2011年12月17日 星期六

Home and Away

Home and Away 

When I first traveled to Mainland China in late 1990s as a young kid, I was surprised by how strangely at home I felt, and yet so distinctly away from the world I knew so well. The first thing that got my attention was the hotel. 

Growing up in Taiwan, the island province deemed as “unsinkable aircraft carrier” by the US general staffs during World War II and Cold War, I am no stranger to political indoctrination. Even after Deng’s economic reform had been in full force for almost 20 years, lots of Taiwanese, mesmerized by distorted propaganda, still viewed Mainlanders as poor rural cousins living in People’s Commune. While my precocious mind was largely immune from such misperception thanks to my journalist parents (who enjoyed better access to true information) the idea of people living in a collective dorm haunted my mind. 

The Beijing hotel I stayed at was not really a hotel. It was commonly referred to as “guest house” (招待所) by Chinese people. In a typical guest house the service is quite modest: no concierge to greet you, no bellhop to carry your luggage, no plush pillows and cozy bed. Typical amenities include a tiny soap, some toothpaste, and a thermal carafe to fill hot water in the corridor. Bathroom malfunction is very common. At night you are forced to share other people’s life because the room wall is very thin, and some guests simply do not bother to close the door. For less than RMB90 per night, very soon a foreign traveler learns to affect an indifferent attitude like other Chinese guests. Complaints are futile. 

When I revisited Beijing in 2007 with other Wall St. investors from New York, I stayed at the China World Hotel, a five-star premise providing all lavish services and amenities up to the global standard. Friends told me many other new 5- and 6-star hotels were in construction and the going room rate was reaching RMB3000 per night. However, numerous guest houses were still in business, serving millions of Chinese for less than RMB100 per night. In retrospect, that was my first true lesson in wealth inequality of contemporary China. And the best classroom to review that lesson is in Chinese budget hotel. 

The Blue Sea of Lodging in China 

The volume of domestic travelers in China has expanded to 2.1 billion people in 2010 from 744 million people in 2000. The industry revenue during the respective period grew four-fold to RMB1.3 trillion from RMB318 billion. The volume is expected to grow further as Chinese GDP and disposable income grow. China’s lodging sector includes both hotels (star-rated and non star-rated) and other forms of accommodation (e.g., guest houses). The industry grew from 250,061 lodging premises in 2004 to 328,007 lodging premises in 2010, and from 21 million rooms in 2004 to 29 million rooms in 2010. 

Budget hotel was first introduced in late 1990s and the industry experienced substantial growth during the past decade. Several branded budget hotel chains, including Home Inns (如家) Hainting (漢庭), Seven Days (七天), Jinjiang Inns (錦江) and Motel 168 (莫泰), emerged primarily from China’s prosperous coastal region. Typical room is about 200 sqf, mostly priced under RMB200 per room night. The key target customers are value conscious domestic business and leisure travelers who demand cleanliness, safety, convenience, and value features such as high quality bed and bedding, air conditioning, in-suite bathroom and free Internet access. 

Despite rapid unit growth, branded budget hotel industry is still small and fragmented: it only accounts for 1.6% of total lodging premises in China and the top three budget hotel operators in China accounts for 36% of the total rooms in the branded economy hotel sector versus 67% in the United States. 

Among these branded budget hotel chains, Home Inns (NASDAQ: HMIN) has probably one of the most legendary start-up story in China. An US-listed company since 2006 with about $1.2 billion market cap, HMIN was founded by the original founders of Ctrip.com (NASDAQ: CTRP) the Chinese equivalent of Expedia in 2002. Through its online booking platform (whose volume already reached 100,000 hotel rooms per month in 2002) the Ctrip founders realized that mid-end budget hotel was a “blue sea” for lodging in China. With the help of Beijing Tourism Group, HMIN was founded to fulfill this customer demand. 

Within a decade, HMIN grew from less than 10 hotels to a national chain of over 1000 hotels. The business model follows typical two-pronged chain store format: leased-and-operated hotels and franchised-and-managed hotels. HMIN leases properties located in good areas from State-Owned Enterprise. These properties usually come with legacy issues that render them under utilized for years. Deep local expertise allows HMIN to navigate the bureaucracy with finesse and rents these assets with 15-20 years lease with attractive rent stabilization clause, convert them into hotel, and install HMIN IT system and managers. Once HMIN feels comfortable with a city, it will franchise its brand to property owners for an upfront fee and annual revenue off-take of 3%. As more franchised-and-managed hotels are added, margin expansion can be significant. 

A typical HMIN hotel has 80 to 160 rooms. The size of each room is about 15 to 25m2 (150~250 sqf) and conversion capex per room at a leased-and-operated hotel is about RMB60,000 per room or about $1 million per hotel. The conversion costs vary greatly across regions and minimum cost requires to attain a “Home-Inn-look-alike” room is RMB2,000/m2 or RMB30,000 to 50,000 per room, depending on quality. Further cost-cutting is possible. The biggest capex item is restroom, where HMIN has standardized its design and because of HMIN’s scale, it has good bargaining power against vendors and contractors. 

Because the model is highly scalable, HMIN has quickly expanded nationwide, for a simple reason: the unit rental cost in tier-2/tier-3 cities ranges between RMB0.9 to 1.2/m2 /day, or about RMB18 to 24 per room per day, much lower than RMB30-60/room/day in tier-1 cities. Budget hotels in China primarily accept domestic travelers (over 90% of total customers) who are more value-conscious. Without a broad national portfolio of low-cost, long-term lease, its leading position shall not be secured. 

