How to build an accretion/dilution model ?

An accretion/dilution model is a key tool in mergers and acquisitions (M&A) to assess the financial impact of a transaction on the acquirer’s earnings per share (EPS). This analysis helps determine whether the deal will result in an accretive transaction (increased EPS) or a dilutive transaction (decreased EPS). Below is a step-by-step guide to building an accretion/dilution model.

Understand the Key Inputs

Before building the model, gather the following inputs:

• Acquirer Information: current EPS, current net income, number of shares outstanding, stock price and P/E multiple

• Target Information: current net income, valuation (purchase price or enterprise value), debt levels and cash reserves

• Deal Information: purchase price and premium, payment mix (cash, stock, debt), cost of debt (interest rate) if the deal involves financing, synergies (cost savings or additional revenue expected post-transaction)

Calculate the total purchase price

Equity Value: multiply the target’s share price by the number of shares outstanding. Add a premium if applicable.

Enterprise Value: add the target’s debt to the equity value and subtract its cash.

Consider payment mix:

• Cash: How much of the purchase price will be paid in cash.
• Stock: Number of new shares issued (calculated by dividing the stock consideration by the acquirer’s share price).
• Debt: Amount of debt issued to finance the transaction.

Estimate pro forma net income (NI)

Pro forma NI = Target's NI + Synergies - Interests - Amortization - Tax impact 

Target’s Net Income: Add the target’s net income to the acquirer’s net income.

Synergies: Add any expected synergies to the combined net income.

Interest Expense: Subtract the interest expense from any debt financing used in the deal.

Amortization of Intangibles: Deduct amortization expenses from intangibles such as goodwill or customer relationships.

Tax Impact: Account for the tax shield from interest expense and other tax adjustments.

Calculate pro forma shares outstanding

Add the acquirer’s existing shares to any new shares issued as part of the deal.

 pro forma shares outstanding = existing shares + new shares issued

Calculate pro forma EPS

Divide the pro forma net income by the pro forma shares outstanding:

pro forma EPS = Pro forma NI \ shares outstanding

Compare EPS to determine accretion/dilution

Compare the pro forma EPS to the acquirer’s standalone EPS:

• If the pro forma EPS > standalone EPS, the deal is accretive
• If the pro forma EPS < standalone EPS, the deal is dilutive

Run sensitivity analysis

To fully understand the impact of the transaction, perform a sensitivity analysis by varying key assumptions, such as:

• Synergies
• Cost of debt
• Payment structure (cash vs. stock)
• Premium paid for the target

Best Practices

• Ensure assumptions are realistic, especially regarding synergies and financing terms
• Validate inputs with market data and financial statements
• Use a modular approach to allow quick adjustments to assumptions