Accretion/dilution analysis

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Accretion/dilution analysis is a type of M&A financial modelling performed in the pre-deal phase to evaluate the effect of the transaction on shareholder value and to check whether EPS for buying shareholders will increase or decrease post-deal. [1] Generally, shareholders do not prefer dilutive transactions; however, if the deal may generate enough value to become accretive in a reasonable time, a proposed combination is justified.

Shareholder value is a business term, sometimes phrased as shareholder value maximization or as the shareholder value model, which implies that the ultimate measure of a company's success is the extent to which it enriches shareholders. It became popular during the 1980s, and is particularly associated with former CEO of General Electric, Jack Welch.

Earnings per share EPS

Earnings per share (EPS) is the monetary value of earnings per outstanding share of common stock for a company.


Simple example

Pre-deal situation

BuyCo plans to acquire 100% shares of SellCo in a stock-for-stock transaction. [2]

BuyCo has a net income of $300,000 and 100,000 shares outstanding
Market shareprice of BuyCo is $50.0
Pre-deal EPS = $3.0
Pre-deal P/E = 16.7x
SellCo has a net income of $100,000 and 50,000 shares outstanding
Market shareprice of SellCo is $60.0
Pre-deal EPS = $2.0
Pre-deal P/E = 30.0x

The deal

BuyCo agrees to pay a premium for control of 30%, so the offer price for one SellCo share is 1.3*$60.0 = $78.0
Stock-for-stock exchange ratio is $78/$50 = 1.56 of BuyCo shares for one SellCo share
BuyCo issues 1.56*50,000 = 78,000 new shares to exchange them for all the SellCo shares outstanding
Total shares of NewCo = 100,000(pre-deal shares of BuyCo) + 78,000 (new shares) = 178,000 shares
NewCo expected EPS = Total net income/Total shares outstanding = ($300,000+$100,000)/178,000 = $2.25
NewCo expected shareprice = (P/E of BuyCo)*(expected EPS) = 16.7x*$2.25 = $37.45

Post-deal situation

EPS of NewCo falls from $3.0 to $2.25, so the deal is 25% dilutive for BuyCo shareholders
BuyCo shareholders own 100,000/178,000 = 56.18% of NewCo (so they retain control)
SellCo shareholders own 78,000/178,000 = 43.82% of NewCo

Further analysis

A real-life accretion/dilution analysis may be much more complex if the deal is structured as cash-and-stock-for-stock, if preferred shares and dilutive instruments are involved, if debt and transaction fees are substantial, and so on. Generally, if the buying company has a higher P/E multiple than that of the target, the deal is likely to be accretive. The reverse is true for a dilutive transaction.

See also

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