Abu Hurayrah quoted Allah’s Messenger (ﷺ) as saying: “Allah laughs at two men, one kills the other and both of them enter Paradise. One fights in Allah’s cause and is killed and Allah forgives the killer and he also dies a martyr.” Allah forgives the killer because he accepted Islam as the Prophet (ﷺ) said: “Islam erases what preceded it.” In this context,

1. When did the killer accept Islam- before or after killing?

2. How did both of them die as martyrs?

Here is another wording of the same Hadeeth. It is much clearer:

Abu Hurairah, may Allah be pleased with him, reported: The Messenger of Allah (ﷺ) said: "Allah laughs at two men, both of whom will enter Paradise (though) one of them kills the other." They said: "Messenger of Allah, how would this be?" He said: "One of them fights in the way of Allah, the Almighty and Exalted, and dies a martyr. Then Allah turns in mercy to the murderer who embraces Islam, fights in the way of Allah, the Almighty and Exalted, and dies a martyr." [1]

So the two men were enemies, one a Muslim and the other a Kafir. The Muslim fighting to uphold Islam dies a martyr's death, thereby entering Paradise. The Kafir, who should be destined for Hellfire, later becomes Muslim and as a result his previous sins are erased. He then goes and fights in the way of Allah and dies a martyr himself thereby also entering Paradise. They were enemies at one stage on the earth, but later die for the same cause. Therefore, this explains Allah's laughter.

And Allah knows best.

Reference:

[1] Sahih Muslim, Book 34, Hadith: 5000