Definition: The decrease that a buyout of another company will have on the acquiring company’s earnings per share.
Example: Devour Company has 1,000,000 shares outstanding. It is expecting to make $400,000 in net income (aka new profit, earnings) this year. That means the earnings per share will be $400,000/$1,000,000, or $.40. Let’s say that it has a chance to acquire Compco by exchanging with current Compco shareholders 200,000 new shares in its company for all of the outstanding shares of Compco. Let’s also say that Compco is expected to earn $20,000 in profit this year. After the buyout, Devour will have 1,200,000 shares outstanding, but it will also own Compco and all the profits it will achieve. The total profit for the combined company will be $420,000. Dividing $420,000 by 1,200,000 shares that will be outstanding results in earnings per share of $.35. Buying out Compco will cause a drop of $.05 in Devour’s earnings per share, making it dilutive to earnings.
Investeach explains: Companies usually pay a premium for the companies they acquire to motivate owners of the target company to give up their shares. This results in a buyout that is initially dilutive to earnings. This is the reason why, when a buyout offer is announced, the share price of the acquirer usually falls and the price of the target company usually rises. The thinking of the management of the acquiring company is that as cost savings and other synergies are achieved over time, the buyout will prove to have been the right decision.
Riddle me this:
1. To determine whether an acquisition will be dilutive, what do we examine before and after the buyout?
2. Why are acquisitions normally dilutive to earnings?
3. What will probably happen when a company seeking to acquire another company makes an offer that will be dilutive to earnings?
Opposite of: Accretive.