When your company dives into the VDR to start doing all the legwork M&A requires, you put the hours in for the professional and financial boost your business will reap at the finish line – every type of acquisition aims to enrich its parent company, and accretive acquisitions are no different in that department. Where these less-than-flashy acquisitions are different is in their laser focus on that financial part, seeking to benefit market price above all.
Understanding Accretive Acquisitions
It’s all in the name for this unique type of acquisition, with “accretive” meaning “characterized by gradual growth or increase,” per Oxford.
At its core, an accretive acquisition is an acquisition that hones in on a tightly focused goal: to increase the parent company’s earnings per share (EPS). Successful accretive acquisitions benefit the purchasing company’s market value, as the buying price is lower than the financial gains that the new acquisition is expected to provide (do your due diligence, folks). There’s no officiating body on accretive acquisitions, but as a general rule, an accretive merger or acquisition occurs when the price-to-earnings (P/E) ratio of the acquiring firm is greater than that of the target firm. Simple stuff.
Beyond those basics, an accretive acquisition increases the synergy between the two companies, ideally creating a company with a combined value greater than the sum of its parts. Oftentimes, accretive acquisitions generate value because the buyer of a smaller company is able to add the acquired business’s pro-forma EBITDA/earnings ratio to its own EBITDA/earnings ratio (BTW, “EBITDA” means “earnings before interest, taxes, depreciation, and amortization,” ICYDK). In theory, the purchasing company has a higher enterprise value (EV)/EBITDA multiple, so the addition of the acquired company increases the total value of the combined entity.
Accretive vs. Dilutive Acquisition: Unraveling the Differences
You can probably guess that if accretive acquisitions increase the acquirer’s EPS, dilutive acquisitions decrease EPS. But here’s the kicker: that’s not always a bad thing. Here’s how accretive vs. dilutive acquisitions break down.
Pros of Accretive Acquisitions
OK, obviously increasing the acquiring company’s EPS is a pretty big perk. According to Harvard Business Review, about a third of companies that perform accretive acquisitions surpass their industry’s average stock-price returns by more than 10 percent. Ultimately, the accretive M&A model can quickly and efficiently create value for shareholders and, some might argue, that is exactly what a firm’s directors should be focused on.
On a more conceptual, but equally vital, level, all-important synergies can elevate accretive acquisitions to the next stratosphere. When the companies in question complement each other in terms of market offerings, investment strategies or even governance, productivity and revenue gains often follow – more R&D resources or increased economies of scale might just come with that accretive acquisition, after all.
Cons of Accretive Acquisitions
On the flip side, since pro-forma financial statements and 12- to 24-month forecasts are used to derive the potential accretive value of the acquisition, those deal-defining synergies are never guaranteed. When the new combination of the firms fails and the resulting entity realizes an EPS that falls short of expectations, the firm loses overall value.
Plus, not all accretive acquisitions end up positive in the long term. While they typically generate an immediate (and appealing) EPS spike, the pro-forma EPS still has to be realized over the next 1 to 2 years. They’re a risk for the patient.
Consider Company A, with a current EPS of $1.00. Company A acquires Company B, resulting in a combined pro-forma EPS of $1.40. So the acquisition is 40% accretive. But to maintain a good financial position, it might be necessary to cut costs or restructure: let’s say now that companies A and B are merged, they gain the freedom to shed some structures, which means they can add benefit by cutting redundant costs, like duplicate sales teams or top execs.
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Real-world Examples of Accretive Acquisitions
Case Studies: Successful Accretive Acquisitions
Companies don’t tend to spell out accretive acquisitions as much as they celebrate sexier mergers, but even that doesn’t stop us from knowing that this strategy can pay off impressively. Just a few examples of banger accretive acquisitions in recent years include:
- Oracle’s $28.3-billion acquisition of Cerner in 2022 was directly responsible for rocketing the parent company’s shares by nearly 20 percent.
- Also in 2022, Prologis’ shares went up 9 percent after their accretive merger with Duke Realty.
- In 2020, Cigna’s $67-bil acquisition of Express Scripts guided their shares from $20 to $21, versus standalone EPS of $18.
- That same year, Bristol-Meyers’ $74-billion accretive acquisition of Celgene trimmed $2.5 billion in costs from the acquiring company, with Bristol forecasting EPS accretion of over 40 percent in the first year alone.
Lessons from Accretive Acquisition Failures
Per a Harvard study of nearly 100 U.S. acquisitions, dilutive deals tended to outperform accretive acquisitions. “What could account for this?,” study writers David Harding and Phyllis Yale ask. The answer?
“In a word: discipline. The market’s suspicion of dilutive deals places enormous pressure on executives to be rigorous in both analyzing and executing mergers. Meanwhile, the market’s embrace of accretive acquisitions eases the pressure on executives, raising the likelihood of sloppiness in analysis and tardiness in execution.”
The study suggests that strategic fit, due diligence, business synergies, and management capabilities need to take precedence for an accretive acquisition to enjoy long-term success.
Navigating Challenges and Best Practices
With that in mind, the key to a consistently lucrative accretive acquisition is less about the accounting and the numbers, and more the ability to integrate and synergize both companies. It’s common for mergers that are seen as accretive to falter simply because the companies are not compatible. When that happens, accretive additions become short-term stopgaps in poorly laid out merger plans, at best.
As for best practices, Harding and Yale suggest that “merger leaders [must] emphasize strategic fit and integration skills, not just immediate earnings accretion. And if a little apprehension about a deal’s prospects redoubles executives’ focus on discipline, investors are bound to benefit.”
It’s Accretive: Meaning in Synergy
The bottom line is, if the target company has a smaller P/E ratio than the acquiring firm, pursuing an accretive acquisition is more than worth considering. But that tasty initial spike in EPS doesn’t ensure the long-term success of the deal. For a sustainable future, company synergies are what guide the most lucrative accretive acquisitions to positive outcomes.
Synergies don’t succeed without due diligence, full stop. With execs, bankers, lawyers, accountants, consultants and more sharing your virtual data room – the arena where due diligence thrives – you need to simplify these complex M&A transactions as much as possible, or risk slowing the transaction to a crawl. With best-in-class security, speedy document review, less asks of admin staff, super specific permissioning, built-in IT, and more, CapLinked streamlines your deal-making due diligence as much as it accelerates the process. Consider our 14-day trial an accretive acquisition you can make right now, for free.
Sources:
Investopedia – Accretive vs. Dilutive Mergers: What’s the Difference?
Harvard Business Review – Discipline and the Dilutive Deal
TheStreet – The 6 Biggest Mergers and Acquisitions of 2022
Kiplinger – 15 Large-Cap Stocks Betting Big on M&A
