Contents . Accretion Dilu in 101 (Template Included) What is accraton! aon? 0 2019-04-22 (/2019/04/22/aceretion-aiution-101/) Intodution How to calculate accretion! tion Intraductian.. Exploring EPS aceration ston ‘Aceh pak. Buljon was one ofthe most cfcut finance concepts for me to understand when Iwas starting out Ironigalel 8.92 ofthe simplest. | thnk the jargon can make it intimidating at fst, Med Cash & Stock Deale “Thimasisianll leche he eengyehabageretion/alution -how to caluat t and when / why its used in ‘freA Fia SRNEaP Srapsnee What'is'aceretion T'dilution? Accretion | lution means: How much wil same per-share financial metric change as a result ofa transaction? ‘That's i. Generally, i's used to evaluate the projected change in EPS (Earnings Per Share) resuting from a ‘merger of acquisition But its not exclusive to EPS - the concept can be applied to any per-share financial metric. For example, when evaluating MLP mergers, you might look a the projected accretion / elution for LP distrbutons. Why per-share metrics only? Well discuss below. How to calculate accretion / dilution EPS Accretion | (Dilution) = (Pro Forma EPS - Standalone EPS) / Standalone EPS Here's quick exam) ‘Standalone FY 2020E EPS: 1.00 ro Forma FY 20208 EPS: 1.25, EPS Accretion / (Dilton) = (1.25 - 1.00) 1.00 EPS Accretion / (Dilution) = 0.25 1.00 ‘8, the proposed transaction is 25% accretive, and we're projecting @ 0.28 increase in FY2020E EPS. ‘Since the PF EPS is greater than the standalone EPS, the deals accretive, Ifthe PF EPS is lower than the standalone EPS, the deal would be dllutive, Here's an example: ‘Standalone FY 2020E EPS: 1.00 Pro Forma FY 20206 EPS: 0.98,EPS Accretion / (Dilton) = (0.98 - 1.00), 1.00 EPS Accretion / (Dilution) = 0.02 / 1.00 So, the proposed transaction is 2% dilutive Remember, accretive is positve and dilutve is negative. Quick Review - Jargon Finance jargon can be overwhelming at fst, but youl see the same elements pop up over and over. Here's a Quick review: ‘© FY 20208 - FY is the abbreviation for fiscal year. A company's fscal year can be cifferent from the standard calendar year (1/1 - 12/81). Furthermore, the E alter 2020 just means “Estimated” since we're working with estimated financials fr fiscal year 2020, © Pro Forma - That's Latin for as it.” You often seeit abbreviated as “PF.” When evaluating a potential transaction, the financial forecasts are Pro Forma, as ihe transaction had occurred, Exploring EPS accretion / dilution We've shown how to caloulate EPS accretion /cllution above. Below are some of the factors that influence EPS: ‘accration / dilution in an acquisiven: © Target company earnings © Synergies © Cost to realize synergies (synergies aren’ treo!) «© Acquisiton offer (how much was paid, and what form: cash vs. stock) «© Deal financing (as applicable) We've put together an EPS accretion / ition template (niipssmutipleexpansion,comvlexcellaccretion-dilution- 4101.xlsx) that you can use to explore these concepts and the scenarios below. All-Stock Deal ‘This is one of the hypotheticals that always used to rip me up. Ignaring synergi you know ithe deal is accretive? in an altstock deal, how do It depends on two factors: 1. Target PIE multiple (using the offer price per share) 2. Acquitor PIE multiple If company A (20x PIE multiple) purchases company B (10x P/E multiple) in an all-stock transaction, the deal wil be accretive. The more expensive stock is buying the less expensive stock. Here's another way to tink about ‘© 20x PIE mutiple means 5% Earrings / Share yield © 10x PIE multiple means 10% Eamings / Share yield «© Ifyou issue 8 5% bond to purchase a 10% bond, the interest income from the 10% bond will more than ‘outwoigh the 5% interest expense you owe. © Inthis case, company Ais the 5% bond (since company Ais issuing shares as merger consideration), and ‘company Bis the 10% bond (ts shares trade ata higher eamings yield).All-Cash Deal In an altcash deal, the acquiror pays the target's shareholders 100% cash (no stock). The acquiror has to get that cash from somewhere. They have a few options: 1, Excess balance sheet cash (e.g. Apple) 2. Raise debt 3, Raise equity (and pay target's shareholders with cash proceeds) For simplicily, we're going o assume option 2 (Raise debt). In ths case, understanding the accretion | lation is simple: is the acquired earnings yield >the tax effected interest rate from the acquisition debt? Here's an example: Company Ais buying company B for 25.00 per share. Company B has projected EPS of .50 and 100 shares, Company A finances the transaction with debt issued at 9%. Company B has 3 10x PIE multiple, or 10% earnings yield. Company Ais issuing debt at 5% pretax (~3.5% posttax). The transaction is clearly accretive. Company A wll receive extra net income equal to 162.5 = 25,00 offer price x 100 shares x (10% earnings yield - 3.5% postax interes rate) To calculate tne exact accretion we need to know Company As share count and EPS, Assuming Company A has 200 shares and projected EPS of 3.00, the deal s quite accretive: 162.5 extra net income / 200 shares = 0.8125 extra EPS. 0.8125 / 2.00 =27% accretive Mixed Cash & Stock Deals Use the attached template (hitps:simutipleexpansion,comvexcel/accretion-liution-101 xlsx) to explore how the different variables impact accretion / dilution. Play around with the following assumptions: 2% Premium © Consideration mix (% Stock /% Cash) «© Interest rate on acquisition debt © Synergies «Target & acquitor projected EPS. Why do people care about accretion / dilution? This s the more complicated part ofthe story. Let's start with another question: When evaluating a potential acquisition, what metrics / analyses are most important? Everything below is a good answer: 1. Valuation of target company / asset (are you paying less than the value you're receiving?) 