Accretion describes the positive change to a company's earnings per share (EPS) after a merger or acquisition of another company. In these transactions, the remaining company does not always gain, and the transaction may result in diluted stock. Merger and acquisition analysts perform an accretion/dilution analysis to determine the potential outcome of different business combination scenarios. This serves as part of the decision-making process before an actual transaction takes place.
1. Assemble a projected, pro forma income statement for the new, combined company. A pro forma income statement factors in financial changes you expect as a result of a merger or acquisition transaction. Include a conservative view of the company's net income. Some analysts start with 12 months of historical data and two years of projected data, while others use strictly projected data.
2. Factor expected synergies from the transaction into the projections. Examples include increased revenues from new or complementary product lines or service offerings. Also, factor in expectations of reduced cost benefits from the elimination of any redundant manufacturing processes, buildings, personnel or other company functions.
3. Factor in costs related to the company's transaction, such as increased interest expense if debt was used to finance the deal. If a company uses its cash to finance a deal, lower its future income from interest on cash investments. Add the amortization expense that comes with the acquisition of intangible assets, such as patents, copyrights, goodwill or trade names.
4. Calculate the number of shares for the new company. This number is dependent on whether the transaction is a merger or acquisition, and whether the issuance of new stock will finance any part of the transaction. The result should be a pro forma stock shares outstanding estimate.
5. Divide the pro forma net income by the pro forma shares of stock. This becomes the pro forma EPS estimate. Compare this to the EPS of the original company. If the pro forma EPS is higher, analysts determine the transaction to be accretive.
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