Accretive Mergers Explained

As merger mania heats up, corporate managers can be found in boardrooms around the world extolling the virtues of each deal. Among other things, they stress the accretive nature of the merger. What this means is that the deal will create an increase in earnings per share. Sure, combining the earnings of one company with that of another company increases earnings overall but that doesn't necessarily mean that shareholders will earn more on each share of stock. For example, if I own ten shares of stock and I earn one dollar per share, I would hope that after the merger, that one dollar per share would increase to, say, two dollars.

 

Accretion can occur by growing the combined revenues of the two companies. In other words, 1 + 1 = 3. This occurs when combining forces leads to product or expansion opportunities that would not have existed had the two companies remained separate. For example, company A sells trucks and company B sells trailers. Post-merger, they create a truck-trailer product and sell hitches on top of it all. Revenues soar as do earnings which makes the deal accretive. Another way to create earnings accretion is to reduce expenses. Suppose company A has an expansive research and development facility and company B has several research and development facilities of its own. By combining forces, the new company can eliminate redundancy and cut expenses by consolidating research and development into one operation. This flows through to the company's earnings making the deal accretive.

 

Not all deals are accretive even though corporate managers hope to achieve this. Often, competitive forces or merger integration costs will impede efforts to make a deal accretive. When analyzing mergers, remember that achieving earnings accretion is easier said than done.

 

Reuben Advani is the president of The BARBRI Financial Skills Institute and the author of two finance books. More information on this and other topics can be found at http://legalpractice.barbri.com.

 

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