Leveraged Buyout (LBO) / Private Equity Case Study: Carlyle’s Buyout

of Seven Days Group Holdings [SVN]: Got Budget Travel?

In this case study, you will analyze Carlyle’s $687 million leveraged buyout (LBO) of Seven Days
Group Holdings [SVN], a leading Chinese discount hotel chain.
Although the company is based in mainland China, it was publicly listed on the New York Stock
Exchange and the purchase consideration was in US Dollars.
In its most recent fiscal year prior to the deal, SVN earned revenue of ¥2.6 billion (~$407 million
USD), with EBITDA of ¥564 million (~$90 million USD).
It had 492 Leased & Operated (L&O) hotels, which the company owned and invested significant
capital into, and 853 Managed hotels, which acted as “franchisees” and were largely
responsible for their own expenses (SVN charged a service fee of ~5-7% of net revenue).
The company planned to expand into 2,000+ total locations by the end of FY14 (1.5 – 2.0 years
after the deal), and planned to accelerate its trend into Managed hotels.
Seven Days grew its revenue between 28% and 34% annually over the past 3 years, so it was
largely a growth story: it rapidly expanded its locations, and the core business benefited from
the rising tide of China’s middle class.
However, the average occupancy rate at both L&O and Managed hotels fell substantially in the
2 years prior to the deal, indicating potentially lower revenue per hotel in the future.
So the company’s “story” comes down to which narrative you believe: will the increasing
percentage of Managed Hotel revenue, with significantly higher margins, offset the declining
occupancy rates and the slower hotel growth rate?
Or will the declining occupancy rates, especially in smaller cities, combined with lower growth
rates, make more of an impact than the higher-margin Managed Hotel revenue?

http://breakingintowallstreet.com
http://www.mergersandinquisitions.com
In this case study, you will determine whether or not Carlyle made the right decision by
acquiring Seven Days for $687 million (~7.4x LTM EBITDA), and also whether or not the
company itself made the right decision by selling at this price.
To do this, you’ll review SEC filings, press releases, and investor presentations to form an
overall picture of the market and the company’s operational and financial performance.
Then, you will build a “simplified” (as in, “simpler than a full 3-statement LBO model, but still
more complicated than many LBO models”) model based on Income Statement and Cash Flow
Statement projections for SVN.
You will pay special attention to the mix of L&O vs. Managed hotels, and how that mix affects
operating expenses and Capital Expenditures (CapEx).
You will then use the output of the model to make an investment recommendation, present it
to your private equity firm, and answer the case study discussion questions.
Part 1: Understanding Leveraged Buyout (LBO) Fundamentals
In this set of introductory lessons, you will learn why and how private equity firms buy and sell
companies, how it’s different from “normal” companies buying other “normal” companies, and
how to evaluate these deals using different metrics.
You will also learn about the “tricks” that make leveraged buyouts possible, and the rules of
thumb you can use to determine what the IRR or Money-on-Money (MoM) multiple of a deal
might be.
Finally, you’ll learn why the standard explanations of LBOs in textbooks, other training
programs, and academic sources are often misleading and diverge wildly from what happens in
real life.
Part 2: Reviewing the Data
Please review the following documents before beginning your work on the case study:

• 20-F Filing (Annual Report) and Earnings Call Transcript.

• SEC documents, including the deal-related 13E-3 filings and the key extracts.
• Financial Extracts from the Annual Report.
• Investor Presentations.
• Press Releases and Industry Research.
Use these documents to form your initial view of the company’s operations, its market, its
competitive positioning, and its financial performance.

http://breakingintowallstreet.com
http://www.mergersandinquisitions.com
For example, you should be able to answer questions such as:

• How capital-intensive is the company’s business?

• Is it using its Free Cash Flow wisely?
• Why have its sales or margins changed over time?
• Do you think its expansion plans are realistic?
• How does the company stack up to its key competitors in China, both foreign and
domestic?
Part 3: Transaction Assumptions and Sources & Uses
In this next step, you will build schedules for the Transaction Assumptions, Debt Assumptions,
and Sources & Uses at the top of the LBO model.
Among other features, these schedules will support:

• Different ¥ RMB / $ USD exchange rates.

• Prices of everything listed in both ¥ RMB (in Millions) and $ USD (in Millions).
• Different percentages of equity and debt used to fund the deal.
• The equity rollover – many of the company’s major shareholders, such as the CEO,
chose to roll over their existing shares and maintain/increase their ownership in the
company.
• Legal fees, advisory fees, and financing fees, based on the 13E-3 filings.
• Assuming vs. refinancing SVN’s existing debt.
• The option to use excess cash on SVN’s Balance Sheet to fund the deal, even though the
company did not use any in real life.
• Debt tranches and interest rates based on estimates in press releases and the SEC 13E-3
filings.

