Description

Company and situation overview

Greentree Hospitality Group (“GHG”) is a Chinese company and rather illiquid so proceed accordingly (there has been vast discussion and difference of opinion on VIC about the risks of Chinese companies). That said, this is an opportunity for those who can participate in taking advantage of a large liquidity discount to purchase a top-5 China hotel company at a heavily depressed price.

At YE’21, GHG’s network included >4,600 hotels with another >1,200 under development. The company grew to this level from only 792 hotels in 2012. GHG concentrates on Tier 3 and lower cities, serving value-conscious and business travelers, though has added some diversification to higher end hotels over time. The value focus has proven a wise strategy as those areas and customers offer a unique combination of growth opportunities and customer resilience that has allowed for outperformance relative to industry pressures seen in China’s Tier 1-2 cities.

A good analytical comparison for GHG is peer company Huazhu Group (“HTHT”). HTHT is a competing hotel chain with 1,073 franchised hotels in China, much lower than GHG’s 4,593 as GHG is the purer franchise play. HTHT does have far more leased & owned (“L&O”) hotels (1,565 vs. 66) as well as a European division such that total revenue is much larger. Because of differing composition between L&O and franchise, I’ll focus on adj. ebitda to give a rough comparison. On this measure, HTHT is ~5x as large as GHG (rmb 1,571 vs 325 mm for FY’21). However, despite the roughly 5x difference in ebitda, HTHT enjoys a 30x larger enterprise value. This simplified comparison evidences the potential opportunity in GHG.   

Thesis

Several issues have led GHG to its current depressed levels, which I discuss below. I think rectification of just a couple of these items could lead to 100% upside in share prices (which only amounts to a reset to January 2022 levels). Some of the items are clearly more controllable by the company and others will depend on macro factors.

Less lockdowns in China. Of course, this is a key item not controlled by the company. As China becomes more and more of an outlier in the global covid response, I expect the country’s lockdown approach to relax by YE after the twice-a-decade party congress meeting.

Return to 2019 (pre-covid) operating levels. This is certainly contingent upon the lockdown point above but it’s worth observing that when lockdowns have lessened historically, China’s hotel RevPar reacted swiftly, with GHG’s RevPAR eclipsing 2019 levels in 4Q’20, May 2021, and approaching 2019 levels in November 2021 (see investor presentation RevPAR as % of 2019 chart). HTHT also shows a similar pattern while even certain U.S. chains haven’t yet shown such potential. The simple point here is that when covid lessens, travel / hotel use quickly responds and we don’t need to be overly concerned with a permanent reduction to industry demand having occurred under the surface.

In 2019, GHG generated over 60 US cents of earnings and FCF per share and I believe the company will grow beyond this level beginning in 2023. Of note here, GHG’s current hotel count stands at 4,659 (with a 1,225 pipeline), which is ~18% higher than the 2019 level as the company has kept growing the asset base during covid. If we assume the pipeline hotels enter service in the next couple years and 300 of offsetting hotel closures (historical pace prior to an outlier 2022 closure rate), then the YE’23 hotel count would approach 5,600, or +41% from the 2019 level. While I believe a return to 2019 financial performance makes this investment a success, the much larger hotel count makes that very realistic under even conservative RevPAR assumptions. GHG has actually outperformed the industry in RevPAR consistently over the past few years and its largely franchise model allowed the company to remain profitable even during depths of covid and whilst offering significant franchisee fee relief.

Governance perception. I believe the CEO to be honest and frank about company operations. I suggest listening to conference calls beyond just reading transcripts and developing one’s own opinion. That said, the company has been delayed in its reporting, even beyond the normal delayed Chinese reporting schedule. The company indicated they’d largely catch up for 1Q’22 but was then further delayed with Shanghai lockdowns affecting their year-end audit, with the 20-F published within a 15-day grace period. GHG also just announced a related party acquisition, acquiring a franchise-model dumpling chain that was majority owned by the CEO and spending nearly $60 mm to do so. The Board utilized independent advisors in approving the transaction, which arguably does have nice synergy (potential to co-locate, combine food and lodging, and leverage the parent’s franchise expertise); however, this transaction doesn’t help overcome the likely already-negative perception towards the company.

Liquidity. The CEO controls/owns nearly 90% of the company and the resulting small float has of late reduced the company’s trading volumes significantly. The reason why I think this idea is worthwhile beyond some other pure liquidity discount type investments is that there is real interest here. The conference calls are well-attended by Street analysts and historical trading volumes were far better.

Other related risks and opportunities.

Another big concern is the potential for delisting of U.S. ADRs which has also been heavily discussed on this board. GHG doesn’t yet have a dual listing and is therefore at elevated risk. The company incurred significant expense over the past year to engage advisors in part to prepare for this issue but there has been no clear outcome yet. The company also closed considerable hotels in 2021 which appears to be a pruning / cleaning up of the portfolio which improves compliance with local regulations and improves the overall brand standard. These costs and efforts are likely in pursuit of some value enhancing event which could include a secondary listing. However, the company’s small capitalization is thought to be an obstacle to a HK listing and given the lack of clarity, I don’t want to oversell this potential. Delisting remains a risk, with mixed reports of progress in recent news articles. Separately, in mid-April, Bloomberg reported that CICC Capital and management was considering a buyout of shares at a 30%+ premium to then-share price levels (around $5 / share) though there hasn’t been any follow-up. The company did announce a US$20 mm share repurchase authorization with the recent 4Q’21 results, which could easily support the share price during the remaining difficult covid period.

Catalyst

lessening lockdowns, value realizing event as discussed above