Warren Buffett (Trades, Portfolio) has been a vocal critic of companies that issue stock, either for stock options or to acquire competitors, for a long time.
He has said that on most occasions, companies that issue stock are defrauding existing investors because they usually overpay and think of the funds as free money.
One of the only deals Buffett has completed using Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial)'s stock rather than cash was the conglomerate's acquisition of Dexter Shoe. The Oracle of Omaha has since declared this to be one of his worst deals of all time.
Berkshire's worst deal
In 1993, Berkshire paid $433 million for the Maine-based company. Rather than using cash, Buffett paid in Berkshire class-A stock. However, by 2001, the company was on its knees, and Buffett took the difficult decision to fold it into what was left into its H.H. Brown Shoe Group unit.
Commenting on this transaction in his 2007 letter to shareholders, Buffett wrote:
"What I had assessed as durable competitive advantage vanished within a few years ... By using Berkshire stock, I compounded this error hugely. That move made the cost to Berkshire shareholders not $400 million, but rather $3.5 billion. In essence, I gave away 1.6% of a wonderful business -- one now valued at $220 billion -- to buy a worthless business."
But Dexter isn't the only company Berkshire paid for in shares. According to a transcript of the 1995 Berkshire annual meeting, Buffett also stuck his neck out to buy Helzberg's Diamonds with stock rather than cash.
The Helzberg's Transaction
According to Buffet, Barnett Helzberg, a longtime shareholder of Berkshire, approached Buffett to discuss selling his business in 1994. The owner had been thinking about selling his business started by his father in 1950 and wanted it to go to a thoughtful owner. As Buffett explained:
"But probably, in some part because of his background as Berkshire shareholder, he had some specific interest in the company becoming associated with Berkshire. He cared very much about the company having a permanent home. He cared very much about it having an environment in which it could grow and be run autonomously and be based in Kansas City. And he wanted to receive something in exchange — that he was happy to own for the rest of his life."
Buffett was attracted to the business due to its high levels of productivity and customer service as well as employee morale. At the 1995 meeting he explained:
"It is — in its position in the jewelry industry, it tends to compete with a Zales or Gordon's, but it does a far, far better job. Their sales, per store, on roughly equivalent square footage, will be very close to double what competitors achieve. It's got a magnificent morale and organizational structure. And the people — Barnett was very generous with people in making the sale. He took it out of his own pocket to treat people right because they'd done such a terrific job over the years."
The CEO of Berkshire went on to say that Helzberg wanted to be paid in Berkshire stock rather than cash for his business. Buffett was so impressed, he was willing to make this trade-off.
As he explained, "If we had not been able to use common stock, we would not have made this transaction, because Barnett has been in no hurry to write a large check to the government. And we can help him in that respect with a common stock deal."
So that's why Buffett was willing to violate one of his most prominent rules of doing business. He saw an attractive opportunity with an owner who was ready to sell, but not willing to write a huge tax check. So far, this deal has turned out to be a lucrative one for Berkshire's investors.
Disclosure: The author owns shares in Berkshire Hathaway.
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