Pro-Forma EPS

"What-if" EPS

What is the Pro Forma EPS?

A pro forma EPS is the calculation of EPS assuming the merger and acquisition takes place. “Pro forma” in latin means “for the sake of form.” In this case, it refers to calculating EPS for the sake of form in the event of the acquisition.

Basic EPS is calculated by dividing a firm’s net income by its weighted shares outstanding. The pro forma EPS, on the other hand, adds the target firm’s net income and any additional synergies or incremental adjustments to the numerator, while adding new shares issued due to the acquisition to the denominator.

(Source: Google Finance, Tesla)

Pro Forma EPS Formula:

Pro Forma EPS = (Acquirer’s Net Income + Target’s Net Income +/- “Incremental Adjustments” ) / (Acquirer’s WASO + New Shares Issued)

What this means in regards to M&A

Pro forma EPS is used by the acquiring company to determine what financial outcome they will have by acquiring the target or merging with the target. This also allows the acquirer to determine whether this transaction will be accretive or dilutive, and cause a positive effect in their EPS. Note that simply analyzing an acquisition or merger on the basis of EPS is not recommended, as there are situations where EPS can increase, but the value of the merged firm is lower than the sum of the acquirer and target.

What are the “Incremental Adjustments”?

These are additional value items that are created when the two firms combine:

  • Incremental after-tax interest expenses that come from new debt financing.
  • After-tax synergies (gains in assets).
  • After-tax depreciation and amortization expense (from write-ups).
  • Lost opportunity cost of cash balances if used to finance acquisition.
  • “Saved” after-tax interest expense from liquidation of Target’s debt.
  • “Saved” preferred stock dividend payment from liquidation or conversion of Target’s preferred stock.

For example, a manufacturing company merges with a transportation firm. Due to this merge, the manufacturing firm can save on their original distribution costs, which were initially paid out to a third party. Because they can now use the assets of the transportation, they realize after-tax savings of $50M. The incremental adjustment here is an after-tax synergy arising from those savings of $50M, which did not originally exist when the firms were separate.

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