Accretion / Dilution - Question
1) Assumptions: P/E target 10x; P/E acquiror 20x; 10% interest on debt -100% Stock = Accretive -100% debt = Accretive -x%Stock & x% Debt = ?
2) Assuming two financing structures: 1) 60% debt, 40% stock; 2) 60% stock, 40% debt
Is there a quick and dirty way to determine which acquisition financing structure will be more Accretive?
I understand the more debt (cash) used to finance a transaction, generally the more Accretive the transaction will be, but I would like to know if there is any way to calculate (quickly using mental math) the difference in accretion.
Thanks in advance.
Not sure but something is likely way wrong since it's pretty rare to be Accretive if the acquirer has a lower a P/E than the target, let alone half of the target.
And no, I don't think there's an easy way to calculate the difference. Though more cash is better than more stock.
You gave two of the exact same considerations, but I think you meant one was 60% debt, 40% equity and the other was 60% equity, 40% debt?
We already know the cost of debt after-tax is basically 10%*(1-T) in the deal. The cost of equity after-tax is inverse buyer's P/E (since you are using your own shares to fund the deal) so it would be 10% flat. Debt is cheaper and so the first set of considerations I listed should be more accretive.
To determine the numerical difference between the two consideration structures you would have to assign share price values and a number of shares. So let's say Buyer Co has 10 shares worth 10 dollars each with $1 of EPS each ($10 earnings total, 10x P/E, $100 dollars of shares total) and Seller Co has 10 shares worth 20 dollars each with $1 of EPS each (10 earnings total, 20x P/E, $200 dollars of shares total). Debt has a 10% flat rate pretax. Let's also assume a 40% tax rate.
In Situation A (60% debt, 40% equity) you pay for 120 dollars of the company with debt, at an effective rate of 6%. The other 80 is paid for by issuing 8 new shares. You now have 20 dollars of earnings but you have to pay $7.2 on the debt and you have 18 shares. Your EPS is around $0.71 per share.
In Situation B (40% debt, 60% equity) you pay for 80 dollars of the company with debt, at an effective rate of 6%. The other 120 is paid for by issuing 12 new shares. You now have 20 dollars of earnings but you have to pay $4.8 on the debt and you have 22 shares. Your EPS is around $0.69 per share.
I also don't know why you are making the assumption that the deal is Accretive in an equity swap. This is impossible given the P/E numbers you listed, as the buyer shares are worth basically half of the seller's shares. (100% stock situation is always dilutive given a buyer P/E which is lower than seller's P/E). Also, looking at the rough math that I did I have no idea how this deal could be Accretive in an all-debt situation either since the interest rate is so high.
Spot on with the last statement that the transaction will generally be dilutive with the buyer's P/E being lower than the seller's in an all-stock deal. However, I just want to correct your math a bit. In both scenarios, you say 300 dollars of earnings, but you are thinking of market cap in that case. Adding stand-alone earnings would put consolidated earnings at 20 before considering synergies and the effects of interest and tax expense.
Wow that's a pretty huge mistake. Thanks for letting me know
You had the right idea, though. It was just mixing them around. I figured you were tired ;)
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