I am preparing for the case study and would love to see your comments on the investment memo.
The case is "KKR to acquire Laser Clinics Australia"
Feel free to try!
Let me know what do you think of this memo, what do i miss/ how can i improve.
Thanks a lot! **
LCA is a good investment because:
a. The company has a strong record to generate cash. The company maintains a low CapEx and working capital rate, so it can maintain a strong cash balance from operation and investing.
b. With our assumption of debt structure to finance the deal, the company is able to pay back all debt within 5 years.
The risk of this investment lies in the following:
c. Business expansion plan not going well;
d. Exit risk
LCA is an Australia provider of non-surgical aesthetic treatments.
a. Franchise model
The most important feature of LCA is its franchise model. LCA operates all clinics a franchise model where it shares 50% of ownership. By doing so, LCA only needs to contribute part of the cost when opening a new clinic, and can enjoy 50% of profit. It also charges clinic marketing and management fees as a service provider.
The upside is LCA only need to share 50% of the risk of opening and running a clinic. The downside is it would be more difficult for LCA to management service quality and build a strong brand name.
b. New clinic rollout plan
The main growth driver of LCA's expansion plan is to open new clinics. It targets to triple the number of clinics from 61 in 2016 to 169 in 2022. According to the management, the plan is backed by demographic studies and surveys.
c. Three layers of revenue
i. Income as a franchisor, including franchise fees, royalty charges, marketing fees and management fees. Most of them are charge on each clinic on a yearly or monthly basis.
ii. Profit on sale of its own skincare products in its clinics and to 3rd party retailers
iii. Share of its clinics' profit as a shareholder
d. Opportunity and Risk
- The unique benefits provided by the franchise model. The upside of its franchise model is LCA only need to share 50% of the risk of opening and running a clinic. In addition, the clinic owner serves as a fulltime manager and LCA can save a lot of trouble and money in finding and hiring managers, nurses, and doctors.
- New clinic rollout plan too aggressive
As the most important growth driver, LCA's business growth strategy depends entirely on how many new clinics it can successfully open the future 5 years. As we can see from the revenue structure, the number of new clinics contribute to the growth of all three parts of revenue. Also, it's the main driver to process cost saving as LCA scales up.
If anything goes wrong with the new clinic plan, LCA's growth plan may experience a significant slowdown.
Manage brand name
The downside of its franchise model is, it would be more difficult for LCA to management service quality and build a strong brand name. With such an aggressive new clinic plan, it would be more difficult for LCA to manage.
In the past 3 years, LCA demonstrates strong record of revenue growth, mostly from successful new clinic rollout. It also maintains a high-profit margins of franchise and skincare business of around 50%. Even when we have a conservative assumption of LCA's rollout plan: 48 new clinics in the next 5 years (instead of more than 80 of LCA's own plan), we still project its revenue to grow at 10% CAGR.
In the past 3 years, LCA demonstrates strong record of EBIDTA growth, showing 42% in 2016 and 33% in 2017.
As the Capex mostly connect with opening the new clinics. Historically Capex took a significant portion of EBITDA (36% in 2015, 27% in 2016 and 19% in 2017). As the expansion goes, the company needs to pull out a lot of cash on Capex, and we expect it to remain around 20% of EBITDA in the future 3 years and 10%+ of ebidta after that.
The company had a strong record of generating cash as per its CFS. Historically cash conversion rate was higher than 75%. Even with high Capex of expansion in the future, we still get a high cashflow conversion rate before financing activities for the next 5 years. As a result, we believe the company can still maintain its strong cash flow in the future.
We assume the deal structure as the following with Equity sponsor contributes 35% of total funds.
As indicated in the sensitivity analysis, even with the worst scenario when we acquire the company with 12.0 x multiple and can only sell it with 9.0x multiple, we still able to get a 12% IRR.
Even with no revenue growth and conservative exit multiple at 9.0, we can still get 30% IRR.
a. High growth non-surgical aesthetics industry
Non-surgical aesthetics treatment sector has experienced rapid growth in recent years, mostly driven by destigmatisation, greater acceptance, and social pressures to maintain a youthful appearance. As the adoption rates are still relatively low, we expect significant upside in the sector remains.
b. Underserved demand
c. Recurring treatment deliver lifetime patient value