Accretion/dilution analysis

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.

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

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.

References

External links

• THE IMPACT OF EPS ACCRETION AND DILUTION ON STOCK PRICES
• Valuation of a P&C Company
• Example of A/D Analysis

Corporate finance and investment banking Capital structure Convertible debt Exchangeable debt Mezzanine debt Pari passu Preferred equity Second lien debt Senior debt Senior secured debt Shareholder loan Stock Subordinated debt Warrant Transactions (terms / conditions) Equity offerings At-the-market offering Book building Bookrunner Corporate spin-off Equity carve-out Follow-on offering Greenshoe Reverse Initial public offering Private placement Public offering Rights issue Seasoned equity offering Secondary market offering Underwriting Mergers and acquisitions Buy side Control premium Demerger Divestment Drag-along right Management due diligence Pitch book Pre-emption right Proxy fight Sell side Shareholder rights plan Special situation Squeeze out Staggered board of directors Super-majority amendment Tag-along right Takeover Reverse Tender offer Leverage Debt restructuring Debtor-in-possession financing Financial sponsor Leveraged buyout Leveraged recapitalization High-yield debt Private equity Project finance Valuation Accretion/dilution analysis Adjusted present value Associate company Business valuation Cost of capital Weighted average Discounted cash flow Economic Value Added Enterprise value Fairness opinion Financial modeling Free cash flow Market value added Minority interest Modigliani–Miller theorem Net present value Pure play Real options Residual income Stock valuation Tax shield Terminal value Valuation using multiples List of investment banks Outline of finance