for $1.00 she then has $1.00 left in her pocket.
If Frank buys the same item that is still worth $1.25 but pays $1.50 he only has $0.50 left in his pocket.
Jane gets richer and Frank gets poorer.
It works the same way with stock buybacks.
Let’s take GH as an example. GH is worth $12.50 – $14.29.
If GH buys back stock below this level, shareholders get richer.
It is a serious blunder for GH not to be buying back its stock
in a big way when it is trading at this steep of a discount to intrinsic value. Dividends can be paid later when the stock if fairly valued.
Gigantic mistake!
The other approach to buying back stock is through a SIB. This is the approach that I prefer much more as it is more meaningful and has a big impact on a Company’s stock price
immediately and over time.
This is the approach that Henry Singleton always used. This approach features less frequent but much larger purchases
and they are timed to coincide with low stock prices and are funded by cash on hand or debt.
Singleton did this 8 times in 12-years including one time when he repurchased 20% of Teledyne’s stock in one shot.
Yes, you bet this makes a difference in your stock price. The premium Singleton paid to Teledyne’s closing stock price was always between 20% and 26%.
If GH where to make an SIB at say $9.00, more sellers would take advantage of this than you think and a huge number of shares would be retired.
Currently GH is paying out over $8M a year in dividends (at $0.36 / share).
Instead, GH should do an $8M SIB at $9.00.
Better use of funds. GH would be buying what is worth $12.50 - $14.29 for $9.00.
Shareholders get richer.
Next year, do the same, shareholders get richer, rinse and repeat.
The perpetual undervaluation that GH has been suffering from for many, many years, would disappear as the free cash flow per share would rise significantly and the market would give a premium to GH stock.
Henry Singleton and Teledyne have demonstrated the power of the stock buyback in creating shareholder value when purchase below intrinsic value.
In 1980, Warren Buffett said that Singleton “has the best operating and capital deployment record in American business”.
If this does not convince GH shareholders that the Company should be buying back its stock in a big way at these very undervalued prices instead of paying a dividend, I don’t know that will.
If GH were to do something similar, all shareholders would get very, very wealthy.
We need a SIB for GH.