A deal is accretive if the buyer's EPS after the deal is higher than before, and dilutive if lower. Boards and analysts look at it closely, so every banker must be able to build it.
Pause and write. When something clicks, pause and put it in your own words in My notes.
| Buyer | Target | |
|---|---|---|
| Net income | 1,000 | 200 |
| Shares outstanding | 500 | n/a |
| EPS | $2.00 | n/a |
| Share price | $30 | n/a |
| P/E | 15.0x | 12.0x at the purchase price |
| Purchase price | 2,400 |
The buyer issues 2,400 / $30 = 80 new shares.
Rule: an all-share deal is accretive when the buyer's P/E is higher than the P/E paid for the target. Here 15x is above 12x.
Rule: a debt-financed deal is accretive when the target's earnings yield (200 / 2,400 = 8.3%) exceeds the after-tax cost of debt (4.5%).
Pre-tax synergies of 40 are 30 after tax. In the all-share case, EPS becomes 1,230 / 580 = $2.12, accretive by 6.0%.
Amortization of acquired intangibles; lost interest income on cash used; financing fees; one-time integration costs (usually shown separately); the timing of synergies; and new shares from the target's options.
In the all-share case with no synergies, the buyer can pay up to 15x the target's earnings, or 3,000, before the deal turns dilutive.
The buyer contributes 1,000 / 1,200 = 83.3% of combined earnings and its shareholders own 500 / 580 = 86.2% of the combined company. The split of ownership against the split of earnings, revenue and EBITDA shows who is getting the better side of a share deal.
A company with a high P/E can make any low-P/E acquisition accretive, even at a price far above what the target is worth. Debt-financed deals look accretive because debt is cheap, while the added risk to shareholders is ignored. The right test remains: does the present value of the target plus synergies exceed the price paid? Accretion is a constraint boards watch; NPV is the measure of value.
After a debt-financed deal, compute combined debt/EBITDA and interest coverage and consider the effect on the credit rating.
Using the module's set-up (buyer net income 1,000, 500 shares at $30; target net income 200; price 2,400), the buyer pays 1,200 in cash borrowed at 6% and 1,200 in shares.
As expected, the mixed deal sits between the all-share (3.4%) and all-cash (9.2%) results.
The buyer revalues the target's assets. Identified intangibles, such as customer relationships and technology, are amortized, which reduces reported earnings. If 400 of intangibles are amortized over 10 years, pre-tax earnings fall 40 a year (30 after tax). In the all-share case, pro forma EPS becomes (1,200 minus 30) / 580 = $2.02, accretion of only 0.9%. Inventory written up to fair value also raises cost of sales in the first months after closing.
Because acquisition amortization is non-cash and arises only from the deal, many companies and analysts present 'cash EPS' that adds it back. It is a reasonable view of ongoing earnings, but the amortized intangibles were paid for in real money; the price, not the accounting, is what matters for value.
In the all-share case, the target's shareholders own 80 / 580 = 13.8% of the combined company. If the target's shareholders would own more than about half, the deal is effectively a reverse takeover, and governance terms (board seats, headquarters, chief executive) become as contested as price.
In the all-cash case, the buyer adds 2,400 of debt. If its EBITDA plus the target's is 2,000, leverage rises by 1.2x. A rating agency may downgrade it unless management commits to paying down debt or issuing equity, and the cost of all its debt may rise. Boards look at pro forma ratings alongside accretion.
Build a one-page accretion and dilution model with inputs for both companies' net income and share counts, the buyer's share price, the purchase price, the cash and share mix, the interest rate, the tax rate and synergies. Reproduce the three results above, then produce a table of accretion for cash percentages of 0%, 50% and 100% against synergies of 0, 40 and 80.
Educational content only; not investment, tax or legal advice. Companies, tickers and figures are illustrative examples, not recommendations. Rules, rates and limits change, so check current details with the regulator, exchange or tax authority before relying on them. Worked examples are not forecasts. Written by Elizabeta Dimoska. RiskStock is not a registered dealer or adviser.