Accretion Follow-Up - Technical Question
Another user posted this question, but it never got completely resolved. Could anyone help figure this one out?
Company A with 100M market cap and P/E of 10 is merging with Company B with 60M market cap and P/E of 20. To whom is the deal dilutive and why? What is the new P/E of the combined entity? What do the synergies have to be worth for it to be dilutive to neither party?
Any insight on this is appreciated.
Edit: To make it easy, lets say they both have 1M shares outstanding. So Company A has a share price of $100, and EPS of 10 since Share Price/EPS = P/E. Company B has a share price of 60 and EPS of 3. Company B is overvalued so the deal is dilutive to Company A because the new share price ought to be $80 (100M + 60M = 160M/2M shares outstanding = $80 share price) and the combined EPS will be 6.5 ((10+3)/2), so the new P/E will be 12.3. Synergies are 3M
Wouldn't the equity of company B have to be wiped out? How would one mathematically arrive at 3M?
Repost to fix typos:
Just for the sake of answering the question (tho per the below, I think you might want to discuss more high level concepts), it's as simple as this:
Company A We know: Market Cap = 100 P / EPS = 10 Earnings yield is the inverse, so 1/10 = 10% That means, Market Cap / Earnings = 10 (since P/E = 10) So, 100 / Earnings = 10, or Earnings = 10
Company B We know: Market Cap = 60 P / EPS = 20 Earnings yield is the inverse, so 1/20 = 5% That means, Market Cap / Earnings = 20 (since P/E = 20) So, 60 / Earnings = 20, or Earnings = 3
We assume, All stock deal
Calcs, Company A issues $60MM of stock to pay Company B's shareholders, so Company A PF market cap is $160MM. Company A takes control of company B's cash flows, so PF earnings are 10 + 3 = 13MM.
Now, our pre-synergy PF P/E multiple is $160MM / $13MM = 12.3x, so our PF yield is 1 / 12.3 = 8%.
If we want the deal to not be dilutive to either of the companies, we need to maintain the higher yield. If we know Company A has the higher yield (10%), we need to aim to maintain their P/E multiple (10x).
Our PF market cap is $160MM and target PF P/E is 10x, so our target Earnings is $160 MM / 10x = 16MM. Per the above, we have $13MM pre synergies, so we need $3MM in synergies.
Questions and answers: 1. It is dilutive to whoever has the highest earnings yield, or Company A (10% vs 5% from Company B) 2. You need $3MM of synergies at the earnings level, so you can maintain the higher yield P/E multiple. That means, the deal will be neutral to Company A but dilutive to Company B.
Hope this helps.