The Acquisition That Looks Accretive but Isn't
Ridgeline Manufacturing (market cap $480M, 40M shares at $12) is considering acquiring Corva Components for $300M cash. Corva has EBITDA of $40M, EBIT of $28M, and net income of $18M. Ridgeline's current EPS is $1.00 and its after-tax cost of debt is 4.5%. Ridgeline would fund the deal with new debt at 6.0% pretax (tax rate 25%), incurring $18M annual interest. The CFO's slide deck shows 'pro forma EPS of $1.07' and calls the deal accretive. A board member notices the deck uses Corva's net income without adjusting for the incremental interest and without any synergies. Separately, the integration team warns that $25M of Corva's reported EBITDA is concentrated in two customers whose contracts expire within 18 months.
1. Recompute the pro forma EPS and assess whether the deal is genuinely accretive to economic value.
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Pro forma EPS math:
- Combined net income = Ridgeline NI (40M × $1.00 = $40.0M) + Corva NI $18.0M − after-tax incremental interest ($18M × (1 − 0.25) = $13.5M) = $44.5M.
- Shares unchanged at 40M (cash deal).
- Pro forma EPS = $44.5M / 40M = $1.11.
So EPS accretion is real on a mechanical basis ($1.11 vs $1.00), even larger than the deck's $1.07 - but the deck's number is wrong because it omits interest. The correct question is whether accretion reflects value creation.
Economic test: the $300M price is 7.5× EBITDA and 10.7× EBIT. Return on the incremental capital must exceed the 4.5% after-tax cost of debt and the blended WACC. After-tax EBIT of $28M × 0.75 = $21M on $300M = 7.0% pre-synergy return, above the 4.5% debt cost but likely near or below WACC once equity weighting is included. Value creation is thin and depends entirely on the durability of the $25M at-risk EBITDA. EPS accretion funded by cheap debt is not proof of value creation; the exam wants the candidate to separate the two.
2. Given the customer concentration warning, what additional analysis should the board demand before approving?
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The board should require:
- A sensitivity showing pro forma EPS and IRR if the two at-risk contracts (roughly $25M EBITDA, ~62% of total) are lost at expiry. At $15M remaining EBITDA, the deal multiple balloons and the return likely falls below WACC.
- Contract-level diligence: renewal terms, customer switching costs, and any change-of-control clauses.
- A purchase price adjustment or earnout tied to contract retention, or a lower base price reflecting the concentration risk.
- A walk-away analysis comparing the deal to buybacks or debt paydown at the 4.5% after-tax cost.
The judgement point: accretion on a fragile base is not accretion. The board should treat customer concentration as a valuation input, not a post-closing integration problem.