Accretion is not a property of the leaseback. It is a comparison between the after-tax cost of the proceeds and what the cash earns, and for a buyback, the share price.
It depends on what the proceeds do, and the test is a comparison of two yields. A sale and leaseback that funds a share buyback is accretive whenever the after-tax cost of the proceeds, rent less the depreciation saved, after tax, divided by the price, is below the company's earnings yield. On an illustrative 80.0 million sale at a 6.0 per cent yield, that cost is 3.37 per cent against an earnings yield of 6.67, so a buyback lifts EPS by 3.11 per cent; repaying 5.5 per cent debt adds 0.67 per cent, and leaving the cash on deposit dilutes EPS by 1.00 per cent.
Worked in full in Sale and Leaseback by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Boards often hear that a sale and leaseback is accretive as if it were a property of the transaction. It is not. The leaseback replaces an asset that cost nothing in the profit and loss account, other than its depreciation, with a rent. Whether earnings per share rise depends entirely on what the cash earns or saves once it arrives, and for a buyback, on the share price.
| Input | Value |
|---|---|
| Sale price, at fair value | 80.0 |
| Leaseback yield / rent, a year | 6.0% / 4.80 |
| Carrying amount of the property | 45.0 |
| Depreciation on the property, saved | 1.2 |
| Tax rate | 25% |
| Net income / shares in issue | 90.0 / 60.0 |
| EPS / share price / P/E | 1.50 / 22.50 / 15.0x |
| Cost of debt repaid / interest on cash | 5.5% / 3.0% |
Change in pre-tax profit = −rent + depreciation saved + income or interest saved on the proceeds
New EPS = (net income + change × (1 − tax)) ÷ (shares − shares bought back)
Buyback accretive if (rent − depreciation saved) × (1 − tax) ÷ proceeds < 1 ÷ P/E
In Excel, with proceeds in B2, yield in B3, depreciation saved in B5, tax in B6, net income in B7, shares in B8 and price in B10: =(B7+(-B2*B3+B5)*(1-B6))/(B8-B2/B10).
Before the proceeds are used, the trade costs 4.80 of rent less 1.2 of depreciation no longer charged: 3.60 pre-tax, 2.70 after tax. Spread over 80.0 of proceeds, that is a pre-tax cost of 4.50 per cent and an after-tax cost of 3.37 per cent. Everything that follows compares that figure with the return on the cash.
| Use of the 80.0 | Pre-tax change | Net income | Shares | EPS | Change |
|---|---|---|---|---|---|
| Before the transaction | 90.00 | 60.00 | 1.500 | ||
| Buy back shares at 22.50 | −3.60 | 87.30 | 56.44 | 1.547 | 3.11% |
| Repay debt at 5.5% | 0.80 | 90.60 | 60.00 | 1.510 | 0.67% |
| Hold as cash at 3.0% | −1.20 | 89.10 | 60.00 | 1.485 | −1.00% |
The buyback retires 3.56 million shares, so net income falls but EPS rises 3.11 per cent: the company has swapped equity with an earnings yield of 6.67 per cent for lease funding costing 3.37 after tax. Debt repayment is accretive only because the 5.5 per cent saved exceeds the 4.50 per cent pre-tax cost of the leaseback, a margin of one point on 80.0. Cash on deposit earns 3.0 per cent against a 4.50 per cent cost and dilutes.
The break-even P/E for a buyback is 1 ÷ 3.37 per cent, or 29.6x. Below that multiple this buyback is accretive; above it, dilutive. The rule says much more about the share price than about the quality of the leaseback.
| P/E | Share price | Yield 5.0% | Yield 6.0% | Yield 7.0% |
|---|---|---|---|---|
| 10x | 15.00 | 7.20% | 6.46% | 5.73% |
| 15x | 22.50 | 3.82% | 3.11% | 2.40% |
| 20x | 30.00 | 2.21% | 1.51% | 0.81% |
| 25x | 37.50 | 1.27% | 0.58% | −0.12% |
| 30x | 45.00 | 0.65% | −0.04% | −0.73% |
A company on 10x earnings shows 5.73 per cent accretion even when it sells at a 7.0 per cent yield, the most expensive leaseback in the table. A company on 30x shows dilution at 6.0 per cent. Neither result says whether the leaseback was priced well; for that, the rent has to be compared with the company's own cost of secured borrowing, as in whether a sale and leaseback is cheaper than a mortgage.
A seller reporting under IFRS 16 does not book the rent. It books a lease liability, here 48.18 at a 5.5 per cent incremental borrowing rate over a 15-year lease, and a right-of-use asset measured as the share of the old carrying amount it keeps: 45.0 × 48.18 ÷ 80.0 = 27.10. Year one charges depreciation of 1.81 and interest of 2.65, 4.46 in all, slightly below the 4.80 rent, because the right-of-use asset sits on the low book value. Of the 35.00 total gain, only 13.92 is recognised at the sale. The buyback case then shows 3.41 per cent accretion in year one; by the final year the charge is down to 2.06 as the interest runs off.
US GAAP differs. Under ASC 842, if the transfer qualifies as a sale and the leaseback is an operating lease, the seller recognises the whole 35.00 gain at once, adjusted for any off-market terms, and charges the rent on a straight-line basis, which is the presentation used in the main table.
Counting the gain. The 13.92 of gain recognised under IFRS 16 adds 0.185 to EPS in the year of the sale, more than the whole recurring accretion of the buyback, and it never recurs; the full gain recognised under US GAAP adds more still. Presentations that show “EPS up” in the transaction year often owe most of it to the one-off gain. Strip it out, compare the recurring effect against the cost of the funding, and remember that the lease is a fixed charge that ranks ahead of the shareholders whose EPS it raised.
A leaseback that funds a buyback is accretive when its after-tax cost, here 3.37 per cent, is below the earnings yield; one that repays debt is accretive when its pre-tax cost, 4.50 per cent, is below the interest saved. Sale and Leaseback prices the same transaction from the buyer's side, building by building; the free workbook for this case includes the seller and IFRS 16 arithmetic.
When the proceeds earn or save less than the lease costs. On an illustrative 80.0 million deal at a 6.0 per cent yield, the pre-tax cost net of depreciation saved is 4.50 per cent; cash left on deposit at 3.0 per cent cuts EPS by 1.00 per cent, and a buyback becomes dilutive above a P/E of 29.6x.
Yes, in timing. The seller books depreciation on a right-of-use asset measured from the old book value plus interest on the lease liability. In the illustrative case year one charges 4.46 against a rent of 4.80, so the buyback shows 3.41 per cent accretion instead of 3.11, and a one-off gain of 13.92 is recognised at the sale.
Not in the recurring figure. In the illustrative case the 13.92 gain recognised under IFRS 16 adds 0.185 to EPS in the year of the sale, more than the buyback's recurring accretion, and it does not repeat. Analysts and boards should judge the leaseback on the recurring effect.
This article is one calculation from Sale and Leaseback. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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