Accretion/Dilution and Maximum Price in a Packaging Acquisition
You are advising a Karachi-listed conglomerate on the acquisition of a private packaging company. The acquirer has 1.20 billion shares, net income of PKR 6.00 billion, and trades at PKR 80 per share (16.0x earnings). The target is expected to earn PKR 900 million next year. The seller will not accept less than PKR 12.0 billion equity value, payable 60% in new debt at 11.0% pre-tax and 40% from cash reserves that currently earn 8.0% pre-tax. The acquirer's tax rate is 29%. Management identifies run-rate pre-tax synergies of PKR 250 million, but the CFO warns that only half is likely in year one. The board wants to know whether the deal is accretive, what maximum price it can pay before EPS dilution, and how sensitive the result is to a 200 bps rise in the debt cost. No goodwill amortisation is assumed.
1. Calculate pro forma EPS at the PKR 12.0 billion price using both full run-rate synergies and year-one synergies. Is the deal accretive?
Read the worked answer
Acquirer standalone EPS = PKR 6.00bn / 1.20bn shares = PKR 5.00.
Purchase price PKR 12.0bn: new debt = 0.60 × 12.0 = PKR 7.20bn at 11%; cash used = 0.40 × 12.0 = PKR 4.80bn at 8% opportunity cost.
After-tax financing cost = [(7.20 × 11%) + (4.80 × 8%)] × (1 − 0.29) = (0.792 + 0.384) × 0.71 = PKR 0.835bn.
Full synergies after tax = 250 × 0.71 = PKR 177.5m. Pro forma net income = 6,000 + 900 + 177.5 − 834.9 = PKR 6,242.6m. Shares remain 1,200m because the consideration is cash/debt. EPS = PKR 5.20, accretion = 4.0%.
Year-one synergies at 50% = 125 × 0.71 = PKR 88.8m. Pro forma net income = 6,000 + 900 + 88.8 − 834.9 = PKR 6,153.9m; EPS = PKR 5.13, accretion = 2.6%.
The deal is accretive on both bases, but the year-one cushion is thin. Accretion is driven by the target's earnings yield of 7.5% (900/12,000) versus the after-tax financing cost of about 7.0% on the consideration, plus synergies.
2. Assuming only half the synergies materialise, what is the maximum equity price the acquirer can pay before EPS dilution?
Read the worked answer
Set pro forma net income equal to standalone PKR 6,000m. Let P be the equity price. Financing cost after tax = [(0.60P × 11%) + (0.40P × 8%)] × 0.71 = (0.066P + 0.032P) × 0.71 = 0.06958P.
Pro forma net income = 6,000 + 900 + 88.8 − 0.06958P = 6,988.8 − 0.06958P.
EPS-neutral condition: 6,988.8 − 0.06958P = 6,000, so P = 988.8 / 0.06958 = PKR 14.21bn.
The maximum price is about PKR 14.2bn, or 15.8x target earnings. That is only 18% above the seller's PKR 12.0bn floor, so the negotiating room is modest. If the board uses full run-rate synergies, the ceiling rises to about PKR 15.5bn, but relying on unproven synergies to justify price is risky.
3. How does a 200 bps increase in the debt cost change the conclusion at the PKR 12.0bn price? What should the board do?
Read the worked answer
New debt cost = 13%. After-tax financing cost = [(7.20 × 13%) + (4.80 × 8%)] × 0.71 = (0.936 + 0.384) × 0.71 = PKR 0.937bn.
With full synergies, pro forma net income = 6,000 + 900 + 177.5 − 937.2 = PKR 6,140.3m; EPS = PKR 5.12, accretion = 2.3%. With half synergies, net income = PKR 6,051.6m; EPS = PKR 5.04, accretion = 0.9%.
The deal remains marginally accretive, but the year-one cushion almost disappears. The board should not treat accretion as the only test. It should stress-test synergy delivery, seek a price reduction or earn-out tied to synergies, and consider a larger cash component if the acquirer has surplus liquidity. If the debt cost rise is likely to be permanent, the maximum price under half synergies falls to about PKR 13.0bn, close to the seller's floor.