Case 100Returns attribution and value creationWarm up

A tile maker was bought at 9x EBITDA of Rs 80 crore with Rs 400 crore of debt and sold at 10x EBITDA of Rs 130 crore with Rs 200 crore of debt. Split the equity gain among EBITDA growth, multiple expansion and debt paydown.

TPGNew York · 2024

The situation

Dhanvik Tiles, a maker of vitrified floor tiles, was bought five years ago at 9x EBITDA of Rs 80 crore, Rs 720 crore, with Rs 400 crore of debt and Rs 320 crore of equity. It has just been sold at 10x EBITDA of Rs 130 crore, Rs 1,300 crore, with Rs 200 crore of debt left, so the equity fetched Rs 1,100 crore.

An LP on the advisory board asks the fund to show how much of the gain came from running the business better, how much from the market paying more, and how much from paying down debt.

Your task

Build the attribution, state the money multiple and IRR, and say what the split tells the LP about whether the return can be repeated.

Quick check

Which of the three engines is the LP most sceptical of?

Worked solution

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

30-second answerThe answer to give first

Of the Rs 780 crore gain, Rs 450 crore came from EBITDA growth, Rs 130 crore from the multiple rising from 9x to 10x, and Rs 200 crore from debt paydown: 3.44x the money and an IRR near 28%. Equity went from Rs 320 crore to Rs 1,100 crore. Growth and paydown, 83% of the gain, were earned by running and funding the business; the multiple, 17%, was bought by the market. The LP should hear that most of this return is the kind the fund can repeat.

Step 1How do you split a gain into three engines?

Change one thing at a time and hold the others at entry. A house that sold for more because you added a floor, because the neighbourhood re-rated, and because you paid off the mortgage has three separate stories, and the buyer of your next house wants to know which one you can repeat. EBITDA growth: Rs 50 crore more EBITDA at the entry multiple of 9x is Rs 450 crore. Multiple expansion: one extra turn on exit EBITDA of Rs 130 crore is Rs 130 crore. Debt paydown: Rs 400 crore to Rs 200 crore is Rs 200 crore. The three sum to Rs 780 crore, which is the check.

Where Rs 780 crore of equity gain came from: earned, bought, or repaid, Rs crore320Entry equity+450EBITDA growth+130Multiple 9x to 10x+200Debt paid down1,100Exit equity3.44x, IRR about 28%earned: 58% of the gainbought: 17%repaid: 26%Green and pine are repeatable in the next fund; paper depends on the next buyer paying more per rupee of profit.
Entry equity of Rs 320 crore grows to Rs 1,100 crore: Rs 450 crore from EBITDA growth at the entry multiple, Rs 130 crore from the multiple moving from 9x to 10x on exit EBITDA, and Rs 200 crore from debt repaid, so 83% of the gain was earned or repaid and 17% was bought by the market.
The relationship
(130−80)×9⏟450+(10−9)×130⏟130+400−200⏟200=780=1,100−320\underbrace{(130 - 80) \times 9}_{450} + \underbrace{(10 - 9) \times 130}_{130} + \underbrace{400 - 200}_{200} = 780 = 1,100 - 320
130 - 80EBITDA gained, Rs crore
9entry multiple, so growth is valued at the price paid
10 - 9the extra turn the exit buyer paid
400 - 200debt repaid from the company's cash
What it says in wordsValue growth at the entry multiple, value the multiple change on exit EBITDA, add the debt repaid, and the three parts must sum to the change in equity.
Step 2Why does the order of the split matter?

Because the cross term, extra EBITDA times the extra turn, Rs 50 crore, has to go somewhere. Valuing growth at the entry multiple and the multiple change on exit EBITDA gives growth Rs 450 crore and the multiple Rs 130 crore; doing it the other way gives growth Rs 500 crore and the multiple Rs 80 crore. Both sum correctly. The convention of crediting growth at the entry multiple is the conservative one for the manager, because it assigns the cross term to the market, and it is the one an LP will expect. Say which you used; an attribution that does not state its convention cannot be compared with anyone else's.

Rs croreEntryExitEngineShare of gain
EBITDA8013045058%
Multiple9x10x13017%
Net debt40020020026%
Equity3201,100780100%
Rs 780 crore of gain splits 58% to EBITDA growth, 17% to multiple expansion and 26% to debt paydown; equity of Rs 320 crore became Rs 1,100 crore, 3.44x, an IRR near 28% over five years.
Step 3What does the split tell the LP?

Whether the return was earned or bought. 83% of this gain came from growing EBITDA by 62% and repaying half the debt, which are things the fund's operating plan and capital structure produced and can produce again; 17% came from a buyer paying one more turn, which the fund did not control. A fund whose last three exits were mostly multiple expansion is a fund that was in the market at the right time; a fund whose exits are mostly growth and paydown has a method. The LP's follow-up will be how the EBITDA grew, volume, price or margin, and whether the debt was repaid from operations or from selling a plant, because those are the lines the next fund's underwriting rests on.

Where candidates lose it

The usual loss is valuing the multiple change on entry EBITDA and the growth at the exit multiple without saying so, which hands the fund the cross term and flatters the operating story by Rs 50 crore.

The second is forgetting that debt paydown is not free. The Rs 200 crore came out of the company's cash, which could have been capex or a dividend, and an LP will ask what the business gave up to repay it.

What the interviewer asks next

  • Rs 60 crore of the debt paydown came from selling a warehouse. How should the attribution show that?
  • The fund took a Rs 100 crore dividend in year 3. Where does it go in the bridge, and what does it do to the IRR?
  • If EBITDA margin rose from 16% to 20% on flat revenue, is that operating improvement or cost cutting the next owner will have to re-spend?

Asked at TPG, Investment Banking, New York, 2024 (Wall Street Oasis): What are the steps to the LBO buyout? What are the key drivers of value creation?

Company names and figures are illustrative.