What Is Accretion/Dilution Analysis?
Accretion/dilution analysis compares the acquirer's standalone EPS to its pro forma EPS after completing an acquisition. If pro forma EPS is higher, the deal is accretive. If lower, the deal is dilutive.
The Intuition
When a company acquires another, it gains the target's earnings but must fund the acquisition. If funded with cash, the acquirer loses interest income. If funded with stock, new shares are issued, diluting existing shareholders. If funded with debt, interest expense increases. The question is whether the target's earnings contribution outweighs these costs.
How to Calculate
Start with the acquirer's standalone net income and EPS. Calculate the target's contribution: its net income, adjusted for synergies and transaction costs. Calculate acquisition costs: lost interest on cash (after tax), new interest on debt (after tax), or new shares issued. Pro Forma Net Income = Acquirer NI + Target NI + Synergies - Transaction Costs - Incremental Interest (net of tax). Divide by pro forma diluted shares.
The Quick P/E Test
For an all-stock deal, compare P/E ratios. If the acquirer's P/E is higher (trades at a premium), the deal tends to be accretive — the acquirer uses expensive currency to buy cheaper earnings. For cash or debt deals, compare the target's earnings yield to the after-tax financing cost.
Synergies and Breakeven
Bankers calculate breakeven synergies needed to make a dilutive deal accretive. This tells the board: 'the deal is dilutive by $X per share, but $Y in synergies would make it accretive.'
Limitations
Accretion/dilution is a short-term, accounting-based metric that does not necessarily indicate long-term value creation. A dilutive deal acquiring a high-growth platform may create substantial value over time. An accretive deal using cheap debt to buy a declining business may destroy value.
In Practice
This analysis is included in virtually every M&A pitch book and fairness opinion. Boards take it seriously because analysts immediately calculate accretion/dilution when a deal is announced. Meaningfully dilutive deals without compelling rationale face shareholder pushback.