Keep An Eye On This $700 Million Private Equity Buyout

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In early March, the Washington, D.C.-based private equity firm known as the Carlyle Group (NASDAQ: CG) announced that it had entered into a definitive agreement to buy out Guangzhou, China-based hotelier Seven Days Group Holdings (NYSE: SVN) in its entirety in a deal valued at nearly $700 million. The terms of the deal would require the Carlyle Group to enter into a partnership and assume a significant amount of debt in order to finance the deal. Thus far, there appears to be little resistance on the part of shareholders or regulators to what is being characterized as a fair and equitable deal. Assuming that nothing arises to scuttle or delay this buyout, it could be finalized by the end of the third quarter of 2013.

About 7 Days Group Holdings and Carlyle Group

Seven Days Group Holdings is a Chinese discount hotel chain that caters primarily to budget-minded business travellers within China's borders. It currently operates over 1,000 hotels in the country under the "Seven Days" brand name. With units in over 160 cities, it enjoys strong geographical representation along the country's populous eastern seaboard. It runs roughly two wholly owned hotels for every franchise unit that it sells. Seven Days employs about 23,000 full-time employees and earned $27.7 million on gross 2012 revenues of $383.9 million.

The Carlyle Group is an American private equity and asset management firm that specializes in corporate takeovers, management-led buyouts, privatization schemes, minority investments, and investments in bankrupt or otherwise distressed companies. Carlyle also engages in a wide variety of financing operations, including mezzanine and venture arrangements. The company provides advisory services, wealth management, fund management and other high-level financial services. It has holdings or investments on every continent but Antarctica and employs about 1,400 people in several cities. In 2012, Carlyle Group earned $642.8 million on about $3 billion in gross revenues.

How the Deal Is Structured

Under the terms of the deal, the Carlyle Group will issue cash payments in the amount of $13.80 per share to all holders of Seven Days's ADR shares. As the agreement currently stands, there will be no stock-issue option. Once this transaction has been completed, Seven Days will cease to trade as a public company and become a majority-owned subsidiary of the Carlyle Group.

Relative to Seven Days's current closing price of $13.38, this buyout offer represents a premium of about 3.3 percent. However, the stock was trading at much lower levels for much of 2012. Until Seven Days received an initial buyout offer in September of that year, it had traded in a range between $8.50 and $11 per share for the previous three months. Relative to the company's pre-announcement closing price of about $9 per share, Carlyle's offer provides a premium of more than 53 percent.

Complications and Legal Issues

Thus far, there have been few issues raised by shareholders or legal actors about the proposed deal. However, the leveraged nature of the transaction does create some internal risk. In addition to Carlyle, there are three major players that have agreed to provide financing for the Seven Days Buyout: Sequoia Capital, Actis and Warburg Pincus. If any one of these backers drops out of the deal at the last minute, it could create an unfavorable situation in which the remaining players are forced to scramble for alternative sources of financing. Under these circumstances, it would not be inconceivable for the deal to fall apart completely. This may be the reason that Seven Days continues to trade at a noticeable discount to Carlyle's offer.

Competitors, Long-Term Outlook and Prospects

Many of Seven Days's direct competitors are small or mid-sized private companies that operate exclusively within China. Among its private competitors, one notable exception is Best Western International. As one of the largest discount hotel chains in the world, Best Western is a formidable player in all of the markets in which it operates. Although this U.S.-based company does operate a number of hotel properties in China, Seven Days should consider itself lucky that it does not maintain a particularly strong presence there. On the upside, Best Western might serve as a willing buyer for Seven Days in the event that the Carlyle consortium chooses to offload the company.

Seven Days's major public competitor is Home Inns & Hotel Management (NASDAQ: HMIN). Like Seven Days, Shanghai-based Home Inns operates a respected brand of discount hotels and motels in various major business centers across China. With around 1,700 outlets, the chain is slightly larger than Seven Days. However, it is by no means dominant and does not appear to be intent on crowding its competitor out of the market.

With China's economy continuing to grow at a rapid clip, it is clear that there is substantial room for expansion in the country's hotel market. As Chinese business travelers become more affluent, Seven Days may well choose to open classier hotels that offer more amenities at higher price points. This could create tremendous value for Carlyle's shareholders and pay off handsomely in the event of a spin-off or sale.

In sum, Seven Days looks like an attractive takeover target. For interested investors, the company's stock currently offers a small takeover premium. Those who believe that the currently envisioned deal will go through without a hitch would do well to pile in at these levels and pocket their gains on the other end of the trade.

Mike Thiessen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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