“Today, I would rather prep for a colonoscopy than issue Berkshire shares,” writes Warren Buffett in his latest letter to Berkshire Hathaway (BRK-A, BRK-B) shareholders.
But back in the day, Buffett didn’t have such an aversion to giving away shares of the company in exchange for parts of other companies.
And one deal in particular cost Buffett and Berkshire Hathaway shareholders $6 billion.
In return, they got nothing.
“I earlier described our gradual shift from a company obtaining most of its gains from investment activities to one that grows in value by owning businesses,” Buffett writes.
“Launching that transition, we took baby steps — making small acquisitions whose impact on Berkshire’s profits was dwarfed by our gains from marketable securities. Despite that cautious approach, I made one particularly egregious error, acquiring Dexter Shoe for $434 million in 1993. Dexter’s value promptly went to zero. The story gets worse: I used stock for the purchase, giving the sellers 25,203 shares of Berkshire that at year-end 2016 were worth more than $6 billion.” (Emphasis added.)
Of course, like all mistakes, this provided Buffett with a learning opportunity. And the lesson here was simple: pay for acquisitions with cash, not stock. This whole lesson, however, wasn’t digested by Buffett overnight. And soon after the Dexter debacle, Buffett again cost himself — and shareholders — money by way of dilution.
Here’s Buffett:
That wreck was followed by three key happenings — two positive, one negative — that set us firmly on our present course. At the beginning of 1996, we acquired the half of GEICO we didn’t already own, a cash transaction that changed our holding from a portfolio investment into a wholly-owned operating business. GEICO, with its almost unlimited potential, quickly became the centerpiece around which we built what I believe is now the world’s premier property/casualty business.
Unfortunately, I followed the GEICO purchase by foolishly using Berkshire stock — a boatload of stock — to buy General Reinsurance in late 1998. After some early problems, General Re has become a fine insurance operation that we prize. It was, nevertheless, a terrible mistake on my part to issue 272,200 shares of Berkshire in buying General Re, an act that increased our outstanding shares by a whopping 21.8%. My error caused Berkshire shareholders to give far more than they received (a practice that — despite the Biblical endorsement — is far from blessed when you are buying businesses).
Early in 2000, I atoned for that folly by buying 76% (since grown to 90%) of MidAmerican Energy, a brilliantly-managed utility business that has delivered us many large opportunities to make profitable and socially-useful investments. The MidAmerican cash purchase — I was learning — firmly launched us on our present course of (1) continuing to build our insurance operation; (2) energetically acquiring large and diversified non-insurance businesses and (3) largely making our deals from internally-generated cash. (Today, I would rather prep for a colonoscopy than issue Berkshire shares.)
Now, given its huge insurance operations and the cash those businesses throw back to the parent company, Berkshire has the unique ability to be able to pay cash for most any business it would want to acquire. Certainly not every manager is going to have that same luxury.
But Buffett’s experience here outlines one of the first concepts that anyone learns in the world of corporate finance — how to fund your business and acquisitions.
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Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland
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