There are various reasons to engage in an acquisition, and there are various ways to achieve this type of transaction. For many companies, acquiring another company is a strategic move that is meant to add to the acquiring company’s production lines, increase its service offerings, or improve its research and development capacity. In some cases, however, an acquisition merely serves to eliminate the competition. And, in other instances, acquisitions are sought for simple financial reasons with the goal of driving up value, without as much emphasis on how the companies can combine forces on the basis of their market niche or client base. An example of a value-driven deal is an accretive acquisition, as explained below.
An Explanation of Accretive
To understand an accretive acquisition, it is important to first understand the meaning behind the word accretive, as that is likely not a part of most people’s daily vocabulary. Accretion entails growth that occurs due to gradual addition or accumulation. For example, there can be an accretion of snow throughout a winter storm. In the financial world, accretion generally refers to a gradual increase in earnings due to some investment or transaction. Therefore, an accretive acquisition is generally one in which the acquiring company’s earnings are increased due to the acquisition of the target entity.
Smaller Company, Higher Earnings Per Share
The reason that an accretive acquisition adds value to the acquiring company’s earnings is usually because the target company, perhaps a smaller entity, will have higher earnings per share as compared to the acquiring company. As a result, when the lower and higher earnings per share are combined, the final earnings per share should be higher, provided that the cost to purchase the entity was low enough to create this net gain. However, these deals sometimes flounder because there is too much focus on finagling the numbers and insufficient focus on integrating the two entities to ensure that the value will continue to be realized.
Consolidate the Proforma EBITDA/Earnings, Increase the Overall EBITDA/Earnings
Another way to understand this type of complex acquisition is by thinking about each company’s earnings before interest, tax, depreciation, and amortization, which is usually known by its acronym, EBITDA. Corporations often evaluate their operational performance based on their EBITDA, without taking into consideration many of their financial obligations.
In an accretive acquisition, when the acquiring company purchases the target company, the two companies’ EBITDA will essentially be combined, which should result in an increased overall EBITDA, thereby resulting in an increase in value. Again, there may be an initial increase in value, but if the transaction does not plan for proper integration, this value may soon decline.