Case 061Screening and ranking businessesCore

A 120-store eyewear chain wants to add 30 stores a year. Each store costs Rs 1.2 crore and earns Rs 0.4 crore once mature. Should the fund pay 14x EBITDA of Rs 50 crore?

The situation

Aadrika Eyewear runs 120 optical stores selling frames, lenses and eye tests. Chain EBITDA is Rs 50 crore after Rs 6 crore of central cost; the existing stores average about Rs 0.47 crore each because the older city-centre stores are larger. A new store in the current format costs Rs 1.2 crore to fit out and stock, earns half its mature EBITDA in year 1 and Rs 0.4 crore a year from year 2. Management wants to open 30 stores a year for five years.

The seller wants 14x, Rs 700 crore. The fund would use 4x debt, Rs 200 crore, at 9%. Cash before interest and growth capex is 60% of EBITDA. The fund assumes a 14x exit in year 5 and tests 12x.

Your task

What is the payback and return on a single store, what does the chain's EBITDA look like in year 5, and should the fund invest at 14x?

Quick check

A store costs Rs 1.2 crore and earns Rs 0.4 crore when mature. When has it paid for itself?

Worked solution

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

30-second answerThe answer to give first

A new store pays back in about 3.5 years and then earns 33% a year on cost, so the rollout creates value even at 14x, and the fund should invest if the new-store numbers survive diligence. Thirty stores a year lift chain EBITDA from Rs 50 crore to about Rs 104 crore by year 5, with each cohort costing Rs 36 crore and worth Rs 168 crore at 14x once mature. On Rs 500 crore of equity the fund earns about 19% at a 14x exit and 15% at 12x. The price buys the base; the stores buy the return.

Step 1Why does the decision start with one store rather than the chain?

Because the chain is just the store repeated, and the price is being paid for the right to repeat it. Think of a tea stall that costs Rs 1.2 lakh to set up and clears Rs 40,000 a year once regulars arrive: the question of whether to open ten more is answered by that one stall. A store returns its Rs 1.2 crore in about 3.5 years and then earns 33% a year on cost, while the fund is paying 14x, an EBITDA yield of about 7%, for the existing stores. New capital earning 33% inside a business bought at 7% is where the return comes from.

One store: Rs 1.2 crore in, Rs 0.4 crore a year out once mature0.61.21.82.40123456Years after openingRs croreCapex Rs 1.2 croreCumulative store EBITDAPayback at 3.5 yearsthen 33% a year on costYear 1: half output
A new Aadrika store costs Rs 1.2 crore and earns Rs 0.2 crore in its first year and Rs 0.4 crore a year from the second, so cumulative store EBITDA crosses the capex line at about 3.5 years and reaches Rs 2.2 crore by year 6, which is the unit economicsThe cost and return of one repeatable unit of a business, such as one store, one clinic or one customer, from which the whole plan is built. the whole plan rests on.
Step 2What does the chain look like after five years of openings?

Stack the cohorts. Each cohort of 30 stores adds Rs 6 crore in its opening year and Rs 12 crore a year after, so chain EBITDA runs 56, 68, 80, 92, 104 across years 1 to 5, with the year 5 cohort still ramping and Rs 110 crore in sight once all 270 stores are mature. Growth capex is Rs 36 crore a year, Rs 180 crore in all, which the business funds from its own cash after interest, with debt roughly flat for the first two years and then falling.

The chain's EBITDA ramp: 30 new stores a year, each cohort stacked, Rs crore5056Year 1capex 36501268Year 2capex 3650121280Year 3capex 365012121292Year 4capex 365012121212104Year 5capex 36Each cohortcosts 36earns 12 matureworth 168at 14xPale: existing stores. Coloured bands: the five cohorts, 6 in the opening year then 12 a year.
With the existing stores holding Rs 50 crore and each cohort of 30 stores adding Rs 6 crore in its opening year and Rs 12 crore a year thereafter, Aadrika's EBITDA rises from Rs 56 crore in year 1 to Rs 104 crore in year 5 against Rs 36 crore of capex a year, and each cohort is worth Rs 168 crore at 14x once mature.
YearChain EBITDANew stores' shareCash before interestInterestGrowth capexDebt at year end
156633.618.036220.4
2681840.819.836235.4
3803048.021.236244.6
4924255.222.036247.4
51045462.422.336243.3
Rs crore. Cash before interest at 60% of EBITDA covers 9% interest on Rs 200 crore and Rs 36 crore of new stores each year, so debt ends year 5 at Rs 243 crore while EBITDA has doubled to Rs 104 crore.
Step 3So is 14x the right price?

Run the exit both ways. At 14x on Rs 104 crore, less Rs 243 crore of debt, equity is Rs 1213 crore on Rs 500 crore, 2.4x and about 19%; at 12x it is 2.0x and about 15%. The return holds even if the exit multiple falls two turns, because the gain is EBITDA built by stores that earn 33% on cost, not a bet on the market. That is the test for any rolloutA plan to grow by opening many copies of a proven outlet format, funded by the cash the existing outlets produce.: the price can be high if the new units are cheap relative to what they earn.

Step 4What would make you walk away?

The new-store numbers failing to match the old ones. If the last two cohorts are maturing at Rs 0.3 crore rather than Rs 0.4 crore, payback stretches past five years and the 33% becomes 25%, and if new stores take sales from old ones, the chain's EBITDA rises by less than the stacked bars show. Ask for store-level EBITDA by opening year, the share of new-store sales from customers who used to shop at an older store, and the lease terms, because 150 new leases are 150 fixed commitments. The limitation of the case: 60% cash conversion and a flat Rs 50 crore from the base are assumptions the diligence has to earn.

Where candidates lose it

The usual loss is judging 14x against the chain's current EBITDA and calling it expensive. The price is high for what exists; the return comes from what the rollout builds, and the right comparison is 33% on new capital against a 7% yield on the price.

The second is forgetting the ramp. Thirty stores earning Rs 0.4 crore from day one adds Rs 12 crore a year; with a half-output first year it adds Rs 6 crore, and the fund's cash plan must carry the difference.

What the interviewer asks next

  • Management wants 50 stores a year instead of 30. Can the cash plan carry it, and what does it do to the return?
  • New stores mature at Rs 0.3 crore. Rework payback and the year 5 EBITDA.
  • Why would a fund pay 14x for a rollout but refuse 10x for a flat chain?
  • What covenant would lenders want on a business that spends Rs 36 crore a year on new stores?

Company names and figures are illustrative.