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Warren Buffett's $11 Billion Mistake
"As a financial disaster, [Berkshire Hathaway's purchase of Dexter Shoe Co.] deserves a spot in the Guinness Book of World Records."
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Over the weekend — basking in the calm before Monday’s 13F storm — I hit a few garage sales. As I voraciously dug through boxes and boxes of junk, I stumbled upon a blast from Berkshire Hathaway’s past.
Don’t be fooled by Warren Buffett’s self-deprecating style. The man does not make many mistakes. His batting average would be the envy of anyone enshrined in Cooperstown.
But Buffett isn’t perfect, either.
And, in his long and illustrious investing career, one of those mistakes looms a bit larger — and cost A LOT more — than the others…
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On September 30, 1993, Berkshire Hathaway announced the $433 million purchase of privately-held Dexter Shoe Co.
Nothing too surprising on the face of it. Warren Buffett had recently acquired two other leading footwear brands — H.H. Brown (1991) and Lowell Shoe (1992).
What was surprising, though, was that the notoriously tight-fisted Buffett — especially when it came to shares of Berkshire itself — agreed to part with a boatload of precious company stock in order to complete the deal.
Because of the immense run-up in Berkshire’s share price over the ensuing three decades, a deal meant to be worth $433 million has instead cost the company over $11 billion — and counting.
This debacle all started when Frank Rooney, CEO of H.H. Brown, put a bug in Buffett’s ear about highly-profitable Dexter Shoe. That ill-fated recommendation led Buffett to reach out to the Maine shoemaker (owned by Harold Alfond) about possibly joining the Berkshire family.
“We went to a little restaurant based on a World War II theme, had a hamburger, and talked about shoes,” Buffett told Forbes in 1994. In typical style, the Berkshire chief made a cash offer for Dexter right there on the spot.
But Alfond, also part-owner of the Boston Red Sox, drove a hard bargain and demanded Berkshire stock instead of the offered cash. Largely because he didn’t want to see up to one-third of his potential windfall disappear into the tax man’s pocket.
Buffett agreed to Alfond’s request and the two men shook hands on the deal.
The Dexter Shoe founder received 25,203 shares of Berkshire Hathaway — a 2% stake in the company that made the Alfond family the second-largest shareholders behind the Buffetts themselves.
And, while Dexter has become something of a four-letter word in Berkshire circles, it’s easy to see why Buffett was so drawn to the company in the first place:
Dexter was America’s largest independently-owned shoe company — with a focus on “New England casual” footwear in the mold of Lands’ End or L.L. Bean.
In 1993, Dexter produced 7.5 million of these middle-class shoes. Durable. Reliable. Not flashy. In other words, pure Berkshire.
The company had no debt.
Higher margins (and lower advertising costs) than its competitors.
Much like H.H. Brown, Dexter defied the trend of outsourcing manufacturing to overseas factories — producing about 65% of its shoes in the state of Maine. The company sought to offset increased labor costs with more efficient, state-of-the-art production equipment.
For these reasons and more, Buffett wasn’t just willing to part with Berkshire stock to bring Dexter Shoe into the fold — he was downright ebullient to do so.
Don’t take my word for it.
He said as much in his 1993 letter to shareholders:
Dexter, I can assure you, needs no fixing: It is one of the best-managed companies Charlie [Munger] and I have seen in our business lifetimes.
Five years ago, we had no thought of getting into shoes. Now we have 7,200 employees in that industry, and I sing “There’s No Business Like Shoe Business” as I drive to work.
He later gushed to Forbes, “At Dexter, they do everything right.”
Narrator: Dexter did not, in fact, do everything right.
Cracks started to appear in the company’s gleaming facade almost immediately.
Profits fell precipitously in 1995 and, despite a slight reversal in fortune the following year, Dexter’s arrow remained firmly pointing down for the rest of the decade.
Buffett and Berkshire tried everything to arrest Dexter’s slide, but its fatal flaw was a simple one: the company’s insistence on domestic manufacturing left Dexter awash in a sea of red ink.
The warm fuzzies of buying “Made in the U.S.A.” typically only last until consumers see the price tag. (That’s not my preference, but simply observing the world as it is.)
By 1999, around 93% of shoes bought in the United States were manufactured overseas. As everyone else successfully reaped the benefits of cheap foreign labor, Dexter’s once-mighty moat evaporated in the blink of an eye.
Buffett all but admitted defeat in 2000:
We try … to keep our estimates conservative and to focus on industries where business surprises are unlikely to wreak havoc on owners. Even so, we make many mistakes: I’m the fellow, remember, who thought he understood the future economics of trading stamps, textiles, shoes, and second-tier department stores.
In 2001, the Dexter story reached its sad conclusion: the company’s Maine factory was shut down and the rest of Dexter was absorbed into H.H. Brown.
A post-mortem of sorts came in 2007:
To date, Dexter is the worst deal that I’ve made. But I’ll make more mistakes in the future — you can 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.”
And in 2014:
The most gruesome [mistake] was Dexter Shoe. When we purchased the company in 1993, it had a terrific record and in no way looked like a cigar butt. Its competitive strengths, however, were soon to evaporate because of foreign competition. And I simply didn’t see that coming.
Consequently, Berkshire paid $433 million for Dexter and, rather promptly, its value went to zero. GAAP accounting, however, doesn’t come close to recording the magnitude of my error. The fact is that I gave Berkshire stock to the sellers of Dexter rather than cash, and the shares I used for the purchase are now worth about $5.7 billion. As a financial disaster, this one deserves a spot in the Guinness Book of World Records.
Of course, that was then and this is now: those 25,203 shares of Berkshire Hathaway have ballooned in current value to over $11.4 billion.
And that’s really the crux of it: Buffett not only bought a company that would soon prove worthless, but he paid for it with an asset that won't stop growing — making this deal look worse and worse with each passing year.
What makes Warren Buffett such an incredible investor, though, is that he doesn’t allow missteps like Dexter Shoe to cloud his judgment. He quickly internalizes the lesson — don’t use Berkshire stock to make acquisitions unless you’re really sure of the company’s long-term prospects — and moves on.
And he’s not afraid to get back on the horse and try again.
If Buffett had sworn off this type of deal altogether after Dexter, he would not have been able to buy BNSF Railway in 2010. The railroad has since become a major cash cow for Berkshire and ranks among Buffett’s crown jewels.
Lessons learned, but no permanent scars.
Buffett’s openness about his own failures, too, provides an excellent example for the millions of individual investors who hang on his every word.
“There’s so much corporate financial reporting where people don’t mention their mistakes,” he told Jason Zweig in 2018, “that I think it’s a good idea to remind the shareholders that we do make them.”
“On average, I think people beat themselves up too much over their mistakes. I don’t think it’s that productive.”
That’s what this little, not-so-happy trip down memory lane is all about. Learning from the mistakes of others so that we don’t make them ourselves.
To paraphrase the immortal words of Frasier Crane — it may be an unwise man who doesn’t learn from his own mistakes, but it’s a damn fool who doesn’t learn from the mistakes of others.
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Disclosure: This is not financial advice. I am not a financial advisor. Do your own research before making any investment decisions.