H World Group Limited (HTHT) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by and welcome to Huazhu's clarification to address allegations against the company in Bonitas report conference call. [Operator Instructions] I must advise you that this conference is being recorded today. If you disagree, you may disconnect now. a I'd now like to hand the conference over to Huazhu's IR Director, [ Jason Chen]. Thank you. Please go ahead.

Thank you, Tara. Good morning and good evening, everyone, and thanks to all of you for dialing today. Welcome to Huazhu's conference call to clarify and address allegations against the company in the Bonitas report. Joining us today is Mr. Teo Nee Chuan, our CFO. Following his prepared remarks, he will be available to answer your questions. Before we continue, please note that the discussion today may include forward-looking statements made under the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. A number of potential risks and uncertainties are outlined in our public filings with SEC. Huazhu Group does not undertake any obligation to update any forward-looking statements, except as required by applicable law. As a reminder, this conference call is being recorded. Also, the webcast of this conference is available in the Investor Relations section of Huazhu Group's website at ir.huazhu.com. With that, now I will turn the call over to Mr. Teo. Please?

Thank you, Jason. Hi. Good morning, everyone. My name is Teo. I'm the CFO for the Huazhu Group. And today, I would like to thank you to calling this morning for this clarification call. And I would like to take this opportunity to express, I would say, that I wasn't expecting anything. But having said that, I'm not -- I do not have prepared remarks. I'm going to be going off-the-cuff. But having said that, I want to make a brief statement on our take on the short selling report, and then we can open up the floor for questions. Now the short selling report alleged that Huazhu overstated our fixed assets, which is property, plant and equipment. And by doing that is that we were able to cycle the cash out from the overused and overstated property, plant, equipment to fund our off-books leasing of mid-hotels. In particularly the people cost. So I mean, let me clarify that. It is also the fund with the property, plant -- overstated property, plant, equipment. Now Huazhu is that -- in our -- actually our analysis is that our -- we think that the, number one, the company is that we have to look at it from the gross investment in the property, plant, equipment rather than the net amount because the net balance of the property, plant, equipment would have to consider the vintage of the hotel portfolio. And for my explanation, I'm not going to compare my numbers with those of Jinjiang as well as BTG as stated in the reports because different companies will have different situations. So what I'm going to focus on is on the gross property, plant, equipment. Now in our analysis provided to Hong Kong Stock Exchange, we actually break down our hotels into the different brands and different number of rooms. And with that, is that -- it's a very simple arithmetic way where we come up with the average number of -- the average cost per rooms that the -- for renovations. And that actually is actually consistent -- the entire amount is actually consistent. It actually ties back to our balance sheet in -- for property, plants and equipments. Now let me give you some brief accounts that during this couple of years, I would say that since the last couple of years is that our net additions of the hotels, our leased and operated hotels, are mainly midscale and upscale hotels, okay? So that carries a higher cost. I would say that, for example, I have been communicating to the market that the average cost for the midscale hotels is ranging from around CNY 120,000 to more -- to up to, like, say, CNY 150,000 to CNY 160,000, okay? And then, therefore, our upscale hotels like Joya, it can cost more than like CNY 300,000 to CNY 400,000. So that itself is that we're actually, during this couple of years, is that the weighted average costs would have been brought upwards. And I think that the average cost per room based on our current PP&E will be in the range CNY 110,000, CNY 120,000. So this is actually consistent with our business situations. We are not trying to compare with the other companies because the different companies would have a different investment plan and capital expenditures. That is number one. Number two is that the claim that we overstated the number of people. What -- in our 20-F, we reported that we have around 18,000 people. But having said that, you are comparing that with the social insurance report statistics from the social insurance, where it is actually the number of social insurance that we contributed to all our employees during that year. However, just to give you an example is that in a hotel, we have 100-room hotels, we have 17 staffs. If the 7 staffs of the hotels has left and then you said we couldn't -- we replaced them with another 7 staffs, so the -- for our annual report, so we reported that the hotel will still have 17 staffs. Having said that is that for the social insurance, we would have picked 17 plus 7, which is 24 for the social insurance. So the number is -- actually, there is a negative. It's natural that there's a difference in these 2 numbers. Number two, the claims that we do have -- we understated our leased and operated hotels, and the claim that in the Ministry of Commerce, that the number of franchise and management agreement is actually lower compared to what we had claimed in our annual reports. So to explain that, again, we have put out in the clarification report saying that under the Chinese law is that we need -- it is totally -- it's legally required to file a franchise agreement. Having said that is that there was no clear definitions on the management agreements. Although we tried to file as much as possible, which is franchise and management agreement, to the Ministry of Commerce, but because the different areas in -- the Ministry of Commerce in different states may have a different interpretation. So some of them -- some of the areas may not accept our filing. So as a result is that the number of franchised hotels in the Ministry of Commerce is actually lower compared to our actual numbers. I strongly advise that -- all of you on the call to check out the other hotels as well -- other hotel group as well. We would have the same issue, okay? So this is number one. Number two, they claim that in the Dianping -- in the Meituan website is that we do -- there are certain franchised hotels that actually carries Huazhu's business license. I acknowledge that this is true. But having said that is that this is also -- this is mainly because that some -- for the Meituan OTA is that they used Huazhu's business license to be -- to post on that and to post on the listings -- to post on the website so that it can have a faster listings for these franchised hotels. We have actually communicated to Meituan to rectify that, and I think they will still do that in a very short period of time. Number two, I think the third allegation is that they claim that the number of our related parties actually have owned some of the franchised hotels. Now I would say that the -- I think we didn't say that, right? We didn't report it, not really. No. Okay, sorry. I think I reserve there for the -- for our next reports, giving the evidence for the independent’s auditors report. But I would like to assure you that Huazhu prohibits our employees to hold any franchise agreement -- franchised hotels but we strongly encourage our contractors to open up franchised hotels. Having said that is that -- to put on the record is that although we try to do that, but some of -- we do occasionally find some of our employees that actually have invested in our franchised hotels. With that is that we will take disciplinary action against such in compliance with our Huazhu corporate governance that prohibits our employees to hold the franchised hotels. Thank you. Let's open the floor for questions.

