Case 011Paper LBOsWarm up

Five-minute paper LBO: a logistics company bought at 10x EBITDA of Rs 50 crore with half debt, EBITDA reaches Rs 80 crore, Rs 120 crore of debt is repaid, exit at 10x. What are the MOIC and IRR, and where did the return come from?

TPGSan Francisco · 2015

The situation

Pranjal Logistics runs a fleet of trucks and three warehouses serving consumer goods companies in north India. A fund buys it at 10x EBITDA of Rs 50 crore, funding 50% of the price with debt at 9%. Over five years EBITDA grows to Rs 80 crore and cumulative free cash flow repays Rs 120 crore of debt. The fund sells at 10x at the end of year 5.

The interviewer wants the answer out loud in five minutes, with no calculator.

Your task

Give sources and uses, exit equity, the money multiple and an approximate IRR, and split the gain into its three sources.

Quick check

The multiple is the same at exit as at entry. Does that mean the multiple contributed nothing, or that leverage contributed nothing?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Rs 250 crore of equity becomes Rs 670 crore, 2.68x and an IRR of about 22%. Entry EV is Rs 500 crore, debt Rs 250 crore. Exit EV is Rs 800 crore less Rs 130 crore of remaining debt. Of the Rs 420 crore gain, Rs 300 crore is EBITDA growth at the entry multiple, Rs 120 crore is debt paydown and nothing is multiple expansion.

Step 1What do you say in the first thirty seconds?

Sources and uses, out loud, as three numbers. Rs 50 crore times 10 is Rs 500 crore; half debt is Rs 250 crore; so equity is Rs 250 crore. Then say one thing about the debt so the interviewer knows you saw the interest rate: 9% of Rs 250 crore is Rs 22.5 crore of interest in year 1, which EBITDA of Rs 50 crore covers more than twice. Think of buying a Rs 50 lakh flat with a Rs 25 lakh loan: the first thing a sensible buyer says is how much the EMI is against the rent.

Step 2What comes back at exit?

Exit EV is Rs 80 crore times 10, Rs 800 crore. Debt started at Rs 250 crore and Rs 120 crore was repaid, so Rs 130 crore remains. Exit equity is Rs 800 less Rs 130, Rs 670 crore, which over Rs 250 crore is 2.68x. For the IRR without a calculator, anchor on two facts: 2x in five years is just under 15% and 3x is just under 25%; 2.68x sits two thirds of the way between, so call it about 22%, and say that you are approximating.

The relationship
MOIC=80×10−(250−120)250=670250=2.68×IRR≈22%\text{MOIC} = \frac{80 \times 10 - (250 - 120)}{250} = \frac{670}{250} = 2.68\times \qquad \text{IRR} \approx 22\%
80 x 10exit enterprise value, Rs crore
250 - 120debt remaining after cumulative repayment
250equity invested at entry
What it says in wordsExit equity of Rs 670 crore on Rs 250 crore is 2.68 times the money, which over five years is roughly 22% a year.
Step 3Where did the Rs 420 crore of gain come from?

Three places, and only three. EBITDA growth of Rs 30 crore at the entry multiple of 10x is Rs 300 crore; the multiple did not move, so it adds nothing; and debt fell by Rs 120 crore, which is now equity. Rs 300 plus 0 plus 120 is Rs 420 crore, the gain. Saying this split unprompted is what separates a candidate who did the arithmetic from one who understands the deal.

Where a buyout return comes from: growth, multiple, paydown, Rs crore of equity250Entry equity+300EBITDA growth+0Multiple change+120Debt paid down670Exit equity(80 - 50) x 1010x in, 10x out250 - 130670 / 250 = 2.68x in five years, about 22% a year
Entry equity of Rs 250 crore grows by Rs 300 crore of EBITDA growth at 10x, nothing from the multiple and Rs 120 crore of debt paydown to Rs 670 crore at exit, 2.68x and about 22% a year.
Exit multipleExit EVEquityMOICIRR
8x6405102.04x15.3%
9x7205902.36x18.7%
10x8006702.68x21.8%
11x8807503.00x24.6%
Each turn of exit multiple is worth Rs 80 crore of equity, so a sale at 8x instead of 10x cuts the return from 2.68x to 2.04x even though the business and the paydown are unchanged.

The limit: the case hands you Rs 120 crore of paydown as a fact. In a real model it is the output of five years of cash flow after interest, tax, capex and working capital, and a logistics business buying trucks can easily generate less. If the interviewer asks what you would check first, say the cash conversion that produced the Rs 120 crore, because the growth and the multiple are visible and the paydown is the number that hides the assumptions.

Where candidates lose it

The usual loss is subtracting the original Rs 250 crore of debt at exit instead of the Rs 130 crore that remains. Debt paydown is one of the three sources of return; forgetting it understates equity by Rs 120 crore.

The second miss is a precise-sounding IRR with no method. Anchor on 2x and 3x over five years, place the answer between them, and say that you are approximating; a wrong decimal costs more than an honest range.

What the interviewer asks next

  • The fund sells after four years instead of five, at the same numbers. What happens to the IRR?
  • If EBITDA had stayed at Rs 50 crore, what would the return have been?
  • How would you check whether Rs 120 crore of paydown is plausible for this business?

Asked at TPG, Generalist, San Francisco, 2015 (Wall Street Oasis): Highly technical, not your usual case study. Paper lbo required.

Company names and figures are illustrative.