- July 29, 2022
- Posted by: Ramkumar
- Category: Posts

EPS Accretion VS Value Creation In M&A
Many people perceive ๐ ๐ข๐ง๐๐ง๐๐ ๐๐ฌ ๐ ๐๐จ๐ฆ๐ฉ๐ฅ๐๐ฑ ๐ฌ๐ฎ๐๐ฃ๐๐๐ญ. However, in my view, ๐ ๐ข๐ง๐๐ง๐๐ ๐ข๐ฌ ๐ ๐ฌ๐ข๐ฆ๐ฉ๐ฅ๐ ๐ฌ๐ฎ๐๐ฃ๐๐๐ญ ๐จ๐๐ญ๐๐ง ๐ฆ๐๐๐ ๐๐จ๐ฆ๐ฉ๐ฅ๐๐ฑ ๐๐ฒ ๐๐ง๐๐ฅ๐ฒ๐ฌ๐ญ๐ฌ.
To substantiate my viewpoint, let us look at mergers and acquisitions, which are often a dreaded subject due to their abysmal track record.
Company A, whose value is Rs.100, acquired Company B, whose value is Rs.50. Firm A does not pay any premium; thus, the purchase price is Rs.50.
Firm A issues its equity by buying Firm B.
Combined value of A+B = Rs.150
Let us assume,
A’s expected earnings = Rs.5
B’s expected earnings = Rs.3
P/E of A = 100/5 = 20
P/E of B = 50/3 = 16.67
A+B’s expected earnings = Rs.8
P/E of A+B = 18.75
๐๐จ๐ฐ๐๐ฏ๐๐ซ, ๐ข ๐ก๐๐ฏ๐ ๐ฌ๐๐๐ง ๐๐ง๐๐ฅ๐ฒ๐ฌ๐ญ๐ฌ ๐ฃ๐ฎ๐ฌ๐ญ๐ข๐๐ฒ๐ข๐ง๐ ๐ญ๐ก๐ ๐๐๐จ๐ฏ๐ ๐๐๐๐ฅ ๐๐ฌ ๐ฏ๐๐ฅ๐ฎ๐-๐๐๐๐ซ๐๐ญ๐ข๐ฏ๐ ๐๐๐ฌ๐ฉ๐ข๐ญ๐ ๐ญ๐ก๐ ๐๐๐จ๐ฏ๐ ๐๐๐๐ฅ ๐๐๐๐ข๐ง๐ ๐ง๐จ ๐ฏ๐๐ฅ๐ฎ๐.
Bankers would say that after A acquires B, the stock market will apply A’s P/E to B’s earnings.
๐๐ ๐ญ๐ก๐ ๐๐๐ง๐ค๐๐ซ’๐ฌ ๐ฅ๐จ๐ ๐ข๐ ๐ข๐ฌ ๐๐จ๐ซ๐ซ๐๐๐ญ, ๐ญ๐ก๐๐ง ๐+๐’๐ฌ ๐๐ฑ๐ฉ๐๐๐ญ๐๐ ๐๐๐ซ๐ง๐ข๐ง๐ ๐ฌ = ๐๐*๐ = ๐๐๐, ๐ข๐ฆ๐ฉ๐ฅ๐ฒ๐ข๐ง๐ ๐ญ๐ก๐๐ญ ๐ญ๐ก๐ ๐๐จ๐ฆ๐๐ข๐ง๐๐ ๐ฏ๐๐ฅ๐ฎ๐ ๐จ๐ ๐ญ๐ก๐ ๐๐ข๐ซ๐ฆ ๐ข๐ง๐๐ซ๐๐๐ฌ๐๐ฌ ๐๐๐ฌ๐ฉ๐ข๐ญ๐ ๐ง๐จ ๐ข๐ง๐๐ซ๐๐๐ฌ๐ ๐ข๐ง ๐ญ๐ก๐ ๐๐จ๐ฆ๐๐ข๐ง๐๐ ๐๐๐ฌ๐ก ๐๐ฅ๐จ๐ฐ๐ฌ.
Bankers define the above as ๐ข๐ช๐ก๐ฉ๐๐ฅ๐ก๐ ๐๐ญ๐ฅ๐๐ฃ๐จ๐๐ค๐ฃ ๐ค๐ง ๐ง๐๐ง๐๐ฉ๐๐ฃ๐ย to justify their rationale.
Let us reverse our above example with Firm B acquiring Firm A. Now bankers will justify this deal as a company B with a lower P/E purchases Firm A with a higher P/E, implying B is accelerating its growth; thus, B’s P/E should expand to A.
In my view, if ๐ฆ๐ฎ๐ฅ๐ญ๐ข๐ฉ๐ฅ๐ ๐๐ฑ๐ฉ๐๐ง๐ฌ๐ข๐จ๐ง ๐ข๐ฌ ๐๐๐๐ฎ๐ซ๐๐ญ๐, ๐๐ฅ๐ฅ ๐&๐ ๐๐๐๐ฅ๐ฌ ๐๐๐ ๐ฏ๐๐ฅ๐ฎ๐, ๐๐ฎ๐ญ ๐ฐ๐ ๐ค๐ง๐จ๐ฐ, ๐ข๐ง ๐ซ๐๐๐ฅ๐ข๐ญ๐ฒ, ๐ญ๐ก๐๐ญ ๐ข๐ฌ ๐ง๐จ๐ญ ๐ญ๐ก๐ ๐๐๐ฌ๐.
๐๐ป ๐ฎ๐ป ๐ &๐ ๐ฑ๐ฒ๐ฎ๐น, ๐ถ๐ณ ๐ฎ ๐ฏ๐๐๐ฒ๐ฟ ๐ฐ๐ฎ๐ป๐ป๐ผ๐ ๐ฝ๐ถ๐ป๐ฝ๐ผ๐ถ๐ป๐ ๐๐ต๐ฒ ๐๐ฝ๐ฒ๐ฐ๐ถ๐ณ๐ถ๐ฐ ๐๐ผ๐๐ฟ๐ฐ๐ฒ๐ ๐ผ๐ณ ๐ถ๐ป๐ฐ๐ฟ๐ฒ๐ฎ๐๐ฒ๐ฑ ๐ฐ๐ฎ๐๐ต ๐ณ๐น๐ผ๐, ๐ถ๐ ๐ถ๐ ๐๐ฟ๐๐ถ๐ป๐ด ๐๐ผ ๐ณ๐ผ๐ผ๐น ๐ถ๐๐ ๐๐ต๐ฎ๐ฟ๐ฒ๐ต๐ผ๐น๐ฑ๐ฒ๐ฟ๐.
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