HTHT - H World: A Mixed View Of Proposed Fund Raising

Summary

• H World is proposing to raise around $260 million in fresh funds with the issuance of new shares.
• On the positive side of things, the fundraising is reflective of HTHT's substantial growth opportunities.
• On the negative side of things, the timing of the equity financing could possibly indicate that H World's valuations have peaked to some extent.
• I assign a Hold rating to H World, based on my analysis of the positives and negatives relating to HTHT's recent fundraising.

Elevator Pitch

I award a Hold investment rating to H World Group Limited's ( HTHT ) [1179:HK] shares. I have a mixed view of HTHT's proposed fundraising. On one hand, this provides a validation of H World's growth potential. On the other hand, it also suggests that HTHT's current valuations might not be that appealing. As such, I decide that a Hold rating for H World is fair.

Company Description

H World refers to itself as a "multi-brand hotel group in China with international operations" in the company's most recent fiscal 2021 20-F filing . HTHT derived 90% of its revenue for the first nine months of FY 2022 from its home market, China. Hotels located in Germany and other foreign markets contributed 8% and 2% of H World's top line, respectively for the 9M 2022 period. According to its Q3 2022 earnings press release , HTHT's portfolio comprised of 8,402 hotels (and close to 800,000 rooms) as of the end of the third quarter of 2022.

Proposed ADS Offering Draws Investors' Attention

On January 10, 2023, HTHT issued an announcement disclosing plans for "an underwritten public offering of US$260 million of American depositary shares" or ADS. Specifically, H World will be raising fresh funds from the issuance of 6.19 million ADSs at $42 apiece.

H World's stock price rose marginally by approximately +1% from $43.80 as of January 9, 2023 to $44.19 at the end of the January 10, 2023 trading day following the announcement. But it is worthy of note that HTHT's shares initially corrected by -2% in premarket trading when the equity financing plan was first announced. As such, it is reasonable to assume that investors are divided on HTHT's recent equity financing move.

Investing In Future Growth Is The Right Thing To Do

In its January 10, 2023 ADS offering announcement (which I referred to in the preceding section), H World emphasized that it is raising fresh capital now to "fund its growth strategies amid post-COVID reopening" and "to invest in initiatives that support its long term success."

In my opinion, there are both short-term and long-term growth opportunities for HTHT which justify the need for fund raising.

In the near term, H World has the potential to increase its portfolio ADR (Average Daily Rate) and RevPAR (Revenue Per Available Room) by optimizing the company's asset mix with new investments.

As per its third quarter results presentation slides , HTHT's percentage of midscale and upscale hotels (versus economy hotels) as a proportion of its total hotels increased from 33% as of September 30, 2019 to 39% as of the end of the third quarter of 2022. In absolute terms, the number of midscale and upscale hotels for H World grew by +114% from 994 as of end-Q3 2019 to 2,122 as of end-Q3 2022. As of September 30, 2022, H World has 1,001 midscale and 263 upscale hotels in its pipeline. The funds raised from the issuance of new ADS will help H World to further expand its pipeline of midscale and upscale hotels, and provide an uplift HTHT's RevPAR going forward.

In the long run, industry consolidation is a major tailwind for large chained hotel companies in China like H World. Many sub-scale players in the Chinese hospitality industry have exited the market in recent years due to COVID-19, and this offers opportunities for HTHT and its larger peers to grab more market share.

The consolidation opportunities in China's hotel market are validated by industry statistics. A January 4, 2023 hospitality sector research report (not publicly available) titled "Standing At The Turning Point" published by Jefferies ( JEF ) highlighted that the combined market share of China's three largest hotel chain operators (which includes H World) grew from 41% in 2019 to 48% in 2021. China's other two large chained hotel companies are Shanghai Jin Jiang International Hotels Co., Ltd [600754 CH] and BTG Hotels (Group) Co., Ltd. [600258 CH].

Therefore, it is reasonable that H World has the intention to raise funds to increase its scale, so that it is in a better position to benefit from market share expansion driven by industry consolidation.

But Timing Of Fund Raising Move Might Indicate That Positives Are Priced In

The timing of the equity financing move does raise questions. It is common for companies to buy back shares when they feel that their stock is undervalued. On the flip side, corporations are also often quick to capitalize on opportunities to raise fresh capital with new stock issuance when they deem their companies' shares to be overvalued.

China has recently moved away from its longstanding COVID-zero stance, and the country has also relaxed pandemic restrictions in the country while reopening its borders. This has sparked an +81% surge in H World's share price from its 52-week trough of $21.84 recorded on March 14, 2022 to $39.45 as of January 11, 2023. During this same period, HTHT's consensus forward next twelve months' EV/EBITDA multiple has also expanded from 17.2 times to 31.4 times as per S&P Capital IQ data.

It is natural to think that the positives relating to China's reopening have largely been priced into H World's current stock price and valuations. The fact that HTHT chose to engage in fresh equity financing at this point in time also supports the view that H World's valuations are fair or even slightly overvalued now.

Closing Thoughts

I have a Hold rating assigned to H World's stock. HTHT boasts a reasonably attractive growth profile, but its shares aren't exactly cheap. This justifies a Hold rating for HTHT.

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