# Accretion / Dilution Analysis
In 2019, when Bristol-Myers Squibb closed its $74 billion acquisition of Celgene, management led with a single number: the deal would be more than 40% accretive to EPS in the first full year. Analysts nodded. The stock, which had cratered when the deal was announced, recovered. Yet three years later, plenty of shareholders were still asking whether the deal actually *created* anything, or whether BMS had simply bought a stream of earnings with cheap debt and a lot of stock, mechanically boosting per-share numbers while adding enormous patent-cliff risk.
That gap—between a deal that lifts EPS and a deal that lifts value—is the entire subject of this lesson. Every acquirer runs the accretion/dilution test. The junior banker builds the model in an afternoon. The CFO's job is to know what the model is *hiding*.
Accretion/dilution is arithmetic before it is strategy. You are comparing the acquirer's standalone EPS to the pro forma combined EPS after the deal closes. If pro forma EPS is higher, the deal is accretive; if lower, dilutive.
The pro forma numerator is the combined net income of both companies, adjusted for the *financing consequences* of the deal:
The denominator changes only if you issue stock. Pay all-cash and the acquirer's share count is unchanged. Pay in stock and you issue new shares at an exchange ratio, inflating the denominator.
This is why the method of payment drives the result more than the strategic logic does. A single, unforgiving heuristic governs stock-financed deals:
> If the acquirer's P/E is higher than the target's effective P/E (the offer price divided by target earnings), the deal is accretive. If lower, dilutive.
A company trading at 25x earnings buying a company at 15x is, in pure EPS terms, converting the target's cheaper earnings into its own richer multiple. Accretion appears almost automatically—which should immediately make you suspicious, because nothing about relative multiples tells you whether you paid a fair price.
Cash and debt deals follow a cruder rule: the deal is accretive if the after-tax earnings yield of the target (target net income ÷ purchase price) exceeds the after-tax cost of the financing. With investment-grade debt at 5% pre-tax—call it 3.9% after tax—almost any target throwing off a normal earnings yield clears that bar in a low-rate environment. This is precisely why the 2010s produced a wave of "accretive" acquisitions: money was nearly free, so the accretion hurdle was trivially low. That environment is gone, and CFOs who internalized easy accretion are now recalibrating.
Before you trust any output, rebuild the synergy assumptions yourself. The most common way an accretion model lies is by front-loading synergies that arrive years later, if at all. A disciplined CFO forces two adjustments:
1. Phase the synergies. Cost synergies rarely hit full run-rate in Year 1. Model a realistic ramp (30% / 70% / 100%) and show accretion in each year, not just the "full run-rate" fantasy year that appears in the press release.
2. Net out the cost to achieve. Integration costs, severance, and system consolidation are real cash outflows. A deal that is accretive on run-rate synergies can be dilutive for two years once you honestly load the integration bill.
Here is the intellectual core of the lesson, and the thing that separates the CFO from the model-builder. EPS accretion and NPV are answering different questions.
Accretion asks: *does this transaction raise earnings per existing share in the near term?* Value creation asks: *is the price we paid less than the discounted value of the cash flows and synergies we will receive?* These can point in opposite directions, and frequently do.
Consider three ways accretion misleads:
1. Accretion can be manufactured by capital structure, not performance. Fund an acquisition with debt cheaper than the target's earnings yield and you get accretion regardless of whether the business is any good. You have not created value; you have levered the balance sheet and relabeled the financial risk as EPS growth. The accretion is real; the value creation is a question the EPS number cannot answer. When rates rise, the same deal flips to dilutive—proving the accretion was a financing artifact all along.
2. Accretion ignores the multiple you're putting at risk. Suppose a high-quality software company at 30x buys a slow-growth services business at 12x. The math is accretive. But the market may re-rate the *combined* company toward a blended multiple, because you have diluted the quality of your earnings mix. You gained EPS and lost multiple. The stock can fall on an accretive deal—which is exactly what happened to plenty of "diversifying" acquirers who bought their way into lower-quality earnings. Accretion measured the numerator; the market repriced the whole equation.
3. Accretion says nothing about the control premium. You can overpay wildly and still show accretion if you fund with enough cheap debt or high-multiple stock. The premium you paid over intrinsic value is destroyed value on day one—but it never appears in an EPS bridge. Only a DCFDCFDiscounted Cash Flow (DCF) is a valuation method that estimates an asset's value by projecting future cash flows and discounting them to present value using a required rate of return.View full definition → or a returns-based test (is the deal's IRRIRRThe Internal Rate of Return is the discount rate that makes a project's net present value equal zero. It expresses an investment's expected annualized return.View full definition → above the acquirer's cost of capital? does ROIC exceed WACC by year three?) catches it.
