In mergers & acquisitions, accretive refers to the increase in earnings attributable to the acquirer following the acquisition of a target company. In general, accretive, which is the adjective form of the word “accretion” can be defined as an incremental financial benefit or growth. It can be broadly applied to corporate actions such as mergers or buyouts, capital gains such as the increase in the value of an underlying asset or used as an accounting metric.
Takeovers are often immediately accretive or generally will be expected to be so in the immediate years following the acquisition. The following paragraph is from the press release filied with the SEC accompanying the proposed Morgan Stanley (MS) takeover of E*Trade FInancial (ETFC)
Morgan Stanley will be better positioned to generate attractive financial returns through increased scale, improved efficiency, higher margins, stronger returns on tangible common equity, and long-term earnings accretion. Morgan Stanley expects the acquisition to be accretive once fully phased-in estimated cost and funding synergies are realized.
Although this point is seldom referred to in initial press releases at the time of the deal announcement, the point is often highlighted by the acquirer in subsequent acquisition details.
If the increase in earnings is not the primary motive for making the acquisition, the acquisition may be dilutive to earnings. This in the opposite of accretive. The acquirer in this instance may have proceeded with the deal to capture market share, a specific technology or patent or even key personnel. In this case, the acquirer is willing to endure a short term reduction in earnings relative to its capital investment for the benefits of a longer term increase in earnings when the benefits of the acquisition are fully realized.
Accretive Example
In the following example we will assume the acquiring firm generates $1,000,000 in EBITDA for the current year attributable to common shareholders and that there are 1,000,000 shares outstanding. This gives an Earnings Per Share (EPS) ratio of
$1,000,000 / 1,000,000 = $1.00
The company goes on to issue 200,000 new shares in order to finance the purchase of a company that generates $500,000 in earnings. The updated EPS figure for the combined companies becomes
$1,500,000 earnings by 1,200,000 = $1.25
As this new figure of $1.25 is higher than the original value of $1, the deal is referred to as being earnings accretive. In turn, the Price Earnings Ratio is also positively affected. However, if things were always this simple, acquiring firms would simply go about buying those companies with a higher EPS. A simple snapshot number such as the current EPS figure is rarely sufficient to tell the whole story of the benefits and risks of a given takeover. Additionally, the effects of dilution via the issuance of new stock of the acquirer’s stock price may cause the value to fall at least in the near term.
