Capital Cities' capital coupNovember 21, 2012: 11:46 AM ET
Wall Street cheered as the 16th-largest communications company prepared to swallow ABC. The outfit that will run the combined operation is famously lean, but its cost-cutting bosses know how and when to spend - and how to motivate managers.
By Stratford P. Sherman
This story is from the April 15, 1985 issue of Fortune. It is the full text of an article excerpted in Tap Dancing to Work: Warren Buffett on Practically Everything, 1966-2012, a Fortune Magazine book, collected and expanded by Carol Loomis.
FORTUNE -- When Capital Cities Communications, a medium-size New York company, worked out a $3.5-billion takeover of giant American Broadcasting Cos., Wall Street paid a rare tribute. Usually only the target company's stock price rises, impelled by whatever premium the purchaser offers. This time ABC's share price skipped up 42% to $106 within a week, and Capital Cities stock moved up too, rising 22% in the same period to $215 a share.
The market's thundering approval denotes an almost reverential confidence in the management of Capital Cities, which will run the surviving company from midtown Manhattan offices with a view of St. Patrick's Cathedral. Chief Executive Thomas S. Murphy, 59, is balding, cheerful, and famed for his cost-cutting propensities and hands-off management. President Daniel B. Burke, 56, is more intense but philosophically much like his boss. They have been described by an awestruck subordinate as ''one of the greatest Mutt and Jeff acts in business today.''
Under Murphy and Burke, Capital Cities has turned in an exceptional performance in its principal businesses: broadcasting, which produced 51% of the company's 1984 operating profits, and publishing (48%). Without much show of effort, Capital Cities' per-share earnings growth since 1974 has averaged 22% annually, compounded. Return on shareholders' equity, a key measure of performance, averaged a splendid 19.2% during the period. In addition to seven TV stations (four ABC-affiliated) and 12 radio stations, Cap Cities has publishing interests ranging from the Kansas City Star Co. to such medical journals as Aches & Pains.
Leonard H. Goldenson, the magisterial chairman of ABC, has shown his admiration for Murphy and Burke by entrusting them with the $3.7-billion-a-year TV, radio, and publishing empire that he has ruled with ferocious independence for over 30 years. ABC, which is more profitable than CBS or NBC despite a recent plunge to third place in prime-time audience ratings, has been beset by suitors for decades. At 79, Goldenson is determined to protect the company he created -- ''in perpetuity,'' as he puts it. He negotiated a deal that security analysts regard as highly favorable to ABC's shareholders.
Warren E. Buffett, 54, chairman and 41% owner of Berkshire Hathaway (BRKA), a wonderfully successful Omaha conglomerate with a large investment portfolio, says of Murphy, his friend for almost 20 years: ''I think he is the top manager in the U.S.'' No slouch as a manager himself, Buffett has placed a substantial part of his future in Murphy's hands. Berkshire helped bring off the friendly acquisition by agreeing to buy about 18% of the merged company, Capital Cities/ABC Inc., for $518 million. That stake should provide a buffer between the surviving company and would-be acquirers. Buffett expects to make good money on the deal, and to get in on it he agreed to sell his holdings in such media companies as the Washington Post Co. (WPO) and Time Inc. (publisher of Fortune) if he's required to by the Federal Communications Commission, which must approve the takeover. More extraordinary, Buffett agreed to vote with management for 11 years -- on condition that either Murphy or Burke be in charge -- and accepted severe limitations on his freedom to buy and sell the stock.
In Buffett's admiring phrase, Murphy and Burke are ''models of pleasant rationality'' who know how to motivate managers without often brandishing bludgeons or setting specific financial goals. Their low-key management style, grounded in decentralization and cost control, is imbued with the notion that each manager has the confidence of superiors, and is expected to realize his or her full potential. ''They implore us,'' says one newspaper publisher, ''they don't give us mandates.'' Adds general manager Kenneth M. Johnson of Cap Cities' KTRK-TV in Houston: ''We have the opportunity to run our properties the way they should be run.'' Nonconformity seems to work. The stations enjoy pretax profit margins as high as an estimated 70% of sales, compared with a broadcasting industry average of 34%.
