Asset Management case study

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Question A1: Comment on the deal originating approach adopted by
Actis for 7 Day Inn

In evaluating 7 Day Inn, Actis applies a top-down approach: from a list of
investable countries, i.e. the emerging markets, as the private equity firm
focuses on investments in these countries. Then, they narrowed down the
relevant industry according to compound annual growth rate (the CAGR
for the lodging industry was at 17%) and prospects of future growth. Next,
they focused on the players in the market: star-rated hotels, budget hotels
and guesthouses. After assessing the growth prospects and popularity of
each type of lodging facility, Li’s team chose budget hotels due to its high
CAGR in comparison to other hotel types (30-35%) and due to
expectations that this type of hotel would ultimately dominate the market
due to economies of scale.
After the team had shortlisted the top seven players in the budget hotel
sector, they attended conferences and arranged meetings with individual
companies. Before consulting experts from the China Hotel Association,
Li’s team members then stayed at these shortlisted hotels to experience
the service being offered. The next evaluation was conducted based on
previous financial statements and future forecasts. The final decision for
recommending 7 Day Inn was taken after intensive due diligence was
conducted by Deloitte and another Big Four accounting firm.
The top-down approach focuses on the economy as a whole before
breaking the investment opportunities down to industries, sectors and
then individual companies. In regards this, the top-down approach was
aptly suited for 7 Day Inn as this is a large equity investment. Careful
consideration of macroeconomic and political factors of the list of
investable countries allowed Li to narrow down on China due to both the
current conditions and future growth prospects. This approach also
enabled Li to understand the prevalent trends in the industry and what
impact they have on its various sectors, hence an evaluation of both the
risks and returns associated with the industry. Further, analysis of
competitors highlighted the strengths and weaknesses of each company

and so did the detailed due diligence of 7 Day Inn by a Big Four firm.
Lastly, Li’s team’s approach of experiencing the service being offered by 7
Day Inn allowed it to get an inside look on how the hotels are run, the
possibilities of improvement and any areas it was better at in catering
customer needs compared to other budget hotels.
Actis deal origination approach was focused on understanding the lodging
sector as clearly as possible. This is shown by the immediate relationship
they form with an former CEO of the budget lodge firm in South Africa.
The relationship plays a key role in the deal as it provides Actis with
information on how business is done in the sector. This would become
important later when Actis would have to prove to management of 7 days
Inn that they understand the business. For further understanding of the 7
Days Inn and its managers Actis appointed three consulting firms (Deloit,
Big Four accounting firm and Egon Zehnder) as advisory firms. The work
done by these firms would enable Actis to understand the risks of
investing in 7 Days Inn.
Question A2: What Strategies proved to be successful?
The first strategy that proved to be successful was the
The strategies that proved to be successful was Actis’ emphasis on
understanding what differentiated 7 Days Inn from other Budget hotels
which could enable Actis to get an understanding on how the business will
keep its high occupancy rate: firstly, 7 Days Inn adopted the use of
internet which would enable the firm to identify its customers. This would
enable Actis to focus future returns. Also the adaptation of internet would
enable 7 Days Inn to interact with its customers more efficiently. To further
7 Days Inn as a service provider Actis’ team visited the hotels to get to
experience the efficiency provided by 7 Days Inn.
To get the management on 7 Days Inn on board with Actis investment
plans, Actis’ engagement with a former CEO and interviews with China
Hotel Association proved to be critical as Actis leveraged on the

information acquired to show 7 Days Inn management about the
understanding of their business and business priorities.
Question A3: What are the areas that could have been improved?
Actis could have conducted customer surveys on what current and
prospective customers at budget hotels are demanding. Using such data,
Li could then generate forecasts that would incorporate both removal of
unnecessary services and products and costs incurred in introducing and
maintaining services that customers demand.
Secondly, Li
I think Actis could have waited for the credit crisis to pass before
approaching 7 Days Inn with funding. In other words the timing could have
been improved. I think they would have gotten a better price.

Question A4: What were the advantages and disadvantages of
focusing on a sector?
The disadvantages of focusing on a sector: outside influence on the sector
will not be seen until it has entered into the sector. There could have been
better investment options in another sector with even lower risks that
could have been compared with 7 Days Inn and Hantin Inn.
The advantages of focusing on a sector: Actis could compare firm that
bear similar risks and be able to choose a firm with future prospects.
Focusing on a sector also enabled Actis to leverage on the skills and
experience they have on the chosen sector. Focusing on a sector means
Actis had more resources for a detailed research on the sector.
Question b1: Was the budget hotel sector in China a good sector
for investments?
A good investment can be defined through the following parameters:
quick payback, good long-term returns, low risk, high growth potential,