The CFO's discipline is to run accretion/dilution as the *communication and financing-feasibility* test, and to run value creation as the *decision* test. Accretion tells you what you'll have to explain to the Street next quarter. NPVNPVNet Present Value is the sum of an investment's future cash flows discounted to today, minus the initial outlay. A positive NPV signals value creation.View full definition →, IRRIRRThe Internal Rate of Return is the discount rate that makes a project's net present value equal zero. It expresses an investment's expected annualized return.View full definition →, and ROIC-versus-WACC tell you whether you should do the deal at all.
In stock deals, the fixed-vs-floating exchange ratio is a risk allocation decision hiding inside the accretion model. A fixed exchange ratio locks the number of shares issued; the target bears the risk that your stock falls before close, and you bear the risk that your stock rises (you overpay). A fixed value (floating ratio) locks the dollar value; you issue more shares if your stock drops, which erodes accretion precisely when you can least afford it. When you present accretion to your board, you must present it against the *plausible range* of your own share price at close, not a single point. An accretive deal at today's price can be dilutive at a share price 15% lower—and your own stock often *falls* on announcement of a large stock deal.
The analyst hands you a model showing 8% Year-1 accretion. Your job is a structured interrogation.
Step one: strip it to breakeven logic. Ask for the *synergy breakeven*—the level of synergies at which the deal is exactly neutral to EPS. If the model needs $400M of synergies to break even and management is promising $450M, you have almost no margin for error. If breakeven is $150M against a $450M promise, you have real cushion. This single reframing tells you more about deal risk than the headline accretion number.
Step two: pressure-test the financing. Rebuild accretion at a higher interest rate and a lower acquirer share price simultaneously. This "double stress" reveals how much of the accretion is genuine versus borrowed from favorable market conditions. If a 100bp rate increase erases the accretion, you are not buying a business; you are making a bet on the rate curve.
Step three: reconcile accretion to returns. Put the accretion bridge next to the ROIC-vs-WACC math. If a deal is accretive but ROIC stays below WACC through Year 3, name that explicitly for the board: *"This lifts EPS but does not clear our cost of capital until Year 4. We are accepting near-term optics for a longer value payback."* That sentence is the whole reason a CFO exists in a deal room.
Step four: decide what you'll tell the Street—and stress-test the narrative. IR will lead with accretion because the buy-side models it. But if you anchor guidance to Year-1 accretion built on aggressive synergies, you have handed the market a stick to beat you with every quarter you miss the ramp. Sophisticated CFOs guide to accretion *cautiously phased and net of integration cost*, then beat it. The accretion number is as much a credibility instrument as an analytical one.
Step five: know when dilution is the right answer. Some of the best deals are dilutive for two or three years—a high-growth target whose earnings are small today but compounding fast. Refusing every dilutive deal is how incumbents miss the acquisitions that would have saved them. The question is never "is it accretive?" It is "does the value created justify the near-term dilution, and can I fund and explain that dilution without breaking my credit profile or my equity story?"
Knowledge check
1. What is the central distinction the lesson draws between an accretive deal and a value-creating deal?
2. Why does the lesson claim that method of payment drives the accretion/dilution result more than the strategic logic does?
3. In building the pro forma numerator, why are revenue synergies typically 'haircut hard' relative to cost synergies?
4. Select ALL correct answers about adjustments made to the pro forma net income (numerator) in an accretion/dilution analysis.
Select all the correct answers.
5. Select ALL correct answers about what a strong accretion result may be concealing, according to the lesson.
Select all the correct answers.
Think of accretion/dilution and value analysis as two instruments on the same dashboard. The four combinations tell you what kind of deal you are actually looking at:
The entire skill is refusing to let the first word in each pair—the accretion signal—decide the deal by itself. Accretion is the noise the market hears first. Value is the signal you are paid to read.
1. Treat accretion/dilution as a financing-feasibility and communication test, never as the go/no-go decision. The decision belongs to NPVNPVNet Present Value is the sum of an investment's future cash flows discounted to today, minus the initial outlay. A positive NPV signals value creation.View full definition →, IRRIRRThe Internal Rate of Return is the discount rate that makes a project's net present value equal zero. It expresses an investment's expected annualized return.View full definition →, and ROIC-versus-WACC. Run both; report the tension between them to your board explicitly.
2. Interrogate every accretion model with the synergy breakeven. The gap between breakeven synergies and promised synergies is your true margin of safety—far more informative than the headline accretion percentage.
3. Double-stress the financing. Recompute accretion at higher rates and a lower acquirer share price together. Accretion that evaporates under stress was a bet on market conditions, not a bet on the business.
4. In stock deals, present accretion across a share-price range, not a single point, and understand how your fixed or floating exchange ratio shifts the risk of overpayment before close.
5. Be willing to defend a dilutive deal when the value case is strong—and to reject an accretive one when it isn't. The CFOs who conflate "accretive" with "good" are the ones who lever up on cheap debt at the top of the cycle and explain the writedown three years later.