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Huazhu Group Limited  (NASDAQ:HTHT)
Q2 2019 Earnings Call
Aug. 21, 2019, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Huazhu Group Limited Q2 2019 Earnings Conference Call. [Operator Instructions] Please be advised today's conference call is being recorded.

I would now like to hand the conference to your first speaker today Ms. Ida Yu. Thank you. Please go ahead, ma'am.

Yu Ida -- Senior Manager Investor Relations

Thank you, Ajay. Good morning, everyone, and thanks to all of you for dialing-in today. Welcome to Huazhu's second quarter 2019 earnings conference call. Joining us today is Mr. Ji Qi, our Founder and Executive Chairman; Ms. Jenny Zhang our CEO; and Mr. Teo Nee Chuan our CFO. Jenny and Teo will present the strategy review and the Q2 results. Following their prepared remarks, management will be available to answer your questions.

Before we continue, please note that the discussion today will 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 as such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC.

Huazhu Group does not undertake any obligation to update any forward-looking statements except as required under applicable law. On the call today, we will also mention adjusted financial measures during the discussion of our performance. Reconciliations of those measures to comparable GAAP information can be found in our earnings release that was distributed earlier today.

As a reminder, this conference call is being recorded. The webcast of this conference call, as well as supplementary slide presentation is available in the Investor Relations section of Huazhu Group's website at ir.huazhu.com.

Now I would like to turn the call over to Jenny Zhang, our CEO. Jenny, please.

Min Zhang -- Chief Executive Officer

Hello and thank you, everyone for joining us today. We are excited to report our second quarter results with double digit growth in our number of hotels, net revenues, adjusted EBITDA.

As shown on Slide 2, at the end of Q2 this year, we had a total number of 4,665 hotels, an increase of 20% from the end of Q2 2018. Our total turnover at the hotel level reached RMB8.8 billion, an increase of 18% from a year ago. Our net revenues increased by 13% from RMB2.5 billion to RMB2.9 billion in Q2 2019. Our adjusted EBITDA stood at RMB1.07 billion for Q2 2019, as compared to RMB965 million in Q2 last year. The proforma adjusted EBTIDA would have been RMB1.15 billion or 40.4% of net revenue is excluding the impact of our significant investments in development teams, upscale brand hotels and IT capabilities during this quarter. We believe such investments will help view [Phonetic] our sustained future growth.

Due to the weak macro economics and the general slowdown in business activity and leisure travel, our same hotel RevPAR and occupancy has softened since the beginning of this year. Nevertheless, our mature hotel occupancy maintained its industry leadership and outperformed the industry average by 20 percentage points in Q2 2019. Huazhu's core competencies and the resilient business model remains solid during cycles. Along with the more challenging economic situation, more growth opportunities for consolidation become available to us, thanks to our industry leader position.

As we are seeing, we are capturing those opportunities effectively through our well-defined strategic focuses as listed on Slide 4. Firstly, we are continuing the rapid expansion of our hotel network. Secondly, we focus on innovative technology applications to enhance our guest experience and operational efficiency. Thirdly, the strategic deployment in Upscale hotel segments. I will walk you through our program in those three areas.

Let's turn to Slide 5. The left part shows strong acceleration of our hotel openings during Q2, 2019, with 269 hotels opened or three hotels net everyday. This is basically tripling the openings in the same period last year. In the first half of 2019, as shown on the right part of this chart, in the first half of the same year -- in the first half of 2019, 435 net hotels were added, also close to tripling the same period of last year.

As we expect future hotel expansions to accelerate, given our strong growing pipeline. As shown on Slide 6, we have a pipeline of 1,553 hotels, equivalent to 33% of our hotels in operation. This ratio has increased from 21% at Q1 last year, indicating a significant acceleration in our growth. The second -- the strong growth is mainly attributable to franchise and the manachised hotels, which account for 96.5% of our total pipeline.

Slide 7 shows that our fast expansion in the Mid and Upscale hotel segments, which is well on track. At the end of Q2 this year, 43% of the total number of Huazhu rooms in operations were Midscale and Upscale, up from 34% in Q2 2018. As shown on the right hand side of the slide, our unopened pipelines for Mid and Upscale rooms accounted for approximately 80% of the total number of rooms in pipeline, same as a year ago. Our enriched Mid and Upscale hotel brand portfolio, within profitable hotel operating models continue to attract potential franchisees into Huazhu's hotel network.

