Case 026Paper LBOsCore
Paper LBO on your own sector: a diagnostics chain of 40 labs bought at 12x, with a plan to open 15 more. Work the return and name the lab-level assumption that matters most.
1The situation
Arogyadeep Diagnostics runs 40 pathology labs in tier two cities and earns EBITDA of Rs 70 crore, Rs 1.75 crore a lab. A sponsor buys it at 12x, Rs 840 crore, with 5x of debt, Rs 350 crore at 10%, interest on the opening balance, and Rs 490 crore of equity. Existing labs grow EBITDA 5% a year.
The plan opens 15 new labs at the start of year 1 at Rs 6 crore each, Rs 90 crore funded by extra sponsor equity. Each new lab reaches Rs 1.5 crore of EBITDA by year 3, ramping through a third and two thirds of that on the way. Maintenance capex equals depreciation of Rs 10 crore a year, tax is 25%, working capital is flat and all spare cash repays debt. Exit at 11x at the end of year 4.
2Your task
What are the money multiple and IRR? Which assumption about a single lab decides whether this deal works?
Quick check
Before the maths: where does most of this deal's return come from?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
About 1.6x and an IRR near 13%, and almost all of it rests on the new labs. Exit EBITDA of Rs 104 crore at 11x is Rs 1,139 crore; debt falls to Rs 194 crore, so equity is Rs 945 crore on Rs 580 crore in. Without the rollout the deal earns 7%. The assumption that matters is steady EBITDA per new lab: Rs 1.5 crore on Rs 6 crore of capex.
Step 1What is different about a paper LBO built on sector knowledge?
The interviewer picked diagnostics because you know it, and expects you to bring the unit with you: a lab is the unit, and the whole deal is 40 old units plus 15 new ones. Think of a family that owns a few tutoring centres and is deciding whether to open more: the question is never the brand, it is what one new centre costs and what it earns once full. Set up the deal in two layers: the base business bought at 12x, and the rollout bought at 6 over 1.5, which is 4x. Rs 840 crore of price, Rs 350 crore of debt, Rs 490 crore of equity, plus Rs 90 crore of equity for the labs: Rs 580 crore in.
Step 2How does EBITDA build, and what does the cash do?
Existing labs grow from Rs 70 crore to Rs 81.0 crore over four years. New labs add a third of Rs 22.5 crore in year 1, two thirds in year 2 and the full Rs 22.5 crore from year 3. Free cash flow is EBITDA less interest, tax and Rs 10 crore of maintenance capex, and every rupee repays debt, so interest falls each year and cash rises faster than EBITDA. Say the rounding out loud: roughly 24, 34, 45 and 52 crore of cash, about Rs 156 crore in all, taking debt from Rs 350 crore to about Rs 194 crore.
| Year | Existing labs | New labs | EBITDA | Interest | Tax | Cash to debt | Debt at year end |
|---|---|---|---|---|---|---|---|
| 1 | 70.0 | 7.5 | 77.5 | 35.0 | 8.1 | 24.4 | 325.6 |
| 2 | 73.5 | 15.0 | 88.5 | 32.6 | 11.5 | 34.5 | 291.2 |
| 3 | 77.2 | 22.5 | 99.7 | 29.1 | 15.1 | 45.4 | 245.8 |
| 4 | 81.0 | 22.5 | 103.5 | 24.6 | 17.2 | 51.7 | 194.0 |
| Exit | 103.5 x 11 = 1,139 | 156.0 | 194.0 |
Step 3Where does the return come from, and which lab assumption decides it?
| 11 x 103.5 | exit enterprise value, Rs 1,139 crore |
| 194.0 | debt left after four years of cash sweep |
| 580 | equity in: 490 for the business plus 90 for the new labs |
Now split it. Run the same model with no rollout: equity Rs 490 crore, exit EBITDA Rs 81.0 crore, equity out Rs 642 crore, 1.31x and 7%. Paying 12x for a business that grows 5% and sells at 11x earns less than the 10% the debt costs; the extra Rs 90 crore spent on labs becomes Rs 303 crore of exit equity, 3.4x, and that is the deal. So the assumption that matters is steady EBITDA per new lab. At Rs 1.0 crore a lab the deal falls to 10%; at Rs 2.0 crore it rises to 16%. Ask for the ramp curves of the last ten labs the company opened: months to breakeven, tests a day at month 12 and 24, and what the slowest third did.
| Steady EBITDA per new lab | Payback on Rs 6 crore | Exit EBITDA | Exit equity | MOIC | IRR |
|---|---|---|---|---|---|
| No rollout | 81.0 | 642 | 1.31x | 7.0% | |
| Rs 1.0 crore | 6.0 years | 96.0 | 844 | 1.46x | 9.8% |
| Rs 1.5 crore (the plan) | 4.0 years | 103.5 | 945 | 1.63x | 13.0% |
| Rs 2.0 crore | 3.0 years | 111.0 | 1,046 | 1.80x | 15.9% |
Step 4What is the view?
Honest, and in two parts. At 12x the base business is fully priced, and even with the rollout the deal lands near 13%, below the 20% most mid-market funds underwrite to. The sponsor either pays less for the base, opens more labs if the ramp evidence supports it, or keeps the new-lab capex in a separate pool it can stop funding after the first five open. The limit of the paper version is that it ignores the working capital a new lab ties up in receivables from hospitals and insurers, which lengthens the real payback by a few months.
Where candidates lose it
The usual loss is running one blended EBITDA line and never separating the base business from the new labs. Then the candidate cannot answer the only question the interviewer cares about: which assumption carries the return.
The second miss is forgetting that the rollout needs its own equity. Adding Rs 22.5 crore of EBITDA without the Rs 90 crore that bought it overstates the multiple by a wide margin.
What the interviewer asks next
- The new labs take five years, not three, to reach Rs 1.5 crore. What happens to the IRR?
- Would you fund the Rs 90 crore of rollout capex with a delayed-draw term loan instead of equity, and what does that do to the return and the risk?
- The exit buyer values the new labs at 9x because they are young. How do you argue for 11x?
Asked at Warburg Pincus, Private Equity, New York, 2014 (Wall Street Oasis): Both involved a mini-case / paper LBO based (at least in my case) on my industry background.
Company names and figures are illustrative.