Case 029Growth equity and softwareWarm up

Pitch a company in two minutes: a 300 store pharmacy chain with 9% same store growth and an 11% EBITDA margin. Structure it as thesis, returns, risks and what would make you wrong.

TPGBeijing · 2014

The situation

Aushadh Mitra Pharmacies runs 300 chemist stores across four southern states, each doing about Rs 1.5 crore of revenue, Rs 450 crore in all. Same store sales grow 9% a year and EBITDA margin is 11%, Rs 49.5 crore. The chain can open 25 stores a year at Rs 50 lakh each, and management believes margin can reach 12% as purchasing scale improves.

The owner would sell at 12x EBITDA, Rs 594 crore. Lenders would provide 3x, Rs 148.5 crore at 10%. Tax is 25%, maintenance capex and depreciation are each 2% of revenue, and spare cash repays debt. Assume a five year hold and the same 12x at exit; treat new stores as earning the chain average from the year they open.

Your task

Deliver the pitch: thesis, returns, risks, and the condition under which you would admit you were wrong.

Quick check

What is the last thing a two minute pitch should say?

Worked solution

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

30-second answerThe answer to give first

Buy a fragmented, recurring retail category at 12x and compound it through 25 stores a year: about 3.2x and a 26% IRR, and I am wrong if same store growth drops under 4% for two quarters. Revenue goes from Rs 450 crore to about Rs 981 crore with 425 stores, EBITDA to Rs 118 crore at 12%. Risks are regulated drug margins, online discounting and pharmacist wages; the downside case returns 1.8x.

Step 1What is the thesis, in thirty seconds?

Start with why the category and why this company, not with the numbers. Medicines are bought every month, close to home, and the shop that fills a prescription twice becomes the family's chemist; that is a tiffin service for drugs, repeat demand with low churn. The thesis is that a chain with 300 stores buys cheaper, stocks better and opens new stores faster than the standalone chemists it competes with, and that same store growth of 9% shows the format already works. Then one line on scale: 25 stores a year at Rs 50 lakh each is Rs 12.5 crore of capex, paid for from the chain's own cash.

The pitch on one page: thesis, return, risks, and what would make you wrong1 Thesis300 stores, Rs 1.5 crore each: Rs 450 croreSame store growth 9%, margin 11%Chemists are local and fragmented;a chain adds 25 stores a year at Rs 50 lakh2 ReturnsEntry 12x: EV Rs 594 crore, debt 3xYear 5: 425 stores, Rs 981 crore revenueEBITDA Rs 118 crore at 12% margin, exit 12xEquity 446 to 1431: 3.2x, IRR 26%3 RisksMargins on scheduled drugs are regulatedOnline pharmacies discount on repeat scriptsPharmacists are scarce; wages riseInventory ties up cash as stores are added4 What makes me wrongSame store growth under 4% for two quartersMargin falls as new stores openDownside: 4% growth, flat margin, 10x exitgives 1.8x, IRR 13%Two minutes: thesis in 30 seconds, return in 40, risks in 30, kill condition in 20.
The pitch fits on one page: a thesis built on 300 stores growing 9% like for like, a return of about 3.2x and 26% from Rs 446 crore of equity at 12x, four named risks, and a kill condition of same store growth under 4% for two quarters.
Step 2What return does the plan produce?

Give the shape, then the number. Stores go from 300 to 425, revenue per store compounds at 9% to Rs 2.31 crore, so year 5 revenue is about Rs 981 crore, and at a 12% margin EBITDA is Rs 118 crore. At the same 12x that is Rs 1,412 crore of enterprise value. Cash after interest, tax and 25 new stores a year repays the whole Rs 148 crore of debt by year 5 and leaves about Rs 19 crore of cash, so equity of Rs 446 crore becomes about Rs 1,431 crore: 3.2x, 26%. Unlevered, the same EBITDA growth is 2.4x and 19%; most of the return is the business, not the debt.

YearStoresRevenueMarginEBITDACapexCash to debtDebt at year end
132553111.2%59.523.113.0135.5
235062411.4%71.125.021.3114.2
337572811.6%84.527.131.482.8
440084711.8%99.929.443.539.2
542598112.0%117.732.158.1-18.9
Rs crore. With 25 new stores a year and 9% like for like growth, revenue reaches Rs 981 crore and EBITDA Rs 118 crore by year 5, while cash flow after store capex repays all Rs 148 crore of debt and leaves Rs 19 crore of cash, shown as negative debt.
Step 3What are the risks, and what would make you wrong?

Name risks that touch the numbers, not generic ones. Margins on many scheduled medicines are set by regulation, so the 11% to 12% margin plan must come from private label, wellness products and purchasing, not from pricing; confirm the current price control rules before relying on any margin figure. Online pharmacies discount repeat prescriptions, which is exactly the loyal customer the thesis counts on. Pharmacists are scarce, and wages are the largest store cost. And each new store carries two months of stock, cash the model above only partly captures in its 2% capex.

Then the kill condition, with a number. If same store growth falls under 4% for two consecutive quarters, the online channel is taking the repeat customer and the thesis is wrong. In that case, with flat margin and a 10x exit, the deal returns 1.8x and 13%, which does not pay for the debt and the five years. Saying that number out loud is what separates a pitch from a sales talk, because it shows you priced the downside before you asked anyone to buy the upside.

Where candidates lose it

The usual loss is a pitch that is all thesis: a growing category, a good team, a fragmented market, and no return. The interviewer waits for the number and the structure that produces it, and marks down a story without one.

The second miss is a kill condition that is a feeling rather than a metric. Say the number and the period over which you would measure it.

What the interviewer asks next

  • An online pharmacy offers to buy the chain's prescription data. Does that change your view?
  • How would you check the 9% same store growth claim in diligence?
  • Would you rather open 25 stores a year or buy a 60 store rival at 8x?

Asked at TPG, Generalist, Beijing, 2014 (Wall Street Oasis): he asked to propose investment ideas and challenged me to justify my investment logic

Company names and figures are illustrative.