# LBO valuation & accretion/dilution analysis
When Mars Inc. announced its $35.9 billion all-cash acquisition of Kellanova in August 2024, the deal was financed entirely with cash and debt, no equity issuance, no share dilution to existing Mars family owners. Compare that to Capital One's $35.3 billion bid for Discover Financial, structured as an all-stock deal that, on day one, was projected by CFO Andrew Young to be 15% accretive to EPS by 2027. Same headline price. Radically different shareholder math. The difference between these two structures, and whether the board approves or kills the deal, comes down to two models every CFO must master: the accretion/dilution analysis and the LBO model.
In 2026, with the Fed funds rate hovering around 4.0% after the 2024-2025 cutting cycle, leveraged finance markets reopening, and OECD Pillar Two's 15% global minimum tax now fully reshaping cross-border deal math, getting these models right is the single highest-leverage skill in corporate development.
Before a banker pitches synergies or an integration consultant draws an org chart, the audit committee wants one number: Does this deal grow or shrink pro forma EPS?
The framework is deceptively simple but the devil lives in the assumptions.
Pro forma EPS = (Acquirer Net Income + Target Net Income + After-tax Synergies − After-tax Incremental Interest − After-tax Foregone Interest on Cash − Incremental D&A from Write-ups) ÷ (Acquirer Shares + New Shares Issued)
The deal is accretive if pro forma EPS > standalone acquirer EPS. Dilutive if not.
Three financing levers drive the answer:
1. Cash consideration: You lose the after-tax interest income on cash deployed (in 2026, roughly 4.5% pre-tax on T-bills × (1 − 25% tax) ≈ 3.4% drag).
2. Debt consideration: You add after-tax interest expense. Investment-grade acquirers can issue 10-year notes at ~5.2% in current markets; high-yield is closer to 7.5-8.5%.
3. Stock consideration: You issue new shares at the acquirer's current price, diluting the denominator.
The simple breakeven rule every CFO should memorize: in an all-stock deal, accretion occurs when the target's earnings yield (Target Net Income / Equity Purchase Price) exceeds the acquirer's earnings yield (1/Acquirer P/E). High-multiple acquirers buying low-multiple targets almost always print accretion on paper. This is exactly why Constellation Software has been a serial accretive acquirer for two decades, buying vertical-market software companies at 6-8x EBITDAEBITDAEBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) measures a company's operating profitability before financing and accounting decisions, used to compare core performance across firms.View full definition → using stock trading at 25x+.
Let's reverse-engineer the Capital One announcement. At deal pitch (February 2024):
Pro forma 2027 net income (illustrative): $5.5B (COF) + $4.0B (DFS) + $2.0B synergies = $11.5B
Pro forma shares: 381M + 262M = 643M
Pro forma EPS: ~$17.90 vs. standalone ~$15.50 → ~15% accretive
Note what made this deal work: Discover's earnings yield (~9%) substantially exceeded Capital One's (~7%), AND the synergy case was credible because of overlapping payment-network infrastructure.
Three traps cause Monday-morning accretion to become year-three dilution:
When KKR, Apollo, or Thoma Bravo bid against a strategic acquirer, they're solving a fundamentally different equation. A strategic asks: "What does this add to my EPS?" A sponsor asks: "What price can I pay and still hit a 20%+ 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 → on my equity check?"
The LBO model inverts valuation. You don't compute price from cash flows, you compute price from required returns.
Step 1: Sources & Uses. In 2026's market, sponsors typically finance with:
Step 2: Operating Model. Project 5 years of revenue, EBITDAEBITDAEBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) measures a company's operating profitability before financing and accounting decisions, used to compare core performance across firms.View full definition →, capexcapexCapital Expenditure (CapEx) is money spent to acquire, upgrade, or extend long-lived assets like equipment, property, or software that deliver value over multiple years.View full definition →, working capitalworking capitalWorking capital is the difference between a company's current assets and current liabilities, measuring short-term liquidity and the funds available to run daily operations.View full definition →, and taxes. The cash flow available for debt paydown = EBITDAEBITDAEBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) measures a company's operating profitability before financing and accounting decisions, used to compare core performance across firms.View full definition → − Cash Taxes − CapexCapexCapital Expenditure (CapEx) is money spent to acquire, upgrade, or extend long-lived assets like equipment, property, or software that deliver value over multiple years.View full definition → − ΔWC − Cash Interest.