The reported average day rate of HMIN has been fluctuated between RMB157-192 since 2004, with quarterly volatility of ±6% ex-Shanghai Expo and occupancy rate seldom dips below 85%. This RevPAR stability largely reflects HMIN’s strong location selection and early-mover advantage in securing long-term lease (10-20yrs). As these leases expire, the convenient location and strong brand should enable HMIN to maintain pricing power to grow with inflation. 

Using the US market as precedent, where Choice Hotels International (CHH) operates and franchises over 6142 hotels (495145 rooms) across 10 brands, the Chinese lodging market should be able to accommodate two or three economy hotel chains with over 3000 to 4000 hotels per chain in the next 10 to 15 years. In that case, blended occupancy rate is unlikely to sustain at 85-90% as customer segmentation drives brand differentiation. Based on interview with Chinese hoteliers, 70-75% as a sustainable long-term occupancy rate for economy and mid-end hotels. However, the sector occupancy rate might not revert to this long-run mean during the 12th Five Year Plan period as more unprofitable stand-alone hotels being consolidated and Chinese disposable income continues to grow. Most importantly, high-cost foreign hotel brands like Accor cannot compete with domestic budget chains for a very simple reason: budget hotel guests in China don’t care about Western hospitality, and they can always sleep on a couch in a distant relative’s house. If you are dealing with unappreciative customers, spending $5 million on a Sofitel project should be viewed as a marketing expense instead of capital investment looking for handsome return. 

While the lodging sector overall is highly sensitive to economic growth, the budget hotel sector has shown strong resilience and rational pricing behavior during economic down cycle: during 1Q 2009 amid aftershock of the Global Financial Crisis, the three listed budget chains all delivered positive quarterly EBITDA margin (HMIN: 13.8%, HTHT: 0.9%, SVN: 11.4%) and high occupancy rate (HMIN: 83% , HTHT: 85%, SVN: 83.5%). HMIN quarterly revenue during 1Q 2009 grew 43% yoy and EBITDA rebounded strongly (up 200% yoy) in 2Q 2009. In addition, from 2008 to 2009 HMIN ADR dropped 7.5% yoy to Rmb160 from Rmb173 but occupancy rate increased 6.5% yoy to 91.5% from 85%, resulting in 1.4% yoy growth in RevPAR. The national average occupancy was around 60% in the respective period. Barring significant slowdown, if not systemic meltdown of Chinese economy, HMIN’s strong track record suggests it should be able to sustain defensive growth even during stagflation period. 

The Big Gets Bigger 

In May 2011, HMIN entered into a definitive agreement to acquire 100% ownership interest in Motel 168, the 5th largest budget hotel chains, for $470 million. Approximately $305 million was paid in cash, and approximately $165 million paid through new issuance of 8.15 million ordinary shares of HMIN. The deal was originally auctioned at $10 billion by Morgan Stanley’s real estate investing team that was looking for an exit due to capital call. The cash portion was funded with a combination of existing cash and a new credit line. This deal is largely being viewed as a must for HMIN as it seeks to solidify its leadership position. Post-acquisition, the combined portfolio of Home Inns and Motel 168 will represent the largest (over 1,215 properties, immediate access to 11 additional cities, expanding coverage to 175 cities in China with 152,512 rooms) and most geographically diverse economy hotel operation in China, with nearly twice as many hotel locations and more than double the total number of rooms of the No. 2 player (7 Days Inn) and accounts for a market share of approximately 24% in the China budget hotel industry. HMIN CEO Mr. Sun believes he can grow the chain to over 3000 hotels in 4 years. 

On P/E basis, the deal looks a bit pricey, as Motel 168 has been printing losses for years due to poor management. On EV/room basis, HMIN was buying Motel 168 at the cash renovation cost per room. With a strong presence in the most affluent Yangtze River Delta region and long-term lease portfolio that is almost impossible to replicate in Shanghai, Motel 168 might be quite an interesting turnaround opportunity misunderstood by the market. Assuming HMIN can maintain +20% EBITDA margin and deliver $1 billion of sales, with a net debt of less than $200 million, or about 1x leveraged, HMIN is offering decent value. This publication argues that, despite its modest appearance, HMIN is actually an Internet company with Ctrip genes inside. A sustainable budget hotel business is not just about getting low rental cost, but more of a play on building a customer service platform supported by strong brand equity and consistent quality, both of are characteristics of a good Internet business. With millions of loyal members, the HMIN ecosystem looks very robust. 

Given bearish dataflow from China these days, especially after Ctrip reported disappointing 3Q2011 results, the sentiment is bad. After all, Ctrip processes over 10 million hotel bookings per month and if its gross margin is shrinking due to lackluster volume, something is wrong with the Chinese middle-class consumers and SME employees who always travel on budget. However, Ctrip only accounts for less than 5% of HMIN bookings. While this publication seeks to aggressively invest in value, it is no fun fighting the tape. In this regard, HMIN’s 2012 or 2015 convertibles look quite interesting: both are sporting a healthy yield and their respective outstanding amounts are covered by healthy cash flow. HMIN might not have a strong track record in rewarding shareholders, it is not incentivized to default on lenders either. While HMIN is busy consolidating the newly acquired business, patient investors should feel at home holding these papers to par.