Regarding our network expansion, I am also very excited to share news about our flagship brand HanTing. Launched in 2005, HanTing today serves the widest range of business and legal travelers in China. Last month, we unveiled our first HanTing 3.0 hotel in Shanghai. As shown on Slide 8, HanTing 3.0 is intelligent and affordable with premium quality. Our guests can enjoy not only the most contemporary design, but also the fast automatic check-in by just easily clicking on display at the front desk. In their rooms, a robot instead of hotel staff can fulfill their delivering orders. What's more exciting is that our guests will also enjoy all artificial intelligence systems, code Hello Huazhu, which features a voice activated two way communication plus guest can control in-room light, television, air conditioning, window shades and other features in their rooms through the Hello Huazhu system or our mobile application.

Our previous market research and our initial customer trials are confirming that this technology applications will enhance our guest experience at HanTing Hotels. And as the enthusiastic response from all franchisees also make us believe this is going to attract many new franchisees and opening more hotels under the HanTing brand going forward. We look forward to the accelerated growth of the HanTing brand under this exciting new model.

Technology application strategy is essential for Huazhu to sustain growth. It enables us to satisfy our customers' evolving needs. When you launched a Huazhu application, you are one step closer to a seamless stay experience. As shown on Slide 9, we divide the full cycle of each guest booking and the stay experience into 16 distinct mobile touch points. And are seeing that we improve their experience with us when they use the Huazhu app. We are a hotelier to digitalize these functions into a single user-friendly application. In addition to reliably and the fast booking through the Huazhu app, you also facilitate a more carefree hotel stay. For example, guests just use the Huazhu app to control the elevator and to open their room door instead of using a traditional door card. Guests are also able to buy their breakfast in the cafeteria through the Huazhu app instead of having to walk to the front desk. Moreover, we also speed up the checkout process through the Huazhu app. The easy billing function makes the invoice immediately available, when each guest checked-out via the Huazhu app.

Our innovative technology also drives our corporate direct sales as shown on Slide 10. First, we could accommodate various corporate booking channels for our corporate clients to access directly to our Huazhu booking app. Huazhu offers the lowest price by booking through our own channels. They can enjoy the membership benefits such as free breakfast and loyalty points.

Second, B2B settlements eliminates the back office headaches previously experienced by our corporate clients because our clients now don't need to process expense reports to reimburse their travelling employees for Huazhu hotel stay. We issue one invoice to each corporate clients per month. And last but not the least, we also help ensure corporate compliance by documenting authentic hotel stays and invoices, all while meeting the travel guidelines of our corporate customers.

Finally, I want to update you on our progress in the Upscale segment. The renovation of our four Joya Hotels are well on track. Two of them are located in Shanghai, Lujiazui and the Shanghai, Gubei SOHO. Both are in Central Business District or we call CBD areas. Another two are located in Hangzhou, Qianjiang CBD and in Chengdu Taikoo Li respectively. Joya will bridge Huazhu's gap with its unique brand proposition of oriental elegance and the Chinese fine-living. We look forward to those grand openings late this year and early next year.

In September 2019, we are going to officially launch two new brands, Madison and Grand Madison to convert the existing four and five star hotels. When joining Huazhu's network, this hotels will benefit from our operating platforms, including IT infrastructure, procurement systems, sales channels and etc. As of June 30, we have already signed a pipeline of 12 hotels under Madison and the Grand Madison.

With that, I will turn the call over to Teo. He will walk you through all the operational and financial results in more detail. Teo, please?

Teo Nee Chuan -- Chief Financial Officer

Thank you, Jenny, and good morning, everyone. Please turn to Page 14. In Q2, our blended RevPAR grew by 1.3%, driven by higher ADR and partially offset by a decrease in occupancy. The ADR increase of 4.4% was contributed by a positive 0.4% increase in our matured hotel ADR and also by an increasing mix of Mid and Upscale and upgraded hotels with higher ADRs. Our hotel occupancy was at 87% in Q2, three percentage points lower compared to 90% a year ago. The lower occupancy was largely attributable to the softer macroeconomic environment as well as a higher base in Q2, 2018.

Turn to Page 15, our Same-hotel RevPAR declined by 2.1% in Q2. Our ADR slightly improved by 0.14% [Phonetic] and partially offset by a lower occupancy of 2.3 percentage points, mainly attributed to softness in business travel demand. We observed fewer hotel stays for trade fairs and conference in April, as compared to last year. In May, the overall travel demand was relatively stronger because of more tourist stays due to a longer holiday. However, the performance in June became softer again.This is consistent with our original forecast earlier this year. However, given the recent escalation in the China-US trade war, as well as the uncertainty in the timing of the final resolution of this trade disputes, we need more data to determine the timing of the final recovery in the subsequent quarters.

Moving on to financial results on slide 16, our net revenues grew by 13.4% in Q2, in line with our guidance of 13% to 15%. As we look at revenue component, net revenues from our leased and operated hotels improved by 5% year-over-year and net revenues from our manachised and franchised hotels were up 30%, compared to last year. In Q2 revenue that was attributable by our asset-light manachised and franchised business models contributed 28.1% of our total revenues, up by 3.7 percentage points from last year. We expect that the contribution from our franchised segment will continue to increase going forward.

As Jenny mentioned, we have made progress in our Midscale hotel segment. The revenue contribution from our Mid and Upscale hotels continue to increase. As shown on Slide 17, in Q2, the revenue from Mid and Upscale hotels increased by 27% to RMB1.6 billion, accounting for 56% of the total revenue, up from 44% a year ago.

Let's now turn to Slide 18, on the operating income and margins. The reported income from operations were RMB657 million, compared to RMB671 million last year. The reporting operating margin was 23%, 3.6 percentage points lower compared to 2018. The lower operating profit and margin was mainly due to our investment in hotel development teams, Upscale hotels and IT capabilities. Excluding this investment, which we mentioned in our Q1 presentation, the proforma income from our operation would have been RMB748 million compared to RMB671 million last year. The proforma operating margin would be 26.1%, compared to 26.6% in Q2 last year.

These investments do not bring in revenue at the current stage, but they would generate revenue in the future. As we also said in our last quarterly earning calls, we have increased the headcount of our development team. The result has been positive. We have seen our unopened pipeline hotels increased by 85% to 1,553 at the end of Q2, as compared to 839 at the end of Q2 last year. The faster hotel network expansion will bring in revenue and operating profits when they are opened.

Another area where we have invested in our -- is our IT capabilities [Phonetic]. As Jenny mentioned in her presentation earlier, our technology capabilities allow us to drive both operational efficiencies and better customer experience. Our technology team is also working on a good number of other projects, which we will incorporate into our hotel operations. We will share these developments with you at a later time.

We also make a strategic deployment into the Upscale hotel segment by expanding our teams and securing a number of strategically located properties in Shanghai, Beijing, Hangzhou, and Chengdu for our Upscale brands. This has caused our payroll cost and pre-operating expenses to increase as compared to last year. And we will not see any revenue contribution from these top-line hotels until they open for business in -- at the late of 2019 and beginning of 2020. We believe this investment will bring in additional revenue and drive margin expansion in the coming years.

In this quarter, we also recorded a lower operating income of approximately RMB37 million. This is mainly due to a one-off compensation received totaling RMB35 million related to an acquisition in Q2, 2018. This has also partially contributed to a lower operating margin in this quarter.

Moving on to the cash flow status on Page 19. In Q2 2019, we recorded net cash flows from operation of RMB1.2 billion. After detecting the capex for maintenance and new developments of RMB301 million, the free cash flow generated in Q2 was RMB860 million. We use this cash to partially pay off approximately RMB1 billion of our offshore syndication loan and provide corporate financing to selected franchises for hotel development. At the end of Q2, our cash and cash equivalents and restricted cash balance came in at approximately RMB4.1 billion.

On Page 20, our guidance. We maintain our full-year gross opening target of 100 -- 1,100, to 1,200 hotels. And we estimate to close about 200 and 250 hotels in 2019. Given the slowdown in the economic growth and the uncertainty as with the timing of the final resolution of the China-US trade dispute, we expect our Q3 revenue, net revenues to grow 9% to 11% year-over-year. We also adjust our full-year revenue growth range to 10% to 12%.

Finally, please turn to Slide 21. Our Board of Directors has approved a share purchase program of up to $750 million effective for five years. Under this program Huazhu is authorized to repurchase in the open market or privately negotiated transactions its outstanding American Depository Shares with an aggregate value of up to $750 million, depending on the market condition and other factors, as well as in accordance with the relevant new rules under the United States securities regulations, The repurchase program does not oblige Huazhu to make any repurchase at any specific time.

With that let's open the floor for questions. Operator?

Questions and Answers:

Operator

Certainly. [Operator Instructions] And the first question comes from the line of Justin Kwok from Goldman Sachs. Please go ahead.

Justin Kwok -- Goldman Sachs -- Analyst

Hi. Good morning, management. Thanks for taking my question. Perhaps, I've two questions to start with. The first one is on the share buyback program. So I think it's interesting to see you have initiated a -- quite a sizable amount [Phonetic] of this program. I want to get a sense on the rationale and the logic in terms of why you are initiating it today? And in terms of the quantum, why you think this $750 million will come up and how do you look at this in the kind of context of balancing, as Jenny mentioned at the beginning of the call, that you actually see opportunities for M&A onshore, how do you balance the use of cash on these both sides?

The second question is on the HanTing 3.0. So I remember a few years back when you rolled out the HanTing 2.0, there was a massive wave of upgrade within your franchisees, which at the end bring in RevPAR growth before and after. So for this HanTing 3.0, would you mind to give a bit more guidance on the -- for the potential ROI or the capex for this upgrade and any timeframe for the roll-out of this program throughout your system? Thank you.

Min Zhang -- Chief Executive Officer

Teo will address for the first one, I will address the second one.

Teo Nee Chuan -- Chief Financial Officer

Okay. Hi, Justin. Okay. We put in place a share buyback program considering a couple of factors. Number one, we believe that, in the current situation, the current economic environment and turbulence may cause some turbulence in our share price, which will cause the share price to fall below the actually long-term valuation of the Company. So what you -- but having said that, we believe that China Lodgings, Huazhu, is that we have a longer term view on the Company and we have been consistently invested in some of the long-term growth of the Company, which will bring back the revenue, as well as the revenue growth in the longer-term. So we believe that the valuation will recover in the longer-term. So we expect that we would like to put in place a longer-term kind of like share buyback program to enable us to actually buyback some of the shares when the share price is far below our long-term value, is number one.

Number two is, that the cash that we have put in place in terms of the M&A as well as the share buyback is that we have actually had some cash balance offshore to facilitate this share buyback. In addition to that is that for -- if there is any M&A opportunities within China, we have also -- have some cash balance as well as the credit facilities within China to execute the M&A activities.

Min Zhang -- Chief Executive Officer

On your second question on the HanTing upgrade, by now we have already got more than 55% of our HanTing Hotels -- are 2.0 or above. And this launch of the new 3.0 model has brought a lot of excitement to the market. So we have decided to accelerate the renovation and upgrade of the existing HanTing portfolio.

Our internals we [Technical Issues] goal is to increase the 2.0 up version of the product to 65% by the end of this year and 80% by the end of next year. That will be driven by three components. One is the accelerated growth of new openings of the HanTing Hotels. The second is the upgrade of the existing old HanTing Hotels. And thirdly, we will also, of course, some exit and also some of that will be natural expiration of franchise agreement for some of the oldest hotels. We believe those efforts are going to continuously strengthen our HanTing brand, and our goal is to make HanTing the largest single brand hotel in the world in the next 18 to 24 months.

Justin Kwok -- Goldman Sachs -- Analyst

I see. Thank you.

Min Zhang -- Chief Executive Officer

Thank you. Justin.

Operator

The next question comes from the line of Billy Ng from Bank of America. Please go ahead.

Billy Ng -- Bank of America -- Analyst

Hi. Good morning. I have two questions. The first one is that can you provide a little bit more color on the current quarter in terms of the demand on the RevPAR front and in particular, in different segments, if you can provide some -- shed some light that will be appreciated?

Teo Nee Chuan -- Chief Financial Officer

Okay. Hi, Billy. What we have observed in Q2 was that, the -- if I bring it out to the different tier cities, is that the tier 1, I would say that that is due to mix where we see a continued growth in Beijing as well as Guangzhou, but on the other hand, we do see some weakness in Shanghai and Tianjin. On the other hand is that -- that the overall in the -- in tier 1 cities, the RevPAR has been holding up, but on the other hand is that in tier two cities is that, we see that the RevPAR has experienced a quite significant, I would say, drop in the tier