The Accretion/Dilution Formula, Explained
The question
What is the accretion/dilution formula, and what changes between a cash-financed deal and a stock-financed deal in the pro forma share count and pro forma net income?
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The answer
Pro forma diluted EPS equals combined pro forma net income divided by pro forma diluted shares outstanding, and accretion or dilution is that pro forma EPS divided by the acquirer’s standalone EPS, minus one. In a cash-financed deal, the pro forma share count does not change; it remains just the acquirer’s standalone diluted shares. What changes is the pro forma net income.
That line now subtracts incremental interest expense on any new acquisition debt and also subtracts, net of tax, the interest income the acquirer loses on cash used to fund the deal. In a stock-financed deal, the pro forma share count increases by the new shares issued as consideration, so the denominator goes up. Pro forma net income, however, picks up no new financing cost.
The synergies and the incremental depreciation and amortization from the purchase price allocation hit net income the same way in both structures; what differs is the financing drag. So the trade-off is share dilution versus P&L drag from financing costs.
Accretion / dilution
| Acquirer standalone net income | 300 |
| + Target net income | 80 |
| + After-tax synergies | 15 |
| − After-tax incremental interest | (10) |
| Pro forma combined net income | 385 |
| Acquirer standalone EPS | $3.00 |
| Pro forma share count | 125 |
| Pro forma EPS | $3.08 |
| Accretion | 2.7% |
Also asked as
- Name the six stages of building a merger model in order, and explain why each stage depends on the one before it.
- Walk through how you compute the equity purchase price for a public target, including why the treasury stock method must be re-run at the offer price rather than the current price.
- Acquirer standalone EPS is $4.00 on 250M shares. It pays $600M all cash for a target with $60M of net income, funded from cash earning 2.5% pre-tax, tax rate 25%, ignore PPA. Compute pro forma EPS and the accretion/dilution percentage.
- Explain the reciprocal P/E rule for an all-stock, no-synergy deal, and then explain how introducing cash/debt financing changes the comparison from 'target P/E vs acquirer P/E' to 'target earnings yield vs after-tax cost of financing.'
- Why do models typically phase in synergies over two to three years rather than assuming the full run-rate amount in year one, and what year-one distortions would result from ignoring the phase-in?
- Explain why accretion/dilution is not the same thing as value creation, and describe at least two ways a deal can be accretive to EPS while still destroying shareholder value.
- Acquirer trades at 18x earnings and funds an all-stock acquisition of a target trading at 11x earnings, no synergies. Separately, compute whether an all-cash deal funded with debt at 6% pre-tax (25% tax rate) would be more or less accretive than the stock deal, and explain the intuition for the difference.
- Purchase price $2.5B, target existing debt of $300M must be refinanced, fees $50M. Financing: $800M cash, $1.2B new debt, remainder in stock at a $40 acquirer share price. (a) Solve for the stock component and shares issued. (b) If the board caps pro forma Net Debt/EBITDA at 3.5x, and pro forma EBITDA (combined plus $50M run-rate synergies) is $900M, does this financing plan satisfy the constraint given acquirer standalone net debt of $1.4B?
- A deal shows +9% year-one EPS accretion driven mostly by cheap acquisition debt (5% pre-tax) against a target earnings yield of 9%. Rates subsequently rise and the debt must be refinanced in year four at 8.5% pre-tax. Explain, with the underlying math, why the deal's accretion profile is at risk, and what you would have flagged to the board at signing to pre-empt this.
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The rest of this topic
Accretion and dilution