Accretive acquisition definition
/What is an Accretive Acquisition?
An accretive acquisition is one that increases the earnings per share of the acquirer. This is accomplished by offering a lower price for the acquiree than the earnings that the acquiree will contribute to the combined entity. The result is a greater market value for the combined entities than would have been the case if they had remained separate. When this is the case, investors are more likely to bid up the price of the acquirer’s shares. An accretive acquisition is more likely to be the result when the acquirer can identify significant synergies in the acquiree, either by boosting sales through cross-selling or (more commonly) cutting expenses by eliminating redundant costs.
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Example of an Accretive Acquisition
TechNova Inc., a large publicly traded software company, decides to acquire CodeStream Solutions, a smaller private firm known for its innovative cloud-based development tools. TechNova currently has earnings of $500 million and 100 million outstanding shares, giving it an earnings per share (EPS) of $5.00. CodeStream, while smaller, has strong profitability, earning $50 million annually. TechNova offers $400 million in cash to acquire CodeStream, using funds from its strong balance sheet without issuing new shares.
After the acquisition, CodeStream’s earnings are added to TechNova’s financials, raising the combined earnings to $550 million. Since no new shares were issued, the total number of outstanding shares remains at 100 million. The new EPS becomes $5.50 ($550 million ÷ 100 million shares), up from $5.00 prior to the acquisition. This increase in EPS indicates that the acquisition is accretive.
This accretive acquisition benefits TechNova’s shareholders by immediately enhancing the value of their investment. Because CodeStream was acquired at a favorable price relative to its earnings and without diluting the stock, TechNova efficiently increased its profitability per share.
Problems with Accretive Acquisitions
There are a few problems with the accretive acquisitions approach, which are as follows:
Synergies not realized. It is entirely possible that the expected synergies are not realized for various reasons, such as not following through on an integration plan, resistance by acquiree employees, or excessive optimism in setting synergy targets. Consequently, an acquirer needs a great deal of experience in spotting accretive acquisition opportunities, planning for them carefully, and following through to ensure that all planned synergies are actually accomplished.
Limits acquisition opportunities. Some prime acquisition candidates cannot be purchased for a price low enough to yield an accretive acquisition. If senior management is determined to only enter into accretive acquisitions, they may be foregoing any number of strategically valuable acquisition opportunities.