[Operator Instructions] Our first question comes from Justin Kwok from Goldman Sachs.

I'll stick with the 2 questions then. Perhaps the first one is regarding the registration of the -- what you call the manachise or franchise agreement to the MOC on the local bureau side. Can I check without the so-called registration of filing, does that affect your tax or your operational conditions for these hotels at all? Or this is more like a formality? Can you kind of give us a bit more color on whether there is any operational implication on that? The second question is regarding the last part you had mentioned about the related parties or these formats. So for example, in the event where Huazhu would potentially be the minority investor in certain franchise -- franchisees' projects or franchisees' operations in a way, how would that reflect in your P&L or your balance sheet if there is such investment?

Thank you. To answer the first question is that the filing with the Ministry of Commerce is actually a filing. It doesn't impact the hotel operation at all. The license that requires the filing and the license required for the hotel opening actually is the business license then filing registrations, which is the most important thing. But the rest is the tax filings, the revenue recognition, the cash collection, et cetera, that has no impact at all on the hotel operations, okay? These are more -- to answer the first question. The second one is that the -- we encourage -- as I mentioned is that we encourage our contractors to be our franchisees, so -- because these contractors have very good connections locally, very locally. So they do -- they will be able to secure a number of properties or hotels that are in the location that Huazhu do not have access to. So in that way is that they would actually try to use their own financing to open up their own franchised hotels. But having said that is that in certain circumstances where we think that if they are short of cash, okay, we may enter into some joint ventures with them to open up these hotels. So if Huazhu's -- normally is that the franchise will have the majority stakes, say, 60%, 70% and Huazhu may have like 20%, 30% or we were up to like 40%. So in that way is that Huazhu will account for that as equity accounting, basically is that we will use that, for the profit that we received from this company, we would actually put it under the line and actually at the bottom, which use the equity pickup from the associate companies. With that is that even for these companies, I would like to put it on the record that we will still collect the management fees, okay? The central reservation fee, as usual. Only the balance, the residue of the profits of the company will be split based on the equity accounting of Huazhu's. Now if Huazhu's stake is actually more than like 50%, okay, 60% or 70%, and in that way that we would actually consolidate that and then we would actually reduce -- we would actually minus the minority interest out at the bottom of the -- our P&L.

