Accretive and dilutive acquisitions

The Wall Street Journal reported the following on 10/21/08 regarding Exelon's unsolicited bid for NRG:

NRG should push for better terms. Yet persuading Exelon to play ball could be tough. Based on enterprise value, Exelon is offering roughly 6.5 times 2008 Ebitda. Having also taken a battering, Exelon's own multiple is only about seven times, so there is little room to sweeten the deal before it starts looking dilutive on that measure.

What does it mean to be dilutive? In an all-stock deal, if a company acquires a target with a lower P/E ratio, it must be accretive to earnings. Basicially, the target firms earnings a "cheap" enough that the buyer can add them to its own and still come out ahead. In the case above, if Exelon increased the price paid for NRG, that would imply a higher multiple, and if they acquired a firm at a higher multiple than their own (with an all-stock deal) that would be dilutive to earnings, which is viewed negatively by investors. For lack of a better measure, the change in earnings is used as a proxy for value creation (accretion) or destruction (dilution) as a result of the merger. There is a good illustration of this concept at this link.