An acquirer earns $300m and trades at 15 times earnings on 300m shares. It buys a target earning $100m for $1.8bn, funded half in cash borrowed at 4% pre-tax and half in stock, with a 25% tax rate. Is the deal accretive to earnings per share and by how much?

An acquirer earns $300m and trades at 15 times earnings on 300m shares. It buys a target earning $100m for $1.8bn, funded half in cash borrowed at 4% pre-tax and half in stock, with a 25% tax rate. Is the deal accretive to earnings per share and by how much?

Approach: Build the pro forma numerator by adding target earnings and subtracting after-tax interest, build the denominator by adding shares issued at the acquirer's own price, then compare with the standalone figure.

3.6%. The deal is accretive by 3.6%. Standalone earnings per share are 300/300, or $1.00, at a share price of $15. The $900m of debt costs 900 * 4% * 0.75, which is $27m of after-tax interest, and the $900m of stock issues 900/15, or 60m new shares. Pro forma earnings are 300 + 100 - 27, which is $373m, on 360m shares, giving $1.0361 and accretion of 3.6%. The quick check is the yield comparison: the target is bought at 18 times, an earnings yield of 5.56%, while the blended funding cost is half at 3% after tax and half at the acquirer's 6.67% earnings yield, or 4.83%. Paying 4.83% for 5.56% is accretive, and accretion says nothing about whether $1.8bn was the right price.

Follow-up: The target's earnings are expected to fall 15% next year. At what purchase price does the deal turn dilutive on next year's numbers?

Key concepts: accretion dilution, pro forma earnings per share, after-tax interest, share issuance.