When proposing M&A transactions management will often mention EPS accretion to appeal to the belief that it will generate value for shareholders. Whilst this metric has relevance, it should not be used as a shortcut for evaluating a transaction in its entirety and can even be misleading.
Earnings per share (EPS) is simply a company’s profit divided by the number of its shares. Company stock is commonly valued on the basis of EPS through a price-to-earnings (P/E) ratio. If stock is trading at $1.00 price and EPS is $0.10, then the P/E will be 10x. If an accretive transaction adds $0.02 EPS to bring group EPS to $0.12, applying the current 10x P/E will bring the share price to $1.20, a 20% uplift! But this logic depends on the market ascribing the same P/E multiple of the current business to the combined group, which does not always hold.
For example, If the acquiring business is a high growth, high margin SaaS business trading on 30x P/E and the target is a low margin, low growth cyclical trading on a 6x P/E, despite being highly EPS accretive, investors will adjust the combined group P/E to reflect the slower growth and increased risk associated with the overall business, neutralising any valuation uplift from EPS increasing. If integration costs blow out or business synergies aren’t realised, the transaction may lead to destruction of shareholder value despite being initially EPS accretive. Similarly, if a transaction is initially EPS dilutive, it may still be beneficial for shareholders through unlocking synergies over time.
So although EPS accretion is a useful measure to evaluate the merits of a transaction, it should not be used as a shortcut to bypass harder-to-answer questions about whether a transaction will drive value for shareholders. Below we’ve included some questions which should be considered alongside the blunt metric of EPS accretion to determine whether a transaction is desirable.
