Monday, November 19, 2012

Buffett on Teledyne's Henry Singleton

From this recent CNBC interview with Warren Buffett:

"...we mostly buy stocks for future earnings. And if they use the money to...repurchase shares like Henry Singleton did with Teledyne years ago, that could be even more advantageous."

Earlier this year, Singleton's approach with Teledyne (now Teledyne Technologies: TDY) was summarized in this Bloomberg article:

"...Henry Singleton, made acquisitions using the company's stock when its price was high. When the share price went down, Singleton bought back shares repeatedly."

The article not only mentions the 23 percent annual return that Singleton's skilled management and capital deployment produced over two decades, it also mentions a letter that Buffett wrote to Leon Cooperman congratulating him for his analysis of the stock.
(Cooperman liked the stock in 1968 before it went on to produce those impressive returns. That letter is apparently framed and displayed in his office.)

According to John Train's book The Money Masters, Buffett once said the following about Singleton:

"Henry Singleton of Teledyne has the best operating and capital deployment record in American business."

Another good excerpt from Train's book:

"According to Buffett, if one took the top 100 business school graduates and made a composite of their triumphs, their record would not be as good as that of Singleton, who incidentally was trained as a scientist, not an MBA. The failure of business schools to study men like Singleton is a crime, he says. Instead, they insist on holding up as models executives cut from a McKinsey & Company cookie cutter."

In the CNBC interview, Buffett used IBM [IBM] as a recent example of effective share repurchases.

"IBM [IBM] spent 3 billion in each quarter this year, almost to the dollar, buying in stock. The cheaper they buy it, the more our interest goes up."

Buffett wouldn't be supportive of those IBM buybacks unless he thought the shares were worth intrinsically more.

Now, Henry Singleton wasn't just smart about buying back Teledyne's shares when cheap.

He was also rather savvy about using the company's stock, when pricey, as a currency for acquisitions. If a company's stock selling at 40, 50, or 60 times earnings* is used as a currency to acquire generally sound businesses selling at low earnings multiples, good things seem likely to happen over the long haul.

So intelligent and disciplined buybacks (repurchasing shares when selling for less than per share intrinsic value) is only part of the story.

Unfortunately, Singleton's way of allocating capital isn't always easy to find. Some companies buy back their stock with too little consideration with how the market price compares to value. They'll buy shares when expensive or, at least, not cheap. Worse yet, some later end up even selling shares at lower prices out of necessity.**
(Making an already less than optimal situation for shareholders only worse.)

Singleton used Teledyne's expensive stock to buy other businesses when they were selling at attractive valuations. He'd also buy pieces of businesses -- shares of common stock -- when cheap instead of paying a premium valuation to gain control of an entire public company via a tender offer.  Some other corporate leaders might be willing to pursue that kind of expensive growth.

Not Henry Singleton.

From this 1979 Forbes article on Henry Singleton:

"American business is still gripped with a mania for bigness. Companies whose stocks sell for five times earnings will think nothing of going out and paying 10 or 15 times earnings for a nice big acquisition when they could tender for their own stock at half the price. Shrinking -- √† la Teledyne -- still isn't done except by a handful of shrewd entrepreneurial companies."

Sounds familiar. That was 1979 but I don't think the dynamics have changed much, if at all, these days. For long-term shareholders, it's increases to per share value, not the total size of the enterprise, that matters.

Why pay a premium valuation to own a company outright when small pieces are selling at attractive valuations?  Why pay a premium valuation, for something likely less well understood, if Teledyne's own stock -- the enterprise Singleton would understand best -- was cheap?

To fund expensive acquisitions, companies do forgo the chance to own pieces of a business -- including their own company's shares -- that sell at a low multiple of earnings and, more importantly, nicely below intrinsic value. Instead of buying what's plainly cheap, they figure out a way to justify the premium required to gain control of the target company, often for "strategic" reasons. As is obvious from the excerpt in the Forbes article, a 2 to 3 times higher multiple of earnings wasn't enough to prevent this sort of behavior.***

The justification may sound compelling and, at times, actually even make sense. Unfortunately, too often the premium does not make sense for shareholders.

With disciplined capital deployment, Singleton was able to increase long-term shareholder returns meaningfully. You'd think this way of thinking would become more commonplace. It certainly wasn't the norm during his time. It basically still isn't now.

Mistakes were made along the way, of course, but anyone interested in understanding effective capital allocation and deployment can learn a lot from Singleton's approach.

Plenty of useful lessons that too few business executives or market participants seem to fully appreciate.

Advantage to those who do.

Singleton also didn't mind portfolio concentration and stuck to buying businesses he understood well.

In fact, his approach seems not at all unlike Warren Buffett's way of thinking in a number of ways.


Related posts:
Why Buffett Wants IBM's Shares "To Languish"
Buffett: When it's Advisable for a Company to Repurchase Shares
The Best Use of Corporate Cash
Buffett on Stock Buybacks - Part II
Buffett on Stock Buybacks
Buy a Stock...Hope the Price Drops?

Related articles:
The singular Henry Singleton
The Brain Behind Teledyne, A Great American Capitalist

* See page 48 of this Forbes article.
** For a buyback to make sense, not only does the stock need to sell nicely below estimated per share intrinsic value, the company itself needs to also be in a comfortable financial position and have a stable business. (Ideally with predictable and easy to understand sustainable competitive advantages.)  Stock shouldn't be bought back if the action could leave the company vulnerable to costly dilution during an economic downturn or a crisis.  A company forced to sell shares extremely cheap (its weakened financial position brought on by buying expensive stock when capital seemed easy to come by) may end up diluting continuing shareholders in a way that's quite expensive. Using up capital to buyback expensive shares may also prevent the company from being on offense when the opportunity to buy back cheap shares eventually arises.
*** It's not that certain businesses aren't worth a slight premium. Occasionally, they certainly can be. So some, of course, are worth a bit of a premium valuation but too often there are extreme premiums paid and questionable justifications made. The premium paid might be portrayed as a way to enhance per share value but, in fact, is more about growth of the "business empire" with per share value creation an afterthought. It's some variation of growth for growth's sake. The kind of growth that ends up being expensive or, at least, less than optimal for long-term shareholder returns.
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