Caselet: Le Meridien Lombok

Suggested Answers to the Strategy Questions

Question A.
1. Four persuasive arguments.
(i) Repeat our successful, proven Thai “town and resort” strategy in Indonesia
(ii) The management fees are huge. The standard is “2+5” which specifically means 2% of the gross
revenue as a base fee and 5% of the gross operating profit as an incentive fee. The management fee in this
case is “3+10” or 50% more in base fee and 100% more in incentive fee.
(iii) Lombok could become “the next Bali.”
(iv) Le Meridien has the opportunity to be the pioneer (or first mover) in the 5-star hotel category on
Lombok.

2. Two reasons for investing $1 million, unusual for a hotel management company
(i) In order to gain credibility with our partner, Modern, and get the huge management fee.
(ii) In order to gain credibility with, and attract, the third party New Investor to the project.

Question B.
3. (Answers to the Financial Model. See separate sheet.)

4. At least 2% for the debt fundraising (1-3%). The debt may be difficult to raise because (1) the loan is 9
years to repayment, average life 4.5 years, which is longer than most commercial banks are comfortable
with; (2) the security for the loan is a first mortgage over the property, BUT no guarantees by the Sponsors,
Modern and Le Meridien, so it is a project financing; (3) the hotel is in a resort location, not in a city with
steady visitor traffic; (4) the resort is on a unknown island; (5) the island is near a well-known, well-
regarded destination, Bali, and so may suffer by comparison; and (6) the management fees are above
normal and affect the cash flow available to service the repayment of the loan.

5. At least 4% for the equity fundraising (2-6%). The equity may be difficult to raise because (1) the IRR
on a realistic basis is in the 15-20% range, not in the 25-30% range, so this is likely to be too low a return
to attract a pure financial investor; (2) it is 9 years before there is any return (dividends) to the investor; (3)
the revenue stream is uncertain because the resort is in an unknown location on an unknown island; (4) the
success of a 5-star hotel concept on Lombok Island is untested and thus highly uncertain; (5) the exit
strategy is not obvious: there are no IPO comparables on the Jakarta Stock Exchange, the principals,
Modern and Le Meridien, are unlikely to buy the 38% equity stake, so the only exit is a sale to a third
party; and (6) it is difficult to sell a substantial minority equity interest where someone else has majority
ownership and control.

6. a. Room rate (price) and Occupancy percentage (volume). The room rates start at $88 (perhaps below
market), rise 13.6% to $100, then have more gradual percentage increases; seems reasonable. The
occupancy percentages, 52% in the first year, 62% in the second year, 70% in the third year, then steady at
73% thereafter seem also to be reasonable, or at least not wildly aggressive. However, if visitor traffic is
seasonal, it would be useful to have a month-by-month breakdown of the occupancy percentages rather
than just the aggregate annual percentage.
b. If the normal room revenue / room cost ratio is 2:1, and even though this is a 5-star resort where the
room rates may be higher than normal and the labor costs on Lombok may be lower than normal, the 6:1,
7:1 and such ratios seem quite aggressive.
c. (2) The base used. The basis is “profit before depreciation and tax in respect of next year”. Profit (E)
before depreciation (D) is OK; adding back depreciation to earnings is effectively free cash flow.
However, it is not correct to add back taxes, which are actual expenses to the company. EBDT as a basis
thus is an unusual (read: made up by Larry) basis and highly questionable, particulary if combined with a
high exit multiple. The usual bases for calculating a Terminal Value are some multiple of earnings (E) (in
respect of NEXT year is OK because that is the way the terminal value formula works), or earnings before
interest and taxes (EBIT) or earnings before interest, taxes, depreciation and amortization (EBITDA).
(1) A reasonable multiple of the base. If one uses E, one can use a higher multiple, then a lower multiple
for EBIT, then lower yet again if the basis is EBITDA. While it will depend on the industry, and the
comparables of listed and unlisted companies, as a rule of thumb one could think about terminal values of,
for example, 15 times (x) E, or a multiple of 10 x EBIT, or a multiple of 5 x EBITDA.
d. Sale to a third party is the most likely. (1) IPO is unlikely for a single resort property. Check: There are
NO listed single resort properties on the 2 likely stock exchanges for this listing, namely the Jakarta and
Singapore stock exchanges. (2) Sale to an existing shareholder is unlikely, because Le Meridien is a hotel
MANAGEMENT company and does not like to invest at all in properties it manages, and Modern sold the
land to the JV at an inflated price and took back shares, and thus seems unwilling to contribute cash to this
project. In addition, Modern already has majority ownership and control.
e. Your IRR estimate for the base case should be around 16%, or, using pessimistic and optimistic
assumptions, somewhere between 10% and 20%.

7. (i) Investors who have the objective of developing tourism on Lombok or in Indonesia (e.g., the
Indonesian Tourism Board), or (ii) investors who are “trophy” or “prestige” investors, who want some
financial return but are more interested in being associated with a 5-star prestige property.

8. Yes. From banks which are familiar banks to either Modern or Le Meridien. [In the event, 3 French
banks committed to provide $3 million each, within 30 days of solicitation by the investment bank. Super!]

9. Should have been Yes, but ultimately No. The financial investors felt the reward was insufficient for the
risk involved. The Indonesian Tourism Board was willing to invest, but required the project to be owned at
least 51% by Indonesians (yes, says Modern) AND the management company as well (no, says Le
Meridien). The investment bank found 13 prestige investors, but in each case the prestige investor wanted
at least 51% and ideally 100% of the equity (yes, says Le Meridien; no, says Modern).

10. Sadly, NO. The concept was valid, but the principals were inflexible in their “greed.” The first
investment bank was terminated by mutual agreement after 8 months. Subsequently a second investment
bank failed to raise the equity funds after 12 months of effort. Le Meridien and Modern were not willing to
renegotiate the terms of entry to make the investment attractive enough for a New Investor.

Le Meridien has no hotel on Lombok. Currently, Le Meridien manages one hotel on Bali, in addition to its
Jakarta hotel. It currently has no other presence in Indonesia.

11. There are 4-star and 5-star hotels on Lombok Island today. For example, the Oberoi group has a 5-star
hotel where the published room rate is in excess of US$500/night, proving the validity of Le Meridien’s
pioneering concept.
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