Our next question comes from Billy Ng from Bank of America.

I just have a couple of follow-up questions. The first question actually relates back to Justin's question. Can you tell us how many hotels that you are involved in as a joint venture with minority stakes and the franchisees? That's my first question. And then the second question is like in terms of the filing the franchisee status with the government, is that the responsibility of the franchisees themselves to file? Or is that Huazhu's responsibility to file that status with the government?

Okay. To answer the first question is that the number of the joint ventures we have with our franchisees, they are not that many. We wish it could be more but unfortunately is that many of the franchisees do not -- or contractors do not prefer us to have a joint venture with them because if the property is in a very good location. If the location is not good, Huazhu is not interested. So I would say that the amount -- the number of joint ventures is actually not meaningful. This is number one. Number two, to answer the second question is that the -- it is actually Huazhu's obligations to actually file the management agreement -- the franchise agreements with the Ministry of Commerce.

Okay. I also wanted to ask one more question regarding -- I think last night, in short seller report site also come up with another piece. And arguing that like basically, they said there still is discrepancy regarding your number with the credit report. To be honest, we are not quite familiar with the credit report. Can you tell us a bit more on that regard? And how the credit report works and what kind of discrepancy that they are describing?

I'm sorry. Sorry. Jason?

Billy, this is Jason. I think that you just mentioned credit report, but to be honest, we have -- not sure -- we're not very sure that -- where Bonitas got the credit report from, and we don't have the exact source of the credit report. So it's very difficult for us to verify whether it is accurate or the numbers stated in the report is right. So we still need to find the source of the credit report and further look into the numbers they reported.

Right. In fact, we welcome -- if Bonitas is on the call, we actually welcome them to approach the company and share with us the information that they have so that we can clarify that. And then we'll share it with the investment community because, otherwise, it's only pure speculations.

One last question is, I know you may not be able to respond right now or may have plan to respond later. I think another thing they mentioned is still related to potential related party transaction that they're still accusing Huazhu have direct employee directly owning some of the franchisees. So is that like you will address that later? Or do you have anything to report on that?

Yes. We will address it later. We'll address it. And number one, the -- and other than that, we shared with you is that the number -- the list of the number of contractors. Number one, we have clarified that contractors are not Huazhu's employees. And under the regulation is that the contractors are not Huazhu's related parties. We have to be very clear with that. And perhaps that they would like to check with the accounting expert as well, legal expert, on the definition of related parties. And the one -- the two is that we would like to have more listed local hotels as well. That will actually increase Huazhu's revenue. I do not have the revenue price that you have with those leased and operated hotels. I wish I could, but unfortunately, it's not. And to clarify that we do have very strict corporate governance on employees' holdings on the franchisees. We do have that. In fact, 2 days to go, we just fired an employee just by having -- by found -- after we found out that they have some stakes in the company, in the franchisees. So we prohibit that. But having said it, we cannot confirm that at this moment, there's none at all, okay? We cannot possibly confirm. But having said that, once we found out one, we will take action against one. So this is a continuous process. The main reason for having that situation is because Huazhu's franchised hotels are actually pretty profitable. So when it's in profit -- when there is a profit, people will actually try to do whatever they try to do to try to get into that part of profit. So we -- but on the other hand, Huazhu's governance is against that, and they're against the employees to do that, and then is that we would take strict action against any incidents that we found. But having said that, I have to put on record that we encourage our contractors to open up franchised hotels. This is because for contractors, with the hotels, the qualities will be in the top-notch condition, okay? The cost will be perfectly low. So in that way, we use -- we like to use that to showcase with other franchise -- potential franchisees so that they can copy. So this will be good.

Our next question comes from Praveen Choudhary from Morgan Stanley.

