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29 Feb Accretion-Dilution Analysis for Mergers and Acquisitions

All-too-often proposed acquisitions are consummated without determining whether the combination of the two entities would create synergies (be accretive) or create a decrease in overall Earnings Per Share (i.e. dilutive). An accretive-dilutive analysis for a merger or an acquisition is best simplified by asking the following question?

Will the combined EPS be greater than the historical EPS of the acquirer pre-merger?

If yes, then the M&A event is accretive and a transaction is positive. An accretion/dilution analysis is key in determining whether an acquisition makes financial sense for the buyer. Stakeholders, and investors in particular, are unlikely to have complete buy-in if an acquisition is found to be dilutive.

When analyzing a proposed transaction for its potential for accretion and/or dilution, the following simple steps are helpful:

a. Estimate a pro-forma Net Income for the combined entity, including conservatively realistic synergies

Historical financials can help here, but there will be some guessing when it comes to estimating future income. One of the best ways to do this is to:

  1. Estimate combined income, include realistic synergies
  2. Subtract interest expense
  3. Subtract taxes
  4. If the deal is financed through an acquisition loan, then the interest expense will need to be increased pro-rata

b. Determine the new share amount for the combined entity

If the deal is all cash, the share total stays the same as no new shares will be issued. If the deal is part cash and part stock, the newly issued stock will need to be added to the shares outstanding for purposes of calculating the total number of shares.

c. Calculate pro-forma EPS

Simply divide the net income estimate calculated in (a) above by the total number of shares calculated in (b). Put simply:
Pro-forma EPS = Pro-forma Net Income / Total Number of Outstanding Shares

d. Calculate the buyer’s stand-alone earnings per share

This is done in the same manner without including any additional shares or boosts in net income.

e. Compare the buyer’s stand alone EPS to the calculated, combined pro-forma EPS

Simply put, if the pro-forma EPS is higher, the transaction is accretive by the delta. If the EPS is lower, then the transaction is dilutive, again by the delta between the two.

This is an oversimplification of a process that often requires the coverage of multiple years of pro-forma calculations.

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