Murphy sometimes carries decentralization a long way. When in 1961 he hired Burke to replace him as general manager of the company's first TV station, in Albany, New York, Murphy spent only an hour introducing Burke around before returning to his own New York City office. Fresh from General Foods' Jell-O division, where he was head of new product development, Burke knew little about broadcasting. He sent off weekly memos to Murphy, many of them containing questions about important operating matters. It was weeks before Burke heard from Murphy. Says Burke, ''He just expected me to take care of things.''
The great exception to the local-autonomy principle is a rigorous annual budgeting process that Burke personally oversees. The company isn't miserly -- executives sometimes fly first class, and capital expenditures last year amounted to $54 million -- but when Burke spots waste he doesn't hesitate to intervene. Recalling one such intervention, Phillip J. Meek, publisher of the Fort Worth Star-Telegram, says: ''The guys here still haven't forgotten his steely blue eyes.''
Cap Cities hires good people regardless of background -- Meek came from Ford Motor Co. (F) -- and keeps them. Few key executives have ever been fired, and many have served the company for 20 years or more. Colleagues claim that Murphy finds happiness feeding other people's egos instead of his own. He regards his job as managing the shareholders' assets; he concentrates on acquisitions and leaves operating decisions to Burke. Managers who perform well get praise, high salaries, and stock options. The result is an enduringly entrepreneurial enterprise. Cap Cities' stock has appreciated at an average rate of around 23% a year since the company went public in 1957. Burke and Murphy don't stint on themselves. Thanks to profits from stock options, Burke's total take in 1983 amounted to $4.3 million, while his boss reaped $6 million, putting them among the best-paid U.S. executives.
Murphy, who grew up in Brooklyn, is the son of a New York State supreme court judge and a mother who always told him he was perfect. He attended a Jesuit high school and got a degree in mechanical engineering at Cornell. After Navy service he applied to Harvard Business School, but was rejected. He worked a year as an oil salesman for Texaco, finally got accepted by Harvard, and stayed near the top of his class. ''They scared the death out of me,'' he explains. Murphy's favorite course was called Control.
After graduation in 1947, he worked in advertising and then for Lever Bros. as a brand manager (Chlorodent toothpaste and Dove soap) before joining Capital Cities in 1954. ''His greatest intellectual gift is simplification,'' says James E. Burke, chairman of Johnson & Johnson (JNJ). He is Dan Burke's older brother and a business school classmate of Murphy. Asked recently to describe the network-TV business he is about to enter, Murphy offered one word: ''Competitive.''
The Burkes grew up near Albany, New York, sons of a New York Life Insurance Co. manager. Their mother, a Wellesley graduate, encouraged stimulating dinnertime conversations. ''Dan was the brightest in the family,'' says his brother. Of the close-knit pair that runs Cap Cities, Jim Burke says, ''They don't have failure in them. They're conquerors.''
The conquerors' cost-cutting reputation is getting close attention at ABC, which has never matched Cap Cities' operating efficiency. Many of the network's employees fear that they'll soon be living lower on the hog. Plenty of heads may roll. ''Obviously there is some concern,'' says one middle manager. ''I, for example, may be out of a job.'' But the deal isn't likely to close for perhaps another year. Murphy says that once it does, Frederick S. Pierce, 53, Goldenson's No. 2 for the last two years, will run ABC autonomously, reporting to Burke. Presumably the arrangement will last as long as Pierce gets results. He has shown himself to be tough. Some employees fear that Pierce, with his ego bruised by Goldenson's decision not to pass him the reins of an independent ABC, will throw himself into the new cost-control era with threatening gusto.
Some security analysts have said the merger won't reduce Capital Cities/ABC's per-share earnings even temporarily, but Murphy cautions, ''We'll have to see what the earnings are.'' His chief financial officer predicts some dilution the first year. Earnings per share will be hit by additional shares issued to Buffett, and in two other ways as well. Even with Buffett's $518 million, and after selling roughly $1 billion of what Murphy calls ''offending assets'' under FCC rules (such as TV stations whose signals overlap with those of others owned by the company), Cap Cities will have to borrow $2 billion from banks. That means big interest costs. There'll also be large charge-offs for what accountants call goodwill -- the difference between ABC's net tangible assets and the purchase price. The charge-offs could amount to $50 million a year. But Warren Buffett says: ''It's a damn good deal. The company will do very well.'' Wall Street obviously agrees.