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What is an accretive merger?
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What Is Accretive Merger
An accretive merger refers to a mergers and acquisitions transaction where the acquiring firm’s earnings per share go up following the acquisition.
In other words, an M&A deal is said to be “accretive” when the acquiring firm’s earnings per share post transaction increase.
Typically, for a merger to be accretive, the acquiring company must purchase a target with a lower price-to-earnings ratio.
Since the target firm’s price-to-earnings ratio is lower relative to the acquiring firm’s, the acquiring firm will see a boost in its earnings per share following the acquisition.
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Why Accretive Mergers Are Important
Accretive mergers are important as many companies look to acquire a target allowing the acquiring firm’s earnings per share to go up.
Typically, shareholders perceive M&A deals leading to an increased EPS in a favorable light.
If the acquiring company is able to take advantage of the potential synergies, economies of scale, and scope, the transaction can be a highly successful one.
A successful M&A transaction will allow the acquiring firm to take advantage of the target’s know-how, cash flow, production efficiencies, and excess capacity to increase production and lower costs per unit.
However, it’s important to keep in mind that not all accretive mergers bring value to the acquiring firm’s shareholders.
If the acquirer is unable to adequately integrate the target, manage its operations, or take advantage of the potential synergies, an accretive transaction can lead to potential losses.
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Accretive Merger Limitations
Although the general tendency is that an accretive merger is positive, you should also be mindful of its limitations.
The first thing you should consider is that an accretive merger is considered in a positive light.
However, an accretive merger is similar to a bootstrap merger where the acquiring firm’s objective is to artificially increase its earnings per share by acquiring a company with a lower P/E ratio.
The bootstrap effect is typically seen in a negative light as the primary objective of the acquiring firm is to artificially increase EPS without necessarily considering if the deal brings more value to the shareholders.
Also, a merger that appears to be accretive on paper may not necessarily lead to positive outcomes.
If the acquirer is unable to integrate its business with that of the target, sees cultural clashes, fails to realize the economies of scale, and fails to implement a good strategy, the deal can quickly go bad.
Assessing the accretive nature of a transaction should be viewed simply as an indicator.
The target must perform adequate due diligence to ensure that it could truly realize the potential synergies.
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Accretive Merger Example
Let’s look at an example of an accretive merger to better illustrate the concept.
Let’s say an acquiring company has earnings per share of $10.
It is considering a potential merger with a target having earnings per share of $20.
Following the merger via stock swap, the acquirer calculates that it can increase its earnings per share to $15.
In this case, the merger is said to be accretive as the combined earnings per share of the two entities amount to $15 per share which is $5 more than the acquirer’s pre-merger position.
As long as the acquirer’s cost of acquiring the target is below $10 per share, then the acquisition can provide it with a positive net benefit.
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Accretive Merger vs Dilutive Merger
What is the difference between an accretive merger and a dilutive merger?
An accretive merger is when a company’s earnings per share (EPS) go up following the acquisition of another company.
On the other hand, a dilutive merger is a type of merger where the acquiring company’s earnings per share go down.
A dilutive merger can also mean that the acquiring firm had to issue more shares to acquire the target leading to the dilution of the current shareholders.
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Takeaways
So there you have it folks!
What is an accretive merger?
In a nutshell, an accretive merger is when an acquiring company merges with a target leading to an increase in the acquirer’s earnings per share.
This type of merger is generally well perceived in the market as companies tend to perform accretive mergers to take advantage of synergies, economies of scale, and scope.
In most cases, when the acquirer’s P/E ratio is greater than that of the target, the merger will be accretive.
Companies use the accretive merger test to quickly evaluate whether or not a potential merger can lead to a positive or negative on its earnings per share.
If the earnings per share go up, it means that the merger can be potentially affordable to the acquirer and bring value to its shareholders (the opposite is also true).
Now that you know what an accretive merger is and how it works, good luck with your research!
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