high Return on Equity that is sustainable, a proven business model and
economic stability.
In the case of the budget hotel sector, most of these conditions were
being met: a high CAGR of 17% was sustained, changing traveler trends,
such as the sustained increase in both leisure and business domestic
travelling and the dominance of the lodging market with ‘smart’ travelers.
The business model employed was proven to be successful by the large
number of franchises many of the companies managed to open in short
periods of time. Lastly, compared to star-rated hotels, the budget hotels
had a higher CAGR, and high occupancy rates.
Yes the budget Hotel industry in China was good investment because of
the following factors:
- Demand and growth momentum: The budget hotel industry has fully
developed in the west and was profitable but in China it only made 0.6%
of total number of hotels and 1.5% of total rooms and the occupancy rate
was more than 85% which showed that there was a demand for the
budget hotels. The 90% growth growth of budget hotel showed that was
heavy momentum behind the growth on this sector which provided big
profit portential.
- Affordability:

the 85%+ occupancy rate shows that customers were

willing to pay for the service they got in the budget hotel which provided
an incentive for investment in the industry.
- China’s fast growth: The Chinese economy had been the fastest growing
economy in the world. This meant that there was increasing number of
people moving into the middle class than anywhere in the world who
could afford to stay in the budget hotels since they were not expensive
and offered good service. In a booming economy like China one would
expect to find a lot small businesses whose management would not be
looking to stay in a 5 or 4 star hotel but a hotel in the middle with good
service like budget hotels.

Question b2: Was other information would you need to know before
making a decision to invest in the budget hotel industry?
Specific to the budget hotel industry, Actis should acquire information
regarding both external and internal factors: regarding external factors,
information on business cycles prevailing in the lodging industry must be
studied, to ensure that growth prospects sustainable.
Regarding the actual locations of current hotels is also a matter of
importance: in developing countries cities and towns are continuously
being extended and hence property rates, e.g. lease, renting or purchase
price, will increase in the future. Therefore, all overhead cost structures
should be observed to incorporate any drastic changes into forecasts.
Next, the market should be studied with regards to competition and
saturation in supply. Just as Actis is considering investing in 7 Day Inn, so
are other companies that see the growth potential in the budget hotel
sector. Forecasts should factor in increased competition.
Lastly, macroeconomic parameters of the country should be considered:
which business cycle is prevalent in the economy of the budget hotel and
those in economies that affect the host country, e.g. trade partners. There
is significant impact of change in economic conditions in one country on
its trading partners and hence that can lead to high fluctuations in
demand, specifically in the hospitality industry. Before investing in the
budget hotel industry, one would want to know about external factors to
the industry. These would include government regulations.
Question c1: Which was a better investment for Actis?

Membership program

7 Day Inn
Hantin Inn
membership
 Ability
to
run No
schemes
that program
provide greater

Number of hotels

customer
satisfaction and
experience
to
existing
customers
 Possibility
of
improving
customer
service.
 High retention of
clients
153
(greater
than 111
Hantin)

 Larger
area
coverage
 Available
to
repeat
clients
that
either
voluntarily
(leisure travelers)
choose different
locations
or
those that are set
to repeatedly use
one location e.g.
for conferences
and
workshops
(business
travelers)
 Better equipped
to fulfill needs of
customers
that
travel to multiple
destinations:
provide
standardized
service
across
regions
 Develop
contracts
with
businesses
for
repeat business
travelers
at

High
concentration of
hotels close by.

discount rates.
 Available
in
major cities.
CAGR
292.2% (greater than 277.8%
Hantin)
 Aggressive
growth strategy.
Staff to Room ratio
0.26 (roughly 4 rooms 0.33(roughly 3 rooms
per staff member)
per staff member)
 Lower ratio which
 Possibility
of
then translates to
inefficiency
of
lower labor costs.
staff.
 Lower
cost
 Shorter cleaning
passed
on
to
and maintenance
customers
that
time of rooms.

Better
are
budget
attendance
by
conscious.
staff to customer
needs.
Number
of
active Greater than 700,000
None
members in loyalty
 Dedicated client
program
base.
 Don’t need to
rely on walk-in
clients

In addition to the above, 7 Days Inn has a high EBITDA margin, shortest
payback period and lowest daily average rate. After considering all the
above, it can be concluded that 7 Day Inn is a better investment than
Hantin Inn.
The better investment target for Actis was 7 Days Inn. This was because
of lower room prices and lower cost model accompanied by 7 days Inn
better management efficiency, consistency and quality of service which
created higher value for money. 7 days Inn had a higher number of hotels
(153) compared to Hantin (111). The higher number of hotels for 7 Days
Inn may have been an indication that the firm was not very far from
slowing its growth which had kept the firm with negative profits. Finally, 7

Days Inn had identified its customers and could quantify them which
increased the predictability of future returns for an investment.
Question c2: What other critical information do I need to decide
which from is better for investments?
Comparison of the two companies is essential: this is done through
analyzing various ratios from the financial statements of both companies
for at least 5years. Next, qualitative information regarding client
experience should be collected. Investor perception of service being
offered and the brand itself is critical.
To make a well informed decision on which firm to invest in it is critical
that I get hold of both company’s historical financial statements. This
would assist me identifying key investment signals for both companies.
These

investment

signals

include

Liquidity/Leverage of the companies.

profitability

of

the

companies,

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