What is a Dilutive Acquisition?

In a business or company acquisition, the earnings per share (EPS) of the acquiring firm can either decrease or increase depending on the type of acquisition. The dilutive acquisition is one which the EPS of the acquirer declines, there is no increase in the profit margin of the acquiring company. 

When a dilutive acquisition is completed, it might lead to a temporary decline in shareholders value of the acquirer. The decrease in the EPS of the acquirer is due to certain factors such as a negative net income of the acquired, debt-financed acquisition that attracts a higher increase, a low synergy between the companies, and others.

Back To: BUSINESS LAW

How does a Dilutive Acquisition Work?

Negative income in a target company is a major cause of dilutive acquisition. This is because when the greater earning of an acquirer is combined with the weak earnings of the target company, it will create a decrease in the EPS of the acquirer, causing a dilutive acquisition. Dilutive acquisition occurs when the EPS of an acquiring company decreases after completing an acquisition transaction, this also leads to a temporary decline in the shareholder value of the acquirer. 

Dilutive acquisition affects the stock price of a company, this decline is often temporary because the EPS increases in the later years. If during an acquisition, a target company has a huge number of intangible assets that must be amortized, it will create a dilutive acquisition for the acquiring company.

Modeling For Dilution (or Accretion)

It is essential that a financial analyst or an investment bank carries out a painstaking analysis before a firm (client) starts an acquisition process. Through various models, the likely outcome of an acquisition can be determined. In the case of a dilutive acquisition, an accretion or dilution model helps in analyzing an acquisition s to whether it will negatively affect the earnings per share (EPS) of the acquiring firm. When a dilution (accretion) model is used, it entails evaluating the financial statements of the acquirer and the target company. During the analysis, if it is found out that the target firm has lower profitability or has huge debt, dilutive acquisition can occur.

Back to: Business Transactions