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Development of Budget Hotels

At first glance, the budget hotel sectors looks promising over the long term. It offers a reliable value proposition: a clean, dependable, inexpensive place to stay for business people and tourists. These hotels offer better facilities than most one to two star hotels or guesthouses in many cities and districts where previously the economy hotel experience could best be described as uncomfortable -all at a similar price level.

There is also the potential to attract three-star hotel guests, as facilities are very similar and budget hotel prices are often better value for money. As a result, guests are likely to trade up to or switch to budget hotels. Because of the world economic turmoil of 2008 -2009, there are reports that some guests of four to five star hotels are trading down to budget hotels in order to cut their potential travel budgets (Exhibit 1). In addition, the number of business travelers, the main target group for budget hotels, is forecast to resume growing.

Occupancy rates, at an average of 82% for 2007, were also higher than other hotel categories. In 2008, at the beginning of the economic slowdown, the leading player, Home Inns & Hotel Management, reported an average occupancy ate

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of 85%, compared with 91 . 1% in 2007. 2 In a sign that the worst of the global slowdown may be over for the Chinese budget hotel sector, occupancy for Home Inns was 92. 4% for the Second Quarter of 2009, compared to 88. 2% for the same period in 2008, and to 82. 6% in the First Quarter of 2009 (Exhibit 2). Budget hotel chains feel more and more confident, the large ones -Home Inn, Hanging, 7 Days, Greengage Inn, and Motel 168 -have announced aggressive expansion plans in adding over a hundred hotels each in 2009, split between direct-operated and franchise hotels. The long-term industry average equilibrium occupancy rate 5 (“REAR”) is estimated at 75% so there appears to be potential to raise room rates based on current occupancy. Some of the leading chains have even managed to lower their REAR as a result of scale efficiencies.

However, in the short to medium term, the outlook is not so rosy. Dolomite discussions with industry players suggest that so far, no one is willing to take the first step to increase room rates. Also, the sector is likely to be highly contested, as the main players are locked in a “rooms race” to secure suitable sites and increase their leverage in a highly competitive field (Exhibit 3). Beijing ND Shanghai have both seen rapid overall room supply increases, as a result of the 2008 Beijing Olympics and the World Expo in Shanghai, respectively.

New site growth in tier one cities is likely to be at the expense of competitors as budget hotel chains vie for an ever decreasing supply of suitable sites. Large cash reserves could make the difference between survival and bankruptcy, especially if the increased supply of rooms erodes pricing. The player who runs out to money TLS will be the loser, either by collapsing or by being swallowed up by richer players, and so consolidation is expected. Aggressive expansion coupled with low average argils requires capital and strong management execution.

For leading players, mature budget hotels are still able to generate strong EBITDA margins, but rapid expansion has caused stresses at the corporate level, both from a human resource and an internal systems perspective, which may be reducing overall group profitability. The medium-term objectives are to improve customer loyalty; build a strong management team; reduce costs by achieving both network and internal systems of sufficient scale to absorb fixed costs and increase occupancy rates; enlarge the pool of active customers; and improve pricing -to name the most essential.

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