Cash vs. Stock Acquisitions

Yesterday morning, it was reported that computer maker Dell will purchase information-technology company Perot Systems for $3.9 billion in cash. Buffett has always strongly preferred cash over stock acquisitions. In fact, he says his worst mistake was the stock acquisition of Dexter, a shoe business.

“From the economic standpoint of the acquiring company, the worst deal of all is a stock-for-stock acquisition. Here, a huge price is often paid without there being any step-up in the tax basis of either the stock of the acquiree or its assets. If the acquired entity is subsequently sold, its owner may owe a large capital gains tax (at a 35% or greater rate), even though the sale may truly be producing a major economic loss”
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Warren Buffett, 1999 Letter to Berkshire Hathaway Shareholders

"Finally, I made an even worse mistake when I said “yes” to Dexter, a shoe business I bought in 1993 for $433 million in Berkshire stock (25,203 shares of A). What I had assessed as durable competitive advantage vanished within a few years. But that’s just the beginning: 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.

To date, Dexter is the worst deal that I’ve made. But I’ll make more mistakes in the future – youcan bet on that. A line from Bobby Bare’s country song explains what too often happens with acquisitions: “I’ve never gone to bed with an ugly woman, but I’ve sure woke up with a few.”
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Warren Buffett, 2007 Letter to Berkshire Hathaway Shareholders