Case 082Screening and ranking businessesHard

Your thesis says cell costs fall 20% in two years and lift margin from 12% to 18%. The interviewer asks: what if costs do not fall, and how are you so sure they will? Defend it with numbers.

Apollo Global ManagementAnonymous interview candidate in · 2021Apollo Global ManagementAnonymous interview candidate in · 2021

The situation

You pitched Prakashdeep Solar Modules, which assembles solar panels from imported cells. Revenue is Rs 2,000 crore and EBITDA margin 12%, so EBITDA is Rs 240 crore. Cells cost Rs 600 crore a year, 30% of revenue. Your thesis: cell prices fall 20% over two years as new capacity comes on stream, module prices hold because most output is sold under fixed-price contracts, and margin rises to 18%, Rs 360 crore of EBITDA.

The deal is at 8x today's EBITDA, Rs 1,920 crore, with Rs 960 crore of debt at 10% and Rs 960 crore of equity. Depreciation and capex are Rs 50 crore each; tax 25%; exit after three years at 8x. Half the saving arrives in year 1 and all of it from year 2.

Your task

Show EBITDA and the equity outcome if the thesis holds and if costs stay flat, say how much of the thesis the return actually needs, and name the evidence that would prove it.

Quick check

If cell costs stay flat for three years, does the sponsor lose money?

Worked solution

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

30-second answerThe answer to give first

If the thesis holds, equity grows from Rs 960 crore to about Rs 2,387 crore, 2.5x; if costs stay flat it reaches about Rs 1188 crore, 1.2x. The flat case does not lose money, because cash still repays debt, but it earns about 7% a year. A 2.0x outcome needs cell costs down only about 12%, so the thesis has a margin of safety. The proof is the cell supply contract, the cost per watt at year 1 and the year 2 margin.

Step 1What does the thesis actually claim, in rupees?

Pin it to one line before defending it. A restaurant whose rent is about to fall does not become more profitable by belief; it becomes more profitable by the rupees of rent saved, if it does not have to cut prices. Cells are Rs 600 crore of cost; 20% off is Rs 120 crore, which on Rs 2,000 crore of revenue is exactly the six points of margin from 12% to 18%. The thesis therefore has two halves: that cell prices fall, and that module prices do not follow them down. The interviewer's question attacks the first; a good candidate volunteers that the second is the weaker half, because if cells get cheaper for everyone, module buyers will eventually ask for the saving.

The thesis is a line you can check at three dates, not a belief10%12%14%16%18%entryyear 1year 2year 3Thesis: 18%, EBITDA Rs 360 croreCosts flat: 12%, EBITDA Rs 240 crore1. Supply contractindexed cell price?2. Cost per wattdown 10% by year 1?3. Year 2 accountsmargin at 18%?
The thesis path takes margin from 12% to 15% in year 1 and 18% from year 2, Rs 360 crore of EBITDA, while the flat path stays at 12% and Rs 240 crore; the three lime checkpoints are the dates at which the thesis is either confirmed or dead.
Step 2What is the equity worth in each case?

Run both paths through the same debt schedule. With the thesis, EBITDA reaches Rs 360 crore, debt falls to about Rs 493 crore and exit equity is about Rs 2,387 crore, 2.49x and an IRR near 35%; with flat costs, debt falls only to about Rs 732 crore and equity is about Rs 1188 crore, 1.24x and an IRR near 7%. The gap between the two is the price of the thesis, and the flat case is the number the committee will ask you to live with.

Rs croreThesis EBITDAInterestCash to debtFlat EBITDAInterestCash to debt
Year 130096.0115.524096.070.5
Year 236084.5169.224089.075.8
Year 336067.5181.824081.481.5
Debt at exit493732
Exit equity at 8x2,3871,188
On the thesis path, three years of cash repay Rs 467 crore of debt and the exit equity is Rs 2,387 crore; on the flat path only Rs 228 crore is repaid and the exit equity is Rs 1188 crore, so the thesis is worth about Rs 1199 crore of equity.
What Rs 960 crore of equity becomes in three years, Rs croreEntry equity960Thesis holds: costs fall 20%2,387 (2.49x, 35% IRR)Costs stay flat1,188 (1.24x, 7% IRR)2.0xA 2.0x outcome needs cell costs down about 12%, not 20%: the thesis has room, and you should say how much.The flat case is the number you must be able to live with before you sign.
Rs 960 crore of equity becomes about Rs 2,387 crore if cell costs fall 20% and about Rs 1188 crore if they stay flat; the 2.0x line is crossed once costs fall about 12%, so the return needs part of the thesis, not all of it.
Step 3How are you so sure, and what would prove it?

Do not claim certainty; name the evidence and the dates. First, the cell supply contract: if it indexes price to a published cell benchmark, the saving is contractual, not hoped for. Second, cost per watt in the year 1 accounts: the thesis needs about 10% off by then. Third, the margin in year 2: 18% or the thesis is wrong. Then the other half: the share of module output sold under fixed-price contracts and how long those run, because that is what keeps the saving from being passed on. And say what you would do if the first checkpoint fails: hold the dividend, keep the extra cash in the business and run the flat case, which at 1.2x is survivable.

Close by sizing the margin of safety. The return needs cell costs to fall about 12% for 2.0x, so the thesis can be half wrong and the deal still clears a modest bar. That is a better defence than insisting on 20%, because it moves the argument from whether you are right to how wrong you can afford to be.

Where candidates lose it

The usual loss is defending the thesis by restating it with more conviction. The interviewer asked what happens if costs do not fall, and the only acceptable answer is a number for that case, worked and owned.

The second is forgetting the second half of the thesis. Cheaper cells help only if module prices hold, and a candidate who does not raise pass-through risk unprompted has handed the interviewer the next question.

What the interviewer asks next

  • Module prices fall 10% in year 2 as buyers demand the saving. What is the margin and the equity now?
  • The exit multiple is 7x if the thesis fails and 9x if it holds. Does that change how much of the thesis you need?
  • What covenant or structure would you ask for to protect the flat case?

Asked at Apollo Global Management, Investments, Anonymous interview candidate in, 2021 (Wall Street Oasis): Are you sure you thesis can be backed up? What if their costs don't fall? How are you so sure they will?
Asked at Apollo Global Management, Investments, Anonymous interview candidate in, 2021 (Wall Street Oasis): some grilling questions based on your pitch and your thesis

Company names and figures are illustrative.