China discount hotel chain in US$100m IPO

Risks affecting China Lodging’s offer include government action, investors wary of China listings

DISCOUNT hotel chain China Lodging Group Ltd is emblematic of China’s blistering growth, but it could be hurt if the government takes steps to prevent the world’s third-largest economy from overheating.

China Lodging, which hopes to raise about US$100 million in an initial public offering this week, has grown rapidly by renting budget rooms under three different brands for an average of 174 yuan (S$36) a night.

The number of rooms the company had to rent increased 160 per cent in 2008 and another 35 per cent in 2009. At the end of December China Lodging had 28,360 rooms for rent, mostly in big cities in the heavily industrialised eastern part of the country.

Its occupancy rate in 2009 was 94 per cent, up from the mid-to-high 80s the previous two years.

China’s hotel industry has grown rapidly as foreign tourist and business travel has increased and Chinese citizens are travelling more within the country as incomes grow.

Marriott International, Starwood Hotels & Resorts Worldwide and Hyatt Hotels all beat fourth-quarter expectations in part on strength from China.

Chinese citizens are willing to spend on hotels during pleasure trips but budget hotels are the choice for businesses aiming to keep costs down.

‘Budget hotels are growing popular among business executives,’ said William Lo, an analyst at Ample Finance Group in Hong Kong. ‘(However), we think there is an oversupply in the hotel industry.’ China is taking moves to cool its explosive real estate sector and hotels are rumoured to be next. On Thursday, the Chinese government said it would require some large state-owned enterprises whose core business is not in the property sector to withdraw from the business, in a move to try and cool the red-hot sector. Media reports said the government could next target the hotel industry that has assets worth hundreds of billions of yuan, given the huge number of players in the market.

‘Clearly country-specific risk is a factor that investors are going to take into account and that affects the overall risk profile of the transaction,’ said Richard Truesdell Jr, co-head of the global Capital Markets Group at law firm Davis Polk & Wardwell LLP. The firm is an advisor for the offering.

China Lodging has not been immune to the financial meltdown. The company’s hotels in Wuxi, Suzhou and Ningbo have seen a decline in business due to the global financial crisis because they rely heavily on international trade, the company said in its prospectus.

A late November IPO by Chinese discount hotel chain 7 Days Group Holdings could also give investors pause. The shares rose 13.6 per cent in their debut but are now trading 6.7 per cent below their IPO price. 7 Days Group had 28,266 rooms for rent as of Sept 30.

‘Chinese offerings have lost their lustre,’ said IPO Boutique senior managing partner Scott Sweet. ‘There’s a lot of bad will right now with Chinese IPOs. US investors have been hurt badly.’ Mr Sweet said investors are still smarting from losses in IPOs like Shanda Games Ltd, whose shares were hyped but are now 47 per cent below their IPO price.

Mr Sweet said China Lodging’s price – it plans to sell 9 million American Depositary Shares for between US$10.25 and US$12.25 each – may need to be cut.

If the IPO prices at the midpoint of the expected range, China Lodging will have a price-to-book value of 2.6 compared with 7 Days Group’s 8.5 and Home Inns & Hotels Management Inc’s 3.9, according to president Francis Gaskins. Mr Gaskins expects the China Lodging IPO to do well.

China Lodging, sharing characteristics with other Chinese IPOs, said in its prospectus that it might not be in compliance with certain Chinese laws.

The company said it does not hold land use rights or own any of the hotel properties it operates. As of Dec 31, lessors failed to provide documentation for 46 properties.

It also holds several leases without the permission of the property owners or government authorities, it said.

China Lodging said it could be subject to fines and lease disputes for not registering with local housing bureaus and is uncertain whether it is running afoul of a labour contract law that has been in place since January 2008.

Such non-compliance issues may not be unusual among companies operating in China. 7 Days Group made similar statements in its prospectus.

‘Goldman Sachs and Morgan Stanley are proceeding with the offering,’ said president David Menlow.’Evidently it’s not such a major concern.’ Goldman Sachs and Morgan Stanley are leading the underwriters.

China Lodging founder and Executive Chairman Qi Ji was co-founder of online travel services provider and Chinese economy hotelier Home Inns, both of which are publicly traded on Nasdaq.

‘It’s not as though they’re going to be blindsided by any of the metrics that are in the marketplace,’ said Mr Menlow.

China Lodging is expected to price on Thursday. Other IPOs expected next week are telecom equipment maker Calix Networks Inc, First Interstate BancSystem Inc , crude oil and drybulk shipper Alma Maritime Ltd and chipmaker MaxLinear Inc.

Source : Business Times – 23 Mar 2010


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