Case 089Returns attribution and value creationCore

Revenue rose from Rs 400 crore to Rs 700 crore in four years, Rs 180 crore of it from acquisitions bought at 1.0x revenue. What was organic, what was the organic CAGR, and did the acquisitions earn their cost at 8% margins?

The situation

Anvesha Facility Services provides housekeeping, security and maintenance to office parks. Under the current owner, revenue grew from Rs 400 crore to Rs 700 crore in four years, and the management deck headlines a 15% compound growth rate. Diligence shows that three regional contractors were bought along the way, together adding Rs 180 crore of revenue, each paid for at 1.0x revenue. The acquired businesses earn an 8% EBITDA margin, in line with the group.

The sponsor who is considering the company expects to exit at 9x EBITDA.

Your task

Separate organic from acquired growth, restate the growth rate, and judge whether the acquisitions created value for the owner who made them.

Quick check

The deck says 15% growth. Roughly what was the organic rate?

Worked solution

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

30-second answerThe answer to give first

Only Rs 120 crore of the Rs 300 crore of growth was organic, 40%, an organic CAGR of about 6.8% against the 15% headline. The acquisitions cost Rs 180 crore and earn Rs 14.4 crore of EBITDA, so the owner paid 12.5x EBITDA for businesses worth Rs 130 crore at a 9x exit, a pre-tax return of 8%. They did not earn their cost unless margins rise to about 11.1%.

Step 1How do you separate bought growth from built growth?

Take the acquired revenue out of the end point and recompute. A family whose income doubled because a second earner joined has not had a pay rise; the first earner's rise is the organic part. Rs 700 crore less Rs 180 crore of acquired revenue is Rs 520 crore, so organic growth was Rs 120 crore of the Rs 300 crore, and Rs 400 crore to Rs 520 crore over four years is a CAGRCompound annual growth rate: the constant yearly rate that takes the start value to the end value over the period. of 6.8%. That assumes the acquired businesses did not grow after purchase; if they did, the organic figure is slightly higher and you say so.

Growth of 300: 120 built, 180 bought, and what the bought part cost, Rs crore400Revenue, year 0+120Organic growth+180Acquired revenue700Revenue, year 4organic CAGR 6.8%total CAGR 15.0%The bought blockCost at 1.0x revenue180EBITDA at 8%14.4Multiple paid12.5xWorth at 9x exit130Pre-tax return8%Bought growth at 12.5x EBITDA that exits at 9x destroys about Rs 50 crore unless margins rise.
Of the Rs 300 crore of revenue growth, Rs 120 crore was built at an organic CAGR of 6.8% and Rs 180 crore was bought for Rs 180 crore; at an 8% margin the bought block earns Rs 14.4 crore and is worth Rs 130 crore at 9x, less than it cost.
The relationship
Organic CAGR=(700−180400)1/4−1=(520400)1/4−1≈6.8%\text{Organic CAGR} = \left(\frac{700 - 180}{400}\right)^{1/4} - 1 = \left(\frac{520}{400}\right)^{1/4} - 1 \approx 6.8\%
700revenue in year 4, Rs crore
180revenue that came with the acquisitions
400revenue in year 0
1/4four years of growth
What it says in wordsRemove the bought revenue from the end point, then ask what yearly rate takes the start to that end over four years.
Step 2Did the acquisitions earn their cost?

Price them on what they earn, not on what they add to the top line. Rs 180 crore of revenue at 1.0x cost Rs 180 crore; at an 8% margin it earns Rs 14.4 crore of EBITDA, so the owner paid 12.5x EBITDA, and at a 9x exit those businesses are worth Rs 130 crore, Rs 50 crore less than they cost. The pre-tax return on the Rs 180 crore is 8%, below any sponsor's cost of capital. For the deals to break even at 9x, the acquired margin would need to reach about 11.1%, which in facility services means pulling out duplicated branch overheads and repricing contracts, and there is no sign in the 8% that it happened.

Rs croreHeadlineOrganic onlyThe bought block
Revenue, year 0400400
Revenue, year 4700520180
Four-year CAGR15.0%6.8%
Cost180 at 1.0x revenue
EBITDA at 8%14.4
Value at 9x against cost130 against 180
The headline 15% becomes 6.8% once Rs 180 crore of bought revenue is removed, and the bought revenue, which cost Rs 180 crore, is worth only Rs 130 crore at the sponsor's 9x exit multiple.
Step 3What does this do to the sponsor's view of management?

It changes who gets credit and what gets paid for. A team that grew the base business at 6.8% in a market growing at about the same rate has held share, not taken it, and a team that paid 12.5x for businesses the sponsor will sell at 9x has been spending the owner's money on revenue. The sponsor should price the company on organic earnings power, treat the bolt-on capability as unproven, and put margin improvement on the acquired branches at the top of the value creation plan, because that is where the Rs 50 crore gap can be closed. Say the limit too: at 1.0x revenue the deals may have bought contracts or regions worth more than their standalone EBITDA, and diligence should ask what each one was for.

Where candidates lose it

The usual loss is subtracting Rs 180 crore from the Rs 300 crore of growth and calling the organic rate 15% times 120 over 300. Growth rates do not split that way; remove the acquired revenue from the end point and recompute the compound rate.

The second is judging the acquisitions on the revenue multiple. One times revenue sounds cheap until you divide by an 8% margin and see 12.5x EBITDA, above the exit multiple.

What the interviewer asks next

  • The acquired businesses grew 10% a year after purchase. Rework the organic CAGR.
  • At what purchase multiple of revenue would the acquisitions have earned 15% pre-tax?
  • How would you structure earn-outs on future bolt-ons so the seller carries the margin risk?

Company names and figures are illustrative.