HTHT IPO: China Lodging Group closes up 14% on first day

On its first day of trading, China Lodging Group (NASDAQ: HTHT) closed at $13.92, 14% above its IPO price.  According to my calculations, this comes to a 1st day market capitalization of USD $819 million.  Total amount raised was $110.25 million. (source:  WSJ).

I’ve been following this story because I’ve been focusing my time and effort recently on the China travel industry.  I know that the CNReviews readership would rather have me write a controversial post on Google China.  I’ve even got some thoughts I want to share.  But ever since leaving UpTake, I’ve been feeling pressure to “figure out what I’m going to do when I grow up” and my wife has clearly indicated to me that whatever that is, it involves some current-period income sometime in the next future!  The net result of this is that I’m pretty focused on China travel right now, so bear with me…

The China Lodging Group (HTHT, parent company of Hanting Express) story first got my attention when I learned of Ctrip’s intent to invest in the company.  I wrote a long post on China Lodging Group over at Tnooz, a travel industry blog I’m starting to blog at (here’s my feed).  Here’s an excerpt:

Leveraging its market share, cash war chest, and insider relationships, Ctrip is making strategic investments in hotel chains to secure access to inventory and potentially even integrate IT and some operations with their partners.

On March 12, Ctrip announced that it will purchase shares equivalent to 8% of the company at the IPO price (see Tnooz, JLM Pacific Epoch) and also 15% of another hotel chain, BTG-Jianguo Hotels & Resorts. At the expected IPO price, Ctrip’s investment will cost them $48-58 million.  China Lodging Group will appoint Ctrip co-founder and CEO Min Fan as a Board Director.

For China Lodging Group, 8% to Ctrip represents a significant stake—all other public investors are expected to account for only another 15% of the company.

Think Different.  Think Offline.  Play an Offline game to win Online.

The first lesson I think this case holds is that a successful “online business” in China must always be thinking about the “offline” components that will confer them advantage.  The conventional wisdom is that Ctrip was smart to focus on call center and on offline media, while eLong was stuck focusing on a more pure online model, in part because of their foreign investors and meddlers from Expedia.  Whether that is true or not, now we see Ctrip making large $50 mm investments in economy hotel chains.

One hypothesis I have:  The hotel industry is massively fragmented and dominated by local interests.  Because hospitality is basically like a real estate business, local hotels all have local “uncles” and connections to protect their real estate interests, so its difficult to consolidate.  While travelers want a nationwide brand, hotel operators have a hard time acquiring the properties in different cities, dominated by local interests, to get the coverage needed to support a brand.  What Hanting, Home Inns, Motel 168, and others have done is much more remarkable than a Western viewer might initially think.

This fragmentation slows the adoption of technology and service management practices.  As a result, the level of service, technology is very low level and primitive.  That’s why it will take a while before Ctrip, or anyone else for that matter, can move beyond faxes, calls, and SMS messages (and hongbao) to local hotel salespeople.  In turn, this limits the ability for Ctrip (or any online travel agency, for that matter) to improve their service.  Any time a customer makes an online reservation, they need to get a call center rep to contact the hotel to confirm that the room that the customer booked is actually available.  Only after some period of time (e.g. 24 hours) can Ctrip contact the customer to tell them that the room is actually confirmed.

The discount economy hotel chains, on the other hand, can provide instant confirmation.  If Ctrip can get access to their inventory, and connect directly to their Central Reservation Systems (CRS), then Ctrip’s hotel booking service becomes that much better.  And if Ctrip could, say, sit on the Board of these companies, and block competitors from having the same access, then all the better.

Did Google play offline to win online?

Make sure you got juice.  In other words, combine centers of power to gain unfair advantage.

Another general theme I see is combining various sources of power together to gain an unfair advantage.  There is a tight set of interlocking Board directorships and investments going on with Ctrip, Home Inns, Beijing Tourism Group (state-owned enterprise and parent company of BTG-Jianguo Hotels), and China Lodging Group.  From my Tnooz post:

In the case of Home Inns and China Lodging Group, Ctrip enjoys an especially cozy relationship with the two companies.

Home Inn was co-founded by Neil Nanpeng Shen, who also co-founded Ctrip and sits on the Board of both companies.

China Lodging Group was founded by Qi Ji, who co-founded Home Inns and also Ctrip, and sits on the Board of both China Lodging Group and Ctrip.

Home Inn co-chairman Yunxin Mei serves on the board of Home Inn and is also vice-chairman and president of BTG (Beijing Tourism Group), a state-owned enterprise focused on tourism.  BTG’s hotel subsidiary BTG-Jianguo Hotel & Resorts also received an investment from Ctrip.

The real test of Ctrip’s strategy will come when they try to secure similar deals with other hotel operators without as close a relationship as Home Inns, BTG-Jianguo, and China Lodging Group.

So who is BTG exactly?  They’re big and state owned:

Beijing Tourism Group (“BTG”), established in February of 1998, is China’s first provincial-level, wholly state-owned tourism enterprise. Through over ten years of hard work, BTG has realized leap-frog development. According to the “2007 China Big Enterprise Groups” published by the National Bureau of Statistics of China, BTG ranked 188, which showed its leadership among China’s tourism enterprise. By 31st December, 2008p, BTG has a total of 40,367 employees, with total assets of RMB28.55 billion. For the year 2008 alone, BTG has realized business revenue of RMB2.22 billion and a total profit of RMB1.24 billion, which enables it to rank the fourth among enterprises supervised and administered by the State-owned Assets Supervision and Administration Commission of the People’s Government of Beijing.

BTG has nearly one thousand member enterprises, with investment and management expanding as far as to Rizhao of Shandong in the east, Korla of Xinjiang in the west, Sanya of Hainan in the south, and Harbin of Heilongjiang in the north; also, it has several enterprises in America, France, and Hong Kong under its control or in which it has shares; it’s a nationwide strategic controlling and investment group focusing on investment, operation, and management in tourism and modern service industry, with business covering industries of hotel, tourism, catering, tourism service, auto service, tourist spot service, and tourism land property etc.

Despite the Chinglish, its clear that these guys are big and powerful.  They got juice.  And in China, you need juice.

BTG is an investor in Home Inns.  Ctrip is an investor in Home Inns.  Now Ctrip is an investor in BTG-Jianguo Hotels.  I sense a lot of juice flow in this whole arrangement…and juice flow means unfair advantage.  And if you don’t have the unfair advantage, someone else will.  Did I mention that a lot of times this juice comes from the government or an SOE?  I don’t know the specifics, but the pattern seems clear.

Did Google have any juice?

In China, you need an ‘uncle’

Tony, will you be my uncle?

I was sharing my insights about China entrepreneurship with a VC friend, and he crystallized what I was saying in a very concise way: “In China, you need an ‘uncle’.”

I confess I don’t even fully understand what this means, but it totally seems on target.  First, it highlights to me the difference between high-tech entrepreneurship in the United States and in China.  In the US, you need business relationships, reputation, and connections.  But all of these connections and relationships are generally private sector.  In China, the reality is that the government is simply more involved in everything.  And you have to think about the motivations and incentives of your ‘uncle’…even if he is actually your real, biological uncle!

As always, its impossible to generalize about anything in China.  Many businesses don’t need an ‘uncle’ especially if it doesn’t involve real estate or local licenses.  But this fact forces both investors and entrepreneurs to think differently about the sources of advantage for a company in China, and many of these advantages have nothing to do with the technology talents, the innovation capability, or the management expertise of the team.  You need to have all these things AND…have an uncle.

Agree?  Disagree?