Why are all-cash M&A deals usually accretive deals?
I was looking at a small deal involving purely cash and thought about management's focus on EPS accretion and how it will likely be accretive due to the cash. Is the answer as simple as cash being the cheapest form of M&A financing?
On average all cash M&A is a move used by large strategic acquirers/publics with big balance sheets, who tend to actually realize synergies and let them unfold versus sponsors who lever up businesses to boost valuation before sale in 5 years. There are financial reasons like those you mentioned but I’d say this factors in quite a bit as well.
Let’s say for the purposes of an interview Company A acquires Company B (majority debt and will pay 80% now and the remaining 20% in 2 years). The strategic rationale is revenue synergies as a result of geographic expansion (120 countries in target) and increased production capacity by 20%. After the deal is announced, Q3 earnings come out and everything from revenue to earnings is down due to a global slowdown in the sector. This implies that the next Q4 earnings (after deal closing) will also likely be down because this slowdown is substantial and will likely not revert until some time. Would it be fair to say in the interview then that this deal will be dilutive to EPS in the short-term but accretive in long-term as the synergies take hold? Thanks for your help before!
There are 2 ways to think about it. You can think about the math behind EPS acc / dil and see that unless the target has and is projected to have negative EPS then cash deals are accretive as forgone interest on cash is usually very low vs interest on debt and adding new shares issues in the denominator of the EPS calc has higher impact. The reason why (and second way to think about it) revolves around cost of funding and earnings yield of asset bought. Earnings yield is target's inverted P/E multiple so you want funding sources with cost less than that of target's yield. Simplistically, the lower you get vs that cost the more accretive deal becomes. Cost of equity is ofc higher than debt and cash so more likely it makes a deal dilutive. An all stock deal ignoring synergies and Tx fees at equalised P/E multiples should give nil dilution. All the above ignore synergies and tx fees. To your question, you can't market the deal as dilutive because the sector is not doing well. With that kind and scale of external shock the buyer would see EPS decline regardless so i wouldn't attribute any dilution effects to the deal or synergies phasing etc.
Simple answer is just division math - you are gaining additional earnings (higher numerator) but not issuing any shares (same denominator).
The cash you are adding in additional earnings is almost always > than the cost of servicing additional debt. Lots of reasons to pay in equity, but for accretion all cash will win every time.
Yes, the after tax cash yield is less you would earn than the earnings yield of the target. That’s it
Interest rate earned on cash is usually less than yield (E/P) acquired ? I think is another way to think about it
The opportunity cost of cash is 2-3% return on cash and marketables. If target earnings yield (EPS/P or 1/PE) is higher than that, then deal will be accretive.
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