What is accretion/dilution analysis?

Accretion/dilution analysis measures whether an M&A transaction increases (accretive) or decreases (dilutive) the acquirer's earnings per share. It compares pro forma EPS after the deal to standalone EPS. A deal is accretive if pro forma EPS is higher, dilutive if lower.

Expected Time

1-2 minutes

Difficulty

Medium

Frequency

Very Common

Why Interviewers Ask This

This analysis is one of the most important outputs of M&A transaction analysis. Public company acquirers care deeply about EPS impact because it affects their stock price and shareholder perception. Understanding accretion/dilution shows you grasp how deals create or destroy value from a shareholder perspective.

How to Structure Your Answer

Define accretion and dilution, explain why it matters, walk through the key drivers, and mention how different deal structures (cash vs. stock) affect the analysis.

Key Points to Cover

Accretive = pro forma EPS > standalone EPS
Dilutive = pro forma EPS < standalone EPS
Cash deals: Compare interest cost of debt to target's earnings
Stock deals: Compare target's P/E to acquirer's P/E
Key drivers: Purchase price, synergies, financing mix, relative valuations
Rule of thumb: Acquire companies with lower P/E for accretion

Sample Answer

Accretion/dilution analysis is a key M&A output that measures whether a transaction will increase or decrease the acquirer's earnings per share.

A deal is accretive if the combined company's EPS is higher than the acquirer's standalone EPS - shareholders are better off. A deal is dilutive if pro forma EPS is lower than standalone EPS.

The mechanics depend on deal structure:

In an all-cash deal, we compare the after-tax cost of financing to the target's earnings. If the acquirer borrows at 5% and the tax rate is 25%, the after-tax cost is 3.75%. If the target's earnings yield (inverse of P/E) is higher than 3.75%, the deal is likely accretive.

In an all-stock deal, we compare P/E ratios. If the acquirer has a higher P/E multiple than the target, the deal is typically accretive. This is because the acquirer is using 'expensive' currency to buy 'cheaper' earnings. Conversely, if the acquirer has a lower P/E, issuing stock dilutes existing shareholders.

Key drivers of accretion/dilution include: - Purchase price - lower multiples paid generally mean more accretion - Synergies - cost savings and revenue synergies increase combined earnings - Financing mix - debt is often cheaper than equity cost - Transaction costs and amortization of intangibles

It's important to note that accretion/dilution shouldn't be the sole determinant of whether to do a deal. A dilutive deal might still create long-term value through strategic benefits, and an accretive deal might destroy value if the price paid exceeds intrinsic value.

Common Mistakes to Avoid

Confusing accretion with value creation - they're related but not the same
Not understanding the P/E comparison for stock deals
Forgetting the impact of synergies
Not mentioning that short-term dilution might be acceptable for strategic reasons

Pro Tip

Remember: In a stock deal, the acquirer wants a higher P/E than the target. You're using expensive stock (high P/E) to buy cheap earnings (low P/E). This is often summarized as 'high P/E buys low P/E for accretion.'