Proforma Earnings per Share (EPS)

What are Proforma Earnings per Share (EPS)?

Proforma earnings per share (EPS) is the calculation of EPS assuming a merger and acquisition (M&A) takes place and all financial metrics, as well as the number of shares outstanding, are updated to reflect the transaction. “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)

Proforma Earnings per Share EPS Formula:

Here is the formula for proforma earnings per share:

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

What Proforma Earnings per Share Mean in M&A

Proforma EPS is used by the acquiring company to determine the 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 on 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, which impact proforma earnings per share:

• 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 the acquisition.
• “Saved” after-tax interest expense from the 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.

Example of Proforma Earnings per Share Calculation

Here is a simple example of how to calculate proforma earnings per share (EPS) in an M&A transaction.

Here is a breakdown of what’s happening in the table above:

1. The acquirer has total earnings of $5,000 and shares outstanding of 2,500, which results in earnings per share (EPS) of $2.00.
2. The target company being acquired has total earnings of $2,000 (their number of shares outstanding is irrelevant since it’s being acquired).
3. In the “Adjust” column, the acquirer is issuing 675 news shares and handing them over to the target to complete the acquisition.
4. There are no adjustments to the earnings of either company as a result of the transaction (this is to keep it simple, but in reality, there can be).
5. The Proforma column takes the sum of all earnings and divides it by the sum of all shares outstanding to get proforma EPS of $2.20.
6. Accretion (if positive) and Dilution (if negative) is the percent change in EPS after the transaction, compared to what the acquirer had before the transaction.

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More relevant resources

We hope this has been a helpful guide to calculating proforma earnings per share (EPS).  To keep expanding your knowledge and complete your quest of becoming a world-class financial analyst, these additional resources may be helpful:

• M&A Effects
• M&A Complexity
• Proforma Earnings Per Share Template
• Guide to the M&A Process
• See all valuation resources