What Is an Accretive Acquisition?
An accretive acquisition increases the securing company's earnings per share (EPS). Accretive acquisitions tend to be favorable for the company's market price because the price paid by the securing firm is lower than the lift that the new acquisition is expected to provide to the procuring company's EPS. As a general rule, an accretive merger or acquisition happens when the price-earnings (P/E) ratio of the getting firm is greater than that of the target firm.
How an Accretive Acquisition Works
A accretive acquisition is like the practice of bootstrapping, where an acquirer purposely purchases a company with a low price-earnings (P/E) ratio through a stock swap transaction to help the post-acquisition EPS of the newly formed combined business and encourage a rise in the price of its shares.
While bootstrapping is often frowned upon as an accounting practice that games the system and lowers overall earnings quality, an accretive acquisition plays to the combined synergies of a merger in a positive manner.
An accretive acquisition increases the synergy between the acquired and the acquirer. This synergy happens when the combination of two organizations produces a combined value that is greater than the sum of the separate parts. In this way, value in an accretive acquisition is generated because the buyer of a smaller company can add the acquired business' pro-forma EBITDA/earnings ratio to its own EBITDA/earnings ratio, where EBITDA is earnings before interest, taxes, depreciation, and amortization.
On the off chance that the acquisition is done correctly, the purchasing company has a higher enterprise value (EV)/EBITDA multiple, and the expansion of the acquired company increases the total value of the combined entity.
Example of an Accretive Acquisition
There are many cases where an established company seeks to increase the value of its shareholders through a strategic acquisition. Unlike an acquisition that is conducted due to research and development or product acquisition purposes, similarly as with Meta's (formerly Facebook) purchase of Oculus Rift, an accretive acquisition immediately increases the value of the gaining company's stock.
For example, on the off chance that a large, public technology company needs to increase its EPS immediately, hence increasing its share price, it would hope to acquire a smaller technology company with a higher EPS. On the off chance that the larger company had an EPS of $2 and calculated that assuming it acquired a smaller company with an EPS of $2.50, it would realize a combined pro-forma EPS of $2.15, the gross value of the acquisition would be 15%. Assuming the cost of procuring the company is 10 cents per share, the net benefit is positive.
Reactions of Accretive Acquisitions
However, since pro-forma financial statements and 12-to two year forecasts are used to derive the potential accretive value of the acquisition, synergies are not guaranteed. As a matter of fact, the best way to realize the added value of consolidating firms is to integrate the two companies effectively and efficiently, so there are no lost benefits. Often, the combination of the firms fizzles, and the resulting entity realizes an EPS that misses the mark concerning expectations making the firm lose overall value.
- An accretive acquisition increases the earnings per share (EPS) of the gaining company.
- A company can use an accretive acquisition to encourage an increase in its share price.
- The goal of an accretive acquisition is to increase the synergies of the two companies, producing a combined value that is greater than the sum of the separate parts.
- To completely realize the potential EPS benefit of an accretive acquisition, the two companies involved must integrate efficiently and effectively.