Let me try to ask 2 questions. They might be related to the questions already asked. Both are related to staff. The first one is which year -- if you started stopping your employees to be franchisee, when did you put that rule? Was that 2016? Was it since 2010? Was it last year? That's the first question. And the second question is related to one of the allegations where they try to contact one of the franchised and managed hotel. And we all know that general manager is under your payroll. But then it sounded to -- in that report that other -- 15 other employees were also under your payroll. And so what kind of arrangement is there when your franchised and managed hotel's staff is under your payroll?

Okay. Good questions. I think it was the first question. Okay. Okay. Yes, we have put in place the rules against Huazhu's employees, which prohibits Huazhu's employees from becoming a franchisee for a long period of time. I would say that it was before the IPO back in 2010. Just a long period, this has been present for a very long, long, long period of time. This is number one. Number two is that they are -- number one is we have not been able to verify with a hotel manager to claim that. But having -- let me share something with you, okay? Now for all -- I think we have always been explaining to the investor community is that when our franchisees would like to open up the hotel, okay, a franchised hotels, they will find hotel's locations. And then we would help them, to supervise them through the renovations, okay? And then is that we will send in hotel managers, which hotels managers that -- and as well as our HR team. We will help the franchisees to recruit all their staffs. We would help to recruit those employees and all of their staffs. We will train them. We would actually -- we would -- they will need to put in or put up the Huazhu's customs, what we call the customs, okay? Then their day-to-day work are being directed by the Huazhu's hotel managers, okay? And the third one is that the decision to retain, to promote or to demote or firing of those employees, okay, are all carried out by Huazhu, okay? Huazhu's hotel managers or the regional managers. So all of this -- it may not be too unreasonable for them to think that they all belong to Huazhu. In fact, we always claim that Huazhu have 100,000 staffs. We have our family, we have a 10 -- 100,000 people in our network. But having said that, legal is legal and then it's substance is substance. Because given the COVID-19, for example, okay, the franchisees will need to -- still need to pay for their own -- the salaries for their own employees, okay? Regardless of what they think, they need to pay. They will still need to pay for it. Huazhu is not obligated to pay for their salaries as well as the social insurance. This is the real test because when you're put into this situation, who bears the responsibilities? Now the franchisee will need to bear that. This is very, very, very crucial, okay? And what -- so what I'm trying to say is that there may -- one is that we encourage the Bonitas to share with us who they talk to. And I will say that there is a possibility that some of the remarks by the staff that they talked to may have some confusion because of the all-rounding, of engaging kind of Huazhu services to the franchisees. Because we helped them to recruit, we helped them to train, we helped them to -- what do you call that, on their daily work, and we have the filing decisions. Thank you.

Our next question comes from Jisheng Liu from CLSA.

I have only one. Just on the franchisee and management hotel owners. So you are saying that Huazhu has really strict compliance rules and internal controls saying your employees cannot open Huazhu's F&M hotels on their own. So may I know if they are or they can open the hotels of other groups? And why do you think it creates a potential conflict of interest if they can own their own Huazhu hotels? And if they can actually operate other brand's hotels, why do you think it is not?

The reason why we prohibit our all employees opening up Huazhu's hotels is because their daily decisions, okay, their daily operational decisions will affect themselves. They may, in a way, I would say, favor in using their whole internal influence to favor from the operational perspective, their own franchise -- their own franchised hotels. This is something that we need to put it very strictly. We do not know that if they own any other brand's hotels. And if we do, we will need to take very -- some strict action as well, okay, because there will be a conflict of interest.

[Operator Instructions] Our next question comes from Yufei Qiu from DTC.

I noticed that you start disclosing -- you start splitting the CapEx spending on PP&E into hotels in operation, hotels under development in your 2019 annual report. And can you help us understand, in 2019, what causes the huge increase in the total CapEx? What are the reasons behind?