2, PF leverage / capital structure 3, PF combined financials /eamings “There are other aspects we're leaving out that are also important -and that’s parly why evaluating acquisitions isso dificul. A merger or acquisition is @ complex problem, ané you need to examine il from diferent angles, hich can sometimes tell contradictory stories.Let's go back through the list of relevant analyses above. 1. Valuation of targot company - tis is arguably the hardest piece. Valuation is a notoriously trcky beast with lots of variables and hidden assumptions. Skiled finance professionals can make @ DCF tell any story they wish. While other valuation methodologies (e.g. public comparables and precedent ‘tansactions) ae a bit less numerically subjective, there's sill ample wiggle room: Which public comparables do we select? Which, if any prior deals are relevant? 2. PF loverage / capital structure - this isthe simplest piace. In most cases, leverage / capital structure is ‘a constraint. The financing tail generally does not wag the acquisition dog. Below are a couple examples: © The acquiror doesn't want its red rating downgraded, soitcan only raise $Xmm in debt and must fund the rest ofthe transaction with equity. © Tho acquiror’s outstanding dobt has covenants that provent the acquror from raising adltional dobl. Tho ‘acquiror must use equity 3. PF combined financials - what s the projected fnancial profile ofthe company? What synergias isthe ‘acquiror predicting, and what's the cost to realize those synergies? “There's a lotto look a, And tha's one ofthe main reasons why people lke EPS accretion /alluion, All-in-one Deal Snapshot Remember: EPS = Net Income / Fully Diluted Shares Outstanding © Not Income includes the effect of any capital stucture change (interest expense), synergies, cost to realize synergies, and tha eamings of the acquired company. «© Diluted shares outstanding incude any stock offered as merger consideration ‘Thus, EPS accretion / lution can serve as an Lin-one snapshot ofa transaction’s financial impact. I you believe that 1. Management's financial projections (including synergies) are materially accurate and 2. The PF company willirade tthe exact same PIE multiple 2s before ‘Then, any accretive deal will eave shareholders beter off (the stock will rade ata higher price) Disclaimer “That's an oversimpltication, but itis the basic logic behind EPS accretion / dilution. Let's examine these _assumplions and some ofthe ways things ean ga wrong: © Project ‘somewhat wrong. The macroeconomic environment can change, a business unit can unexpectedly financials - Even when management has the best intentions, projections are always dectine, or maybe the acquitor just does a bad job forecasting the target's (or their own) financials © PIE Multiple - While many stocks trade on P/E multiples, many also trade on EV / EBITDA, or a bland of the two. Some trade based on revenue. And some trade purely on hype. Ifa company’s stock price trades ‘on EV / EBITDA, then EPS snot as relevant. Likewise, for a material transaction, i's rare that the trading ‘multiple would remain constant. The market will reac; the mutiple will change. > Accrotive, but overpay - I's very possible for one company to acquire another company in an accretive deal, and overpay. EPS accretion is usually a necessary, but never sufficient, condition for a good deal © Bad strategy -A company acquires another company for the financial rationale (tre deals accretive), but the acquisition is a poor strategic bat ‘So EPS accretion can serve as a financial snapshot, but you shouldn't rely on it as your sole guide.When is accretion / dilution most important? [As you've probably gathered, accretion /luion is mast important fer public companies. Private companies rarely need to worry about per-share metrics, such as EPS. They often have heavily concentrated ownership and owners who are directly represented on the board of directors. Public companies face a diferent set of conditions: «© Diffuse shareholder ownership ‘> Agency problems (most shareholders nat directly represented on the board) © Public quarterly financial results © Constant performance measuring stick: company stock price \When undergoing a material merger / acquistion, management teams of public companies face a lt of extra stress navigating these conditions. ‘© They must communicate to shareholders why the deal is a good use of shareholder capital vs, returning capital to shareholders & organic initiatives) ‘> They must sell the public markets onthe deal (equity research analysts, major investors, and press) Even f the management team and the board are convinced a deals good, they wil face severe displeasure if the stock price tanks folowing a deal announcement. These days, a poorly recelved acquisition and lackluster ‘earnings are an invitation for activist investors (a.k.a. an extremely persistent migraine. For these reasons, EPS accretion is often an essential metic for communicating a deal to the public marke. Its an easy data point that management can refer ton order to show shareholders why a deal makes sense - why itleaves them better off. Well make more money for each of your shares, so your shares will be more valuable, NEWER Asi Fels Cases too Financial Model ((2019104/28/adding-cases-to-fnancial-model/) OLDER ney 180 ((2018/04/23/easy- bo!) Copyright © 2024 Mutpleéxpsrslon com. A RightsReserved. | ABOU about) | Library (Nay) | Privacy Ply (prvacy) | Terms of Servic (ors)