EPS Accretion VS Value Creation In M&A

EPS Accretion VS Value Creation In M&A

Many people perceive ๐…๐ข๐ง๐š๐ง๐œ๐ž ๐š๐ฌ ๐š ๐œ๐จ๐ฆ๐ฉ๐ฅ๐ž๐ฑ ๐ฌ๐ฎ๐›๐ฃ๐ž๐œ๐ญ. However, in my view, ๐…๐ข๐ง๐š๐ง๐œ๐ž ๐ข๐ฌ ๐š ๐ฌ๐ข๐ฆ๐ฉ๐ฅ๐ž ๐ฌ๐ฎ๐›๐ฃ๐ž๐œ๐ญ ๐จ๐Ÿ๐ญ๐ž๐ง ๐ฆ๐š๐๐ž ๐œ๐จ๐ฆ๐ฉ๐ฅ๐ž๐ฑ ๐›๐ฒ ๐š๐ง๐š๐ฅ๐ฒ๐ฌ๐ญ๐ฌ.

To substantiate my viewpoint, let us look at mergers and acquisitions, which are often a dreaded subject due to their abysmal track record.

1647231769515

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

๐‡๐จ๐ฐ๐ž๐ฏ๐ž๐ซ, ๐ข ๐ก๐š๐ฏ๐ž ๐ฌ๐ž๐ž๐ง ๐š๐ง๐š๐ฅ๐ฒ๐ฌ๐ญ๐ฌ ๐ฃ๐ฎ๐ฌ๐ญ๐ข๐Ÿ๐ฒ๐ข๐ง๐  ๐ญ๐ก๐ž ๐š๐›๐จ๐ฏ๐ž ๐๐ž๐š๐ฅ ๐š๐ฌ ๐ฏ๐š๐ฅ๐ฎ๐ž-๐š๐œ๐œ๐ซ๐ž๐ญ๐ข๐ฏ๐ž ๐๐ž๐ฌ๐ฉ๐ข๐ญ๐ž ๐ญ๐ก๐ž ๐š๐›๐จ๐ฏ๐ž ๐๐ž๐š๐ฅ ๐š๐๐๐ข๐ง๐  ๐ง๐จ ๐ฏ๐š๐ฅ๐ฎ๐ž.

Bankers would say that after A acquires B, the stock market will apply A’s P/E to B’s earnings.

๐ˆ๐Ÿ ๐ญ๐ก๐ž ๐›๐š๐ง๐ค๐ž๐ซ’๐ฌ ๐ฅ๐จ๐ ๐ข๐œ ๐ข๐ฌ ๐œ๐จ๐ซ๐ซ๐ž๐œ๐ญ, ๐ญ๐ก๐ž๐ง ๐€+๐’๐ฌ ๐ž๐ฑ๐ฉ๐ž๐œ๐ญ๐ž๐ ๐ž๐š๐ซ๐ง๐ข๐ง๐ ๐ฌ = ๐Ÿ๐ŸŽ*๐Ÿ– = ๐Ÿ๐Ÿ”๐ŸŽ, ๐ข๐ฆ๐ฉ๐ฅ๐ฒ๐ข๐ง๐  ๐ญ๐ก๐š๐ญ ๐ญ๐ก๐ž ๐œ๐จ๐ฆ๐›๐ข๐ง๐ž๐ ๐ฏ๐š๐ฅ๐ฎ๐ž ๐จ๐Ÿ ๐ญ๐ก๐ž ๐Ÿ๐ข๐ซ๐ฆ ๐ข๐ง๐œ๐ซ๐ž๐š๐ฌ๐ž๐ฌ ๐๐ž๐ฌ๐ฉ๐ข๐ญ๐ž ๐ง๐จ ๐ข๐ง๐œ๐ซ๐ž๐š๐ฌ๐ž ๐ข๐ง ๐ญ๐ก๐ž ๐œ๐จ๐ฆ๐›๐ข๐ง๐ž๐ ๐œ๐š๐ฌ๐ก ๐Ÿ๐ฅ๐จ๐ฐ๐ฌ.

Bankers define the above as ๐™ข๐™ช๐™ก๐™ฉ๐™ž๐™ฅ๐™ก๐™š ๐™š๐™ญ๐™ฅ๐™–๐™ฃ๐™จ๐™ž๐™ค๐™ฃ ๐™ค๐™ง ๐™ง๐™š๐™ง๐™–๐™ฉ๐™ž๐™ฃ๐™œย 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 ๐ฆ๐ฎ๐ฅ๐ญ๐ข๐ฉ๐ฅ๐ž ๐ž๐ฑ๐ฉ๐š๐ง๐ฌ๐ข๐จ๐ง ๐ข๐ฌ ๐š๐œ๐œ๐ฎ๐ซ๐š๐ญ๐ž, ๐š๐ฅ๐ฅ ๐Œ&๐€ ๐๐ž๐š๐ฅ๐ฌ ๐š๐๐ ๐ฏ๐š๐ฅ๐ฎ๐ž, ๐›๐ฎ๐ญ ๐ฐ๐ž ๐ค๐ง๐จ๐ฐ, ๐ข๐ง ๐ซ๐ž๐š๐ฅ๐ข๐ญ๐ฒ, ๐ญ๐ก๐š๐ญ ๐ข๐ฌ ๐ง๐จ๐ญ ๐ญ๐ก๐ž ๐œ๐š๐ฌ๐ž.

๐—œ๐—ป ๐—ฎ๐—ป ๐— &๐—” ๐—ฑ๐—ฒ๐—ฎ๐—น, ๐—ถ๐—ณ ๐—ฎ ๐—ฏ๐˜‚๐˜†๐—ฒ๐—ฟ ๐—ฐ๐—ฎ๐—ป๐—ป๐—ผ๐˜ ๐—ฝ๐—ถ๐—ป๐—ฝ๐—ผ๐—ถ๐—ป๐˜ ๐˜๐—ต๐—ฒ ๐˜€๐—ฝ๐—ฒ๐—ฐ๐—ถ๐—ณ๐—ถ๐—ฐ ๐˜€๐—ผ๐˜‚๐—ฟ๐—ฐ๐—ฒ๐˜€ ๐—ผ๐—ณ ๐—ถ๐—ป๐—ฐ๐—ฟ๐—ฒ๐—ฎ๐˜€๐—ฒ๐—ฑ ๐—ฐ๐—ฎ๐˜€๐—ต ๐—ณ๐—น๐—ผ๐˜„, ๐—ถ๐˜ ๐—ถ๐˜€ ๐˜๐—ฟ๐˜†๐—ถ๐—ป๐—ด ๐˜๐—ผ ๐—ณ๐—ผ๐—ผ๐—น ๐—ถ๐˜๐˜€ ๐˜€๐—ต๐—ฎ๐—ฟ๐—ฒ๐—ต๐—ผ๐—น๐—ฑ๐—ฒ๐—ฟ๐˜€.



1 Comment

Leave a Reply

%d bloggers like this: