7 Days Group Priced Too High

Includes: CTRP, HMIN, SVN
by: Chimin Sang

7 Days Group (NYSE:SVN), the third largest economic hotel chain in China, hit the IPO market this week. The stock was priced at $11, the higher end of the suggested pricing range, and closed at $12.50 in its first day's trading. J. P. Morgen, Citi and Oppenheimer were the underwriters.

My analysis shows that it is not a good buy when compared to its peer, Home Inns (NASDAQ:HMIN), the largest economic hotel chain in China.

My comparison is quite straightforward and based on the following basic logic: The smallest unit of a hotel business is the hotel room, so the enterprise value of a hotel chain is the product of the number of hotel rooms and the average profitability of the hotel rooms. (Note: this relationship is more conceptual than mathematical, if you know what I mean.)

As of the end of the third quarter, Home Inns has 68,044 rooms with an enterprise value of $1.58 billion. It also made $15.8 million operating profit in the third quarter. In comparison, 7 days has 28,266 rooms with an enterprise value of $643 million. Even though It made $5 million in operating income in the third quarter, it is worth pointing out that 7 days was NOT operating income positive until the second quarter of 2009, while Home Inns has been operating income positive since 2004.

If we assume that each room of the two hotel chains has the equal earning power and Home Inns is fairly valued, we can reach the fair enterprise value for 7 Days Group of $656 million, slightly higher than its current enterprise value. However, I argue that 7 Days should be sold for a much higher discount due to:

1) 7 Days was running negative operating margin for the past three years, while Home Inns was running a healthy business since 2004. The fast ramp-up of the operating margin for 7 Days during the past two quarters could be decoration for its IPO.
2) Home Inns is the leading hotel chain, its brand more established and its hotels more mature.
3) Home Inns has a close tie with Ctrip (NASDAQ:CTRP), the dominant online travel booking site in China, which help sell Home Inns inventory.
4) 7 Days is an IPO, without much reporting history.

7 Days promoted itself as the most tech savvy firm in the industry, having a member club and an easy online booking system. But they are not unique to 7 Days, Home Inns has both; it just did not tout these in its investor communication.

Cutting to the core, Home Inns' hotel rooms have higher and more proven earning power than 7 Days Group. At the current price, Home Inns is a much better buy than 7 Days to get exposed to the China economic hotel business.

That being said, I do not own Home Inns either because it is NOT YET selling at a price reasonable enough.

Disclosure: No positions in SVN, HMIN, and CTRP as of the writing.