Walk me through an accretion/dilution analysis…

The purpose of an accretion/dilution analysis (sometimes also referred to as a quick-and-dirty merger analysis) is to project the impact of an acquisition to the acquiror’s Earnings Per Share (EPS) and compare how the new EPS (“proforma EPS”) compares to what the company’s EPS would have been had it not executed the transaction.

In order to do the accretion/dilution analysis, we need to project the combined company’s net income (“proforma net income”) and the combined company’s new share count.  The proforma net income will be the sum of the buyer’s and target’s projected net income plus/minus certain transaction adjustments.  Such adjustments to proforma net income (on a post-tax basis) include synergies (positive or negative), increased interest expense (if debt is used to finance the purchase), decreased interest income (if cash is used to finance the purchase) and any new intangible asset amortization resulting from the transaction.

The proforma share count reflects the acquiror’s share count plus the number of shares to be created and used to finance the purchase (in a stock deal).  Dividing proforma net income by proforma shares gives us proforma EPS which we can then compare to the acquiror’s original EPS to see if the transaction results in an increase to EPS (accretion) or a decline in EPS (dilution).  Note also that we typically will perform this analysis using 1-year and 2-year projected net income and also sometimes last twelve months (LTM) proforma net income.