Okay. Now I would say that if you look back, right, over the last 15 years of Huazhu's, you may realize that I think that there is -- when Huazhu started our operation back in 2005 and '06 as leased and operated hotels, mainly the HanTing Hotel, okay? At that time, the average room of cost will be around CNY 65,000 to CNY 70,000, in that kind of range. Then if you follow that closely, you will see that there will be a bump, I would say that starting from 2012, 2013, '14 because when we started to introduce the Ministry of Accounts, okay? There you will see a bump up there. And then is that it was steady a little bit and then it will slightly move gradually up when we have like acquired, I would say, that the -- we had a joint venture with Accor, and we started our Mercure, I would say that ibis, et cetera. And then as a following, in 2017, we -- after we acquired the Crystal Orange brands, we opened up the Crystal Orange brands. You see that the average cost will gradually move up, okay, gradually move up. And then is that, then what happens then is that you see that starting from -- I think in fact in 2018, I actually told the investment committee that you know what, in 2019, I'm going to have very huge CapEx. How much? Significant. How much? We are talking about CNY 500 million through operating expenses during that year. How much do I spend? Because for only 5 hotels, okay, I think we do want that, open a very big 5 hotels. The first one will be in the -- is the Joya Hotel located at the -- in Pudong where we -- it's near the bank, okay? It's near the bank, number one. Number two is that we opened up -- the second one, we opened up in Taiguli, in Chengdu, okay, Joya Hotel. Number three, we opened up another Joya Hotel in the Jinjiang, which is in Hangzhou. And number four is that we opened up the another -- we opened up the Joya Hotel in Xujiahui, Hongqiao. And the fifth is that we opened up another one, I think, Qianjiang at the -- near the bank, okay? So these are very expensive, okay? The cost is very expensive. You're talking about like CNY 200,000, CNY 400,000, okay? So CNY 200,000, CNY 400,000. So that actually it will cost us the significant capital expenditure during the 2018, 2019 period -- beginning of 2019 year. I explained that I might -- my true OpEx may increase significantly because of these 5 hotels, okay? And of course, it was a -- we did CapEx spend, I guess, it's still over into this year as well, into 2020 as well. So this is the main reason why the average cost and capital expenditure goes up despite the net addition -- the additional hotels do not increase that much. Thank you.

[Operator Instructions] Our next question comes from [ Kenan Chen ] from [ Tianhong ].

I have a few questions. Okay. Because of COVID-19, some hotel operators have difficulty in cash flow. So do you see more chances of M&A? And second is, is the rent approximately the same as before? And third question is, how is the confidence of franchisees right now? Are they really good to open more hotels or relatively conservative?

I'm sorry. I can't hear you clearly. Do you mind repeat your questions? One question at a time.

Okay. Okay. The first question is, because of COVID-19, some hotel operators have difficulty in cash flow. So do you see more chances of M&A?

Okay. Thank you. But I would say that the M&A opportunity has always been out there. But this is not the first -- it is not the time to discuss it. We arranged other calls to address any other questions later on during our next conference call.

Okay. And can I ask other questions?

Sure.

The rent right now, are they cheaper than before?

Sorry, can you repeat that?

Yes. Is the rent of property cheaper than before because of COVID-19?

Again, I would say that, I think I explained earlier. Yes. I would say that just a very quick answer is that we are negotiating a number of landlords on the lease rental agreements. And I will say that the -- because of the COVID-19 impact in not only lodging but also other commercial activities, so there are actually significant -- there are actually some rooms to negotiate on the rentals that could lock in for the next 8 to 10 years, which is a very good opportunity for consolidation. But unfortunately, this is not the time to discuss this issue. Thank you.

[Operator Instructions] There are no further questions at this time. I'd like to hand back to management to conclude the call.

Thank you. Thank you for your patience. And just I want to make clear on the record that we have -- during this COVID -- to answer -- in order to have a good response to the allegations, that we have formed a special committee to address that. And then is that the special committee has submitted the report to the Hong Kong Stock Exchange, and we have published the reports to the public already. The next step is that the independent audit committee, we have a 3-person independent committee in Huazhu. They will carry out, I would say, the entirely independent investigation into these allegations, okay? And they will be helped by external counsel. They will also be helped by external auditors. And then -- and they may require the special committee to carry out further work if necessary. So with that is that they will do a more thorough investigation, and we will arrange for their findings to be shared with the Hong Kong Stock Exchange and the U.S. SEC. We'll do that to the SEC as well as to the investment community in the near future. Thank you.

Thank you. Ladies and gentlemen, that does conclude our call today. Thank you for attending. You may now disconnect.