Case 046Growth equity returnsHard

Weekend take-home case: write the investment memo on a Rs 250 crore minority stake in Aushvik Pharma, a speciality generics maker bought at 16x EBITDA, weighing three five-year scenarios, and recommend.

The situation

Aushvik Pharma makes speciality generic medicines, a large share of them exported to regulated markets. Revenue is Rs 900 crore, growing 12% a year, at an EBITDA margin of 20%, so EBITDA is Rs 180 crore. A promoter family wants to sell a minority stake, and your growth fund has been offered Rs 250 crore of existing shares at 16x EBITDA, an enterprise valueThe value of the whole business to all its funders. Aushvik has no net debt, so here enterprise value and equity value are the same Rs 2,880 crore. of Rs 2,880 crore. The fund would own 8.68% and take a board seat.

The partner wants three five-year scenarios, holding the margin at 20%. Bull, 25% likely: 18% growth and an exit at 18x. Base, 50%: 12% growth and an exit at 14x. Bear, 25%: a year-long regulatory inspection of the main plant holds back new launches, growth falls to 4%, and the exit slips to year six at 9x. Assume half of each year's EBITDA becomes cash after tax, capex and working capital and stays in the company. The fund's committee wants a probability-weighted 1.8x on minority stakes in profitable companies. Write the memo and recommend. All figures are illustrative.

Your task

What does each scenario return, what is the probability-weighted multiple, how much bear-case probability can the deal carry before it fails the 1.8x bar, and what does the memo recommend?

Quick check

Before working the numbers, what does the base case return on the Rs 250 crore?

Worked solution

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

30-second answerThe answer to give first

The stake returns 2.84x in the bull case, 1.76x in the base and 0.93x in the bear, a probability-weighted 1.82x that clears the 1.8x bar only while the bear case stays below about 28%. The base case alone falls short because the exit multiple is below the entry multiple, so the bull case carries the deal. The memo recommends proceeding if diligence on the plant's inspection record supports a bear weight of 25% or less, and at about 15.1x if it does not.

Step 1What does each scenario return, and why is the base case weaker than it looks?

Buying a flat in a fashionable neighbourhood at a high price per square foot is a bet twice over: that rents rise, and that buyers in five years still pay that much per square foot. If rents rise but the neighbourhood cools, the two cancel. Aushvik is the same: at 16x EBITDA the fund pays a full price, so in the base case EBITDA grows 1.76 times to Rs 317 crore while the multiple falls from 16x to 14x, and the business is worth only 1.54 times what the fund paid. The Rs 640 crore of cash Aushvik builds over five years is what lifts the base case to 1.76x, 12.0% a year.

The bull case grows EBITDA to Rs 412 crore and sells at a higher multiple than it bought, 18x, so both forces work together: Rs 7,412 crore of enterprise value plus Rs 760 crore of cash is 2.84x. The bear case is the inspection: a year of held-back launches, 4% growth, and an exit in year six at 9x, Rs 2,050 crore plus Rs 621 crore of cash, 0.93x. On Rs 250 crore that is a loss of about Rs 18 crore, and it arrives a year later.

The bull case returns 2.84x, the base case 1.76x and the bear case 0.93x; weighted 25, 50 and 25 they give 1.82x, which clears the committee's 1.8x bar by only 0.02x.

Case	Probability	Final EBITDA, Rs cr	Exit EV, Rs cr	Cash built, Rs cr	Multiple	Return a year	Fund proceeds, Rs cr
Bull (year 5)	25%	412	7,412	760	2.84x	23.2%	709
Base (year 5)	50%	317	4,441	640	1.76x	12.0%	441
Bear (year 6)	25%	228	2,050	621	0.93x	-1.2%	232
Weighted	100%				1.82x	12.4%	456

Each case's multiple is equity at exit over the Rs 2,880 crore entry value, since the fund's 8.68% stake does not change; weighted, the Rs 250 crore returns about Rs 456 crore, 12.4% a year on the expected cash flows.

The relationship

\text{MOIC} = \frac{\text{EBITDA}_T \times m_{\text{exit}} + \text{cash built}}{180 \times 16} \qquad \bar{M} = 0.25\,M_{\text{bull}} + 0.50\,M_{\text{base}} + 0.25\,M_{\text{bear}} \approx 1.82\text{x}

EBITDA_T	EBITDA in the exit year: year five, or year six in the bear case, Rs crore
m_exit	the exit multiple of EBITDA in that case
cash built	half of each year's EBITDA, kept in the company, Rs crore
180 x 16	the Rs 2,880 crore entry value

What it says in wordsA minority stake that never changes size returns the growth in the company's equity value; weighting the three cases by their odds gives the number the committee compares with its bar.

Step 2How much can the bear case's probability rise before the deal fails?

The 25% on the bear case is the number the whole memo rests on, so test it. Hold the bull case at 25% and let the base case give up whatever the bear case takes. Every ten points of probability moved from base to bear costs 0.084x, so the weighted multiple falls from 2.03x with no bear case to 1.61x at 50%. The deal fails the 1.8x bar once the bear case is more than 27.8% likely, under three points above the memo's own estimate. At 40%, a fair weight if the plant has a history of inspection findings, it returns 1.70x.

The weighted multiple falls from 2.03x to 1.61x as the bear case grows from 0% to 50% likely, crossing the 1.8x bar at 27.8%, so the memo's 25% estimate leaves under three points of room.

Step 3What does the memo say, and in what order?

A committee reads the first paragraph and decides whether to read the rest, so the recommendation goes first. Recommendation: proceed to confirmatory diligence at 16x, conditional on the plant's inspection record supporting a bear-case probability of 25% or less; if diligence puts it nearer 40%, the price that still clears 1.8x is about 15.1x, Rs 2,717 crore, and the memo should say so. Then the thesis in three lines: a profitable exporter growing 12% that turns half its EBITDA into cash. Then the three cases and the weighted 1.82x. Then the risk that decides it, the inspection, and what the fund will check: past inspection findings at the main plant, the share of revenue that plant supplies, and the launches waiting on approvals. The reader should confirm how the relevant regulators currently run and publish inspections rather than rely on a memo's summary.

Close with what the fund asks for as a minority holder, because it cannot fix a bad outcome itself: a board seat, information rights, a right to sell alongside the promoters, and an exit right if there is no listing or sale by year six. The limitation of the memo is plain: the probabilities are judgements, the margin is held flat when an inspection would hit it, and the weighted 1.82x is an average of outcomes the fund will live through only one of. The base case on its own, 1.76x, does not clear the bar; the deal works because the bull case pays for the bear, and the memo must say that in so many words.

Where candidates lose it

The common loss is treating 12% growth as a 12% return. Growth compounds EBITDA, but buying at 16x and selling at 14x takes an eighth back, and the base case returns only about 1.76x even with five years of retained cash.

The second is presenting the weighted multiple without testing the weights. The conclusion flips once the bear case is a little under 28% likely, so the probability on the inspection, not the growth rate, is what the committee needs to argue about.

What the interviewer asks next

The promoters offer to sell at 15x instead of 16x. What is the weighted multiple, and how much bear-case probability can the deal now carry?
Diligence finds the main plant supplies 70% of export revenue. How do you change the scenarios?
Would you rather have the board seat or a 1x liquidation preference on this stake, and why?
How would you build the bear case's margin instead of holding it at 20%?

Company names and figures are illustrative.