In making an all-stock deal for TD Ameritrade, Charles Schwab just broke one of Berkshire Hathaway chairman and CEO Warren Buffett's biggest rules about acquisitions: Never give your own shares away.
If a company is in a position to buy a rival, it's probably in better shape than the target is, and that means its stock is worth more of a premium, Buffett wrote in 1997. Paying cash helps the acquirer avoid giving away the appreciation of its existing business to holders of the company getting bought out, which, if you're doing it right, is larger than the gain likely to come from the acquisition, he wrote.
News of the Schwab and LVMH deals hit just as a new edition of the Buffett book is hitting the stands. And the headlines underscore how timely Buffett's advice remains for corporate titans. The 89-year old has long been known in his personal life for being a bit of a miser, eating McDonald's for breakfast and living in the same modest home in Omaha for decades. When it comes to spending a company's cash or stock, in acquisitions or otherwise, his grip on his wallet is no more loose.
That's because the long-term synergies that would result from the combination of the similar businesses — which should reach into billions of dollars — would have required a much higher cash premium in a deal. A stock deal allows shareholders to benefit from those synergies — albeit always uncertain in the initial estimation on deal date — that can accrue over time.
Too many acquirers think their kiss alone will turn a toad of a company into a prince, Buffett wrote in a witty 1981 letter. It rarely happens. That leads to Buffett's most famous rule of acquisitions: It's better to buy a good company at a fair price than a fair company at a good price, an idea he explained in 1992.
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