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