An accretive/dilutive question with a twist
Supposed a company is being traded at 10 times its earnings.
It is trying to sell a part of its business that is being traded at 20 times its earnings.
Will this be an accretive or dilutive deal?
I said accretive because after the sale, you are left with cheaper part of the business = lower PE ratio = higher EPS => Accretive.
What do you think?
The sale in and of itself would not be Accretive. If you have two pieces of business, both earning $50/share for total of $100/share, and sell one piece for $1,000/share, you are left with $50/share of earnings and $1,000 of cash that you received. Until you know what multiple those proceeds are reinvested at you can't know whether the sale is "Accretive" or "dilutive".
Your answer basically assumed that they bought back shares with the proceeds, so if shares are trading at $1,000 beforehand and you receive $1,000 in cash for 50% of the earnings, you would expect the new (pre-buyback) share price to be $1,000/share (for the cash) + $500/share (10 * $50/share of earnings), so $1,500. Then you would be able to buy back 2/3 of a share with your $1,000 of cash, so you'd end up with $50 of earnings for 1/3 of a post-buyback share, or $150/share of earnings post-buyback. So ultimately it would be Accretive IF you sell at 20x and immediately buy back shares trading at 10x, but that is because your reinvestment of proceeds is at 1/2 the price of your sales price...
If instead the company took the $1,000 of cash an invested in a business at 2% yield (or stated differently, is trading at 50x), then it would be dilutive. The math on that would be that you receive $1,000 and then reinvest that in a business line that generates $20/share in earnings ($20 * 50 = $1,000). In that case, your post-revinestment earnings would be $70/share, which is lower than the $100/share you would have before you ever consummated the sale.
TLDR: The trading and sales price aren't all that matter. What determines if the sale is Accretive or dilutive is the relative multiple of the sale price and the reinvestment opportunity. If you sell and then immediately buyback shares at a lower multiple than what you sold at, then the sale is Accretive.
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