Step 3: Debt Schedule. Model mandatory amortization (typically 1% per year on TLB), cash sweep (50-100% of excess cash), and revolving credit usage. Track debt balances year-by-year, this drives the exit equity value.
Step 4: Exit. Apply an exit EBITDAEBITDAEBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) measures a company's operating profitability before financing and accounting decisions, used to compare core performance across firms.View full definition → multiple (almost always assumed equal to or below entry, a sponsor pitching multiple expansion to an LPLPA standalone web page built for a single campaign goal, designed to maximise conversions by removing distractions and focusing visitors on one action.View full definition → is laughed out of the room). Exit equity value = Exit Enterprise Value − Net Debt at exit.
Step 5: IRR/MOIC. Solve for returns. Target: 20%+ 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 →, 2.5-3.0x money-on-money over 5 years.
In April 2024, Thoma Bravo announced a £4.3 billion ($5.3B) take-private of UK cybersecurity firm Darktrace at £6.20/share, a 44% premium to the undisturbed price. Let's deconstruct.
Approximate deal math:
For Thoma Bravo to hit a 22% 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 → over 5 years, they need to roughly 2.7x their equity to ~$8.9B. Working backward: if exit revenue multiple compresses to 5.5x and revenue grows from $820M to $1.7B (16% CAGR), exit EV ≈ $9.4B. Net debt at exit (after 5 years of sweep) might be $1.0B, giving equity of $8.4B. Tight, but achievable, and explains why Thoma Bravo specifically (with deep enterprise software playbook) could pay a price strategic acquirers wouldn't touch.
When a sponsor's deal team presents to the IC, they don't show 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 →. They show:
| Exit Multiple | 5-Yr Revenue CAGR | Implied 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 → |
|---|---|---|
| 5.0x | 12% | 14% |
| 5.5x | 16% | 22% |
| 6.0x | 20% | 29% |
The price they bid is the price at which the base case clears their 20% hurdle. That's the entire game.
Knowledge check
1. According to the accretion/dilution framework, when is a deal considered accretive?
2. In an all-stock deal, what does the 'simple breakeven rule' say about when accretion occurs?
3. Why does deploying cash as consideration create a drag on pro forma EPS?
4. Select ALL of the financing levers that directly affect the accretion/dilution outcome as described in the lesson.
Select all the correct answers.
5. Select ALL statements that correctly reflect the reasoning in the lesson about deal structures and EPS.
Select all the correct answers.
In 2026's auction processes, strategic CFOs are increasingly losing deals to sponsors, or paying egregious prices to win. Understanding the sponsor's math is your competitive weapon.
You have three weapons a sponsor doesn't:
1. Synergies: A sponsor models the target standalone. You model target + synergies. If revenue synergies + cost synergies = $200M after-tax, and you capitalize them at 10x, that's $2B of value you can pay over the sponsor's max bid.
2. Lower cost of capital: Your WACC might be 8%; the sponsor's required equity return is 20%+. You can rationally pay more for the same cash flow stream.
3. Tax-efficient structures: Section 338(h)(10) elections, stock-for-stock tax-free reorgs, and NOL utilization can shift hundreds of basis points of value.
The best corporate development teams, Microsoft's under Amy Hood, Danaher's under Matt McGrew, run both models in parallel on every target:
If your accretion analysis shows you can rationally bid $50/share but the LBO floor is $48/share, you have $2 of negotiating room. If the LBO floor is $52, you're going to lose the auction, or need to find another $400M of synergies to justify matching.
In the last 18 months, "AI-driven cost synergies" have entered every M&A model. Be skeptical. When Cisco closed Splunk in March 2024 for $28 billion, CFO Scott Herren guided to $1B+ of run-rate synergies including AI-driven SG&A reduction. The market gave Cisco credit only after the first quarter of post-close numbers actually showed the cost line moving. Until AI synergies have a track record across multiple deals, model them at 30-50% of management case.
These actions are compiled in the role's Playbook.