Your baseline transaction assumptions should reflect Carlyle’s real offer for Seven Days, in
terms of purchase price and equity/debt used.
The exit multiple should be in-line with the purchase multiple in the baseline scenario.
Part 4: Building Income Statement and Cash Flow Statement Projections for a Budget Hotel
Chain in China
You already know how to complete these sections from the previous case studies in this course,
so we are not going to repeat detailed instructions for each line item.
Please keep in mind the following points for these projections:

http://breakingintowallstreet.com
http://www.mergersandinquisitions.com
Revenue:
You should split the company’s hotels into L&O vs. Managed and assume a # of new hotels per
year, # rooms per hotel, Occupancy Rate, and Average Daily Rate (ADR) for each segment.
These should be based on historical trends, the company’s plans from its investor
presentations, and the projections in the JP Morgan Fairness Opinion and Board of Directors
presentation from the 13E-3 filings.
Make sure you include sensitivity toggles for the key assumptions.
Expenses, CapEx, Depreciation, and Cash Flow Line Items:
Some of these items should be tied to only the L&O Hotels, while others should be linked to all
hotels, while still others should be linked to revenue or the change in revenue.
Decide what makes sense based on the company’s business model and its historical trends in
each expense / CFS line item category.
Hint: Managed Hotel revenue is essentially “free”, with the exception of some corporate
overhead; however, that doesn’t mean that it’s also “free” on the Cash Flow Statement.
Make sure you include sensitivity toggles for the key assumptions.
Income Statement and Cash Flow Statement:
You will not be creating a full 3-statement model in this case study, but you will complete as
much as you can of the “mini” Income Statement and Cash Flow Statement after fleshing out
the assumptions above.
Part 5: Debt Schedule and Linking the Statements
Follow the figures outlined in the 13E-3 filings for interest rates and mandatory repayments,
and assume that LIBOR increases by 25 bps per year. Assume an initial LIBOR rate of 0.30%.
Assume that all excess cash flow is used to repay the Senior Notes, and that any cash generated
after the Senior Notes have been fully repaid accumulates to the company’s cash balance.
Part 6: Key Metrics and Ratios, IRR and MoM, Returns Attribution, and Sensitivity Tables
Once you’re done with the model, calculate the key operational and credit metrics and ratios,
just as you did in the merger model case studies. Please include the following figures:

• Operational: Revenue Growth, Operating Margin, EBITDA Margin, Net Margin, Effective
Tax Rate, D&A % Revenue, and CapEx % Revenue.

http://breakingintowallstreet.com
http://www.mergersandinquisitions.com
 • Leverage Ratios: Total Debt and Net Debt to EBITDA, EBITDA – CapEx, and EBITDA –
CapEx +/- Change in WC.
• Coverage Ratios: EBITDA, EBITDA – CapEx, and EBITDA – CapEx +/- Change in WC to Net
Interest Expense.
• Capital Ratios: Total Debt / Equity, Total Debt / Capital, Net Debt / Equity, and Net Debt
/ Net Capital.
• Other: Debt Service Coverage Ratio, Cumulative Debt Paydown, Free Cash Flow Yield,
and FCF Conversion.
Once you’re done, also calculate the 5-year IRR and Money-on-Money (MoM) Multiple, making
sure that you factor in the equity rollover.
Then, create a Returns Contribution Analysis that shows the % of the returns that come from
EBITDA growth vs. multiple expansion vs. debt paydown and cash generation.
Finally, create sensitivity tables for the key assumptions in the model. It’s up to you to decide
which assumptions to sensitize, and which ranges to pick for each table.
Part 7: Answering the Discussion Questions and Making an Investment Recommendation
Once you’ve completed the work above, please answer the following case study questions in a
20-slide presentation to our firm:
1. If you were Carlyle, would you have done this deal? You must give a definitive “Yes” or
“No” answer.

2. Support your answer with the results of your analysis, your insights into the market,
and other quantitative and qualitative factors. If you’re recommending against
investment, explain what conditions, if any, would cause you to change your mind. If
you’re recommending for investment, make sure you address the potential risks and
how to mitigate them.

3. Do you think the valuation of $4.60 per share (a ~30% premium to the “undisturbed”
share price) is reasonable? Should Carlyle be paying less than that? Is it possible to pay
more than that and still make the numbers work? Support your answers with the
relevant valuation methodologies.

4. What portion of the returns comes from growth vs. multiple expansion vs. debt
paydown, and what does this tell you about the viability of the deal?

http://breakingintowallstreet.com
http://www.mergersandinquisitions.com
 5. What do the credit stats and ratios tell you about the transaction assumptions and the
company’s ability to repay debt?

6. Do you think Seven Days’ move into Managed Hotels will pay off? In other words, is the
higher margin and less capital-intensive revenue a universally positive trend, or are
there risks associated with it as well?

7. Are there any other factors you haven’t considered in this case study that might impact
the deal, the potential returns, and the risk factors? If so, what are they, and what
additional research would you need to do on them?

You have 1 week to complete the LBO model and your presentation, and 1 hour to present
your findings to the committee and answer questions on your investment thesis, analysis, and
conclusions.
Part 8: Extra Credit Questions
If you’ve finished your case study presentation and still have time left, please answer the
following extra credit questions:
BONUS QUESTION #1: Further Simplifying the Model
Suppose that you only had 1 hour to build the LBO model in this case study.
How could you simplify the model in order to finish it within this time constraint?
You model should still include the Income Statement, Cash Flow Statement, and Debt Schedule,
but you can simplify the assumptions and use simple percentage growth rates.
Please build a new, simplified version of your LBO model to demonstrate your approach.
BONUS QUESTION #2: “Paper LBO” Case Study
In some private equity interviews, they give “paper LBO” case studies where you need to
calculate the IRR or MoM multiple given a simple set of assumptions, or calculate the purchase
price or exit price required to achieve a targeted IRR or MoM multiple.
Please refer to the separate case study document on the “paper LBO” case study and calculate
the required figures.
SKIP the formatting and simply make the calculations.

http://breakingintowallstreet.com
http://www.mergersandinquisitions.com