Do EPS Accretive Deals Add Value in M&A

Do EPS Accretive Deals Add Value in M&A

𝐃𝐨𝐞𝐬 𝐚𝐧 𝐌&𝐀 𝐭𝐫𝐚𝐧𝐬𝐚𝐜𝐭𝐢𝐨𝐧 𝐚𝐝𝐝 𝐯𝐚𝐥𝐮𝐞 𝐣𝐮𝐬𝐭 𝐛𝐞𝐜𝐚𝐮𝐬𝐞 𝐢𝐭 𝐢𝐬 𝐄𝐏𝐒 𝐚𝐜𝐜𝐫𝐞𝐭𝐢𝐯𝐞?

In almost every mergers and acquisition deal announcement, we see that the Buyer reports the transaction as EPS accretive. However, in my view, 𝗘𝗣𝗦 𝗮𝗰𝗰𝗿𝗲𝘁𝗶𝘃𝗲 𝗼𝗿 𝗱𝗶𝗹𝘂𝘁𝗶𝘃𝗲 𝗱𝗼𝗲𝘀 𝗻𝗼𝘁 𝗮𝗳𝗳𝗲𝗰𝘁 𝗱𝗲𝗮𝗹 𝘃𝗮𝗹𝘂𝗲. On the other hand, there are instances where EPS accretive deals destroy value.

𝙇𝙚𝙩 𝙢𝙚 𝙨𝙪𝙗𝙨𝙩𝙖𝙣𝙩𝙞𝙖𝙩𝙚:

For instance, the Buyer acquires a seller for $500 million, whose market value is $400 million. The Buyer can finance this transaction by cash or stock.

𝑳𝒆𝒕 𝒖𝒔 𝒂𝒔𝒔𝒖𝒎𝒆 𝒕𝒉𝒆 𝑩𝒖𝒚𝒆𝒓 𝒅𝒐𝒆𝒔 𝒏𝒐𝒕 𝒈𝒆𝒏𝒆𝒓𝒂𝒕𝒆 𝒔𝒚𝒏𝒆𝒓𝒈𝒊𝒆𝒔 𝒇𝒓𝒐𝒎 𝒕𝒉𝒊𝒔 𝒅𝒆𝒂𝒍.

𝗡𝗲𝘁 𝗜𝗻𝗰𝗼𝗺𝗲 𝗼𝗳 𝗕𝘂𝘆𝗲𝗿 = $𝟴𝟬 𝗺𝗶𝗹𝗹𝗶𝗼𝗻
𝗧𝗵𝗲 𝘀𝗵𝗮𝗿𝗲 𝗰𝗼𝘂𝗻𝘁 𝗼𝗳 𝗕𝘂𝘆𝗲𝗿 = 𝟰𝟬 𝗺𝗶𝗹𝗹𝗶𝗼𝗻
𝗘𝗣𝗦 = 𝟮
𝗧𝗵𝗲 𝗽𝗿𝗲-𝗱𝗲𝗮𝗹 𝗦𝗵𝗮𝗿𝗲 𝗽𝗿𝗶𝗰𝗲 𝗼𝗳 𝗕𝘂𝘆𝗲𝗿 = $𝟰𝟬
𝗣/𝗘 𝗼𝗳 𝗯𝘂𝘆𝗲𝗿 = 𝟮𝟬

𝗡𝗲𝘁 𝗜𝗻𝗰𝗼𝗺𝗲 𝗼𝗳 𝗦𝗲𝗹𝗹𝗲𝗿 = $𝟯𝟬 𝗺𝗶𝗹𝗹𝗶𝗼𝗻
𝗧𝗵𝗲 𝘀𝗵𝗮𝗿𝗲 𝗰𝗼𝘂𝗻𝘁 𝗼𝗳 𝗦𝗲𝗹𝗹𝗲𝗿 = 𝟭𝟬 𝗺𝗶𝗹𝗹𝗶𝗼𝗻
𝗘𝗣𝗦 = 𝟯
𝗧𝗵𝗲 𝗽𝗿𝗲-𝗱𝗲𝗮𝗹 𝗦𝗵𝗮𝗿𝗲 𝗽𝗿𝗶𝗰𝗲 = $𝟰𝟬
𝗣/𝗘 𝗼𝗳 𝗦𝗲𝗹𝗹𝗲𝗿 = 𝟭𝟯.𝟯𝟯

𝐒𝐜𝐞𝐧𝐚𝐫𝐢𝐨 𝟏 – 𝐂𝐚𝐬𝐡 𝐓𝐫𝐚𝐧𝐬𝐚𝐜𝐭𝐢𝐨𝐧
The Buyer raises debt to fund 100% deal value at a 6% interest rate. Although the interest rate is tax-deductible, the effective interest payment is $19.5.

Thus, the Net Income of the combined company post-deal was reduced to $90.5.

The combined deal EPS for the Buyer is 2.26 against two pre-deal, which makes the deal accretive.

ROI for this deal = 30/500 = 6% which is more than after-tax interest rate of 3.9% (6%*(1-35%).

The Buyer’s WACC is 10%

𝗘𝗳𝗳𝗲𝗰𝘁𝗶𝘃𝗲𝗹𝘆, 𝘁𝗵𝗲 𝗕𝘂𝘆𝗲𝗿 𝗵𝗮𝘀 𝗽𝗮𝗶𝗱 $𝟭𝟬𝟬 𝗺𝗶𝗹𝗹𝗶𝗼𝗻 𝗺𝗼𝗿𝗲 𝗮𝗻𝗱 𝗳𝘂𝗻𝗱𝗲𝗱 𝟭𝟬𝟬% 𝗼𝗳 𝘁𝗵𝗲 𝗱𝗲𝗮𝗹 𝘄𝗶𝘁𝗵 𝗱𝗲𝗯𝘁 𝗶𝗻𝗰𝗿𝗲𝗮𝘀𝗶𝗻𝗴 𝗶𝘁𝘀 𝗪𝗔𝗖𝗖 𝘁𝗼 𝟭𝟭%. 𝗨𝗻𝗹𝗲𝘀𝘀 𝘁𝗵𝗲 𝗥𝗢𝗜𝗖>𝗪𝗔𝗖𝗖 𝘄𝗵𝗶𝗰𝗵 𝗶𝘀 𝗻𝗼𝘁 𝘁𝗵𝗲 𝗰𝗮𝘀𝗲, 𝘁𝗵𝗶𝘀 𝗱𝗲𝗮𝗹 𝗱𝗲𝘀𝘁𝗿𝗼𝘆𝘀 𝘃𝗮𝗹𝘂𝗲.

𝐒𝐜𝐞𝐧𝐚𝐫𝐢𝐨 𝟐 – 𝐒𝐭𝐨𝐜𝐤 𝐓𝐫𝐚𝐧𝐬𝐚𝐜𝐭𝐢𝐨𝐧
Here, the Buyer issues its stock to the Seller and increases its share count from 40 to 52.5 million. The additional share count is 12.5 (500/40).

EPS of the combined company = 2.10 against 2.0 before the deal.

Here, the EPS is accretive, but no value gets created.

𝗜𝗻 𝗺𝘆 𝘃𝗶𝗲𝘄, 𝗺𝗮𝗸𝗶𝗻𝗴 𝗮 𝗱𝗲𝗮𝗹 𝗘𝗣𝗦 𝗮𝗰𝗰𝗿𝗲𝘁𝗶𝘃𝗲 𝗶𝘀 𝘂𝘀𝘂𝗮𝗹𝗹𝘆 𝗮 𝗿𝗲𝘀𝘂𝗹𝘁 𝗼𝗳 𝗺𝗮𝘁𝗵 𝗮𝗴𝗮𝗶𝗻𝘀𝘁 𝘁𝗵𝗲 𝗮𝗱𝗱𝗶𝘁𝗶𝗼𝗻 𝗼𝗳 𝘃𝗮𝗹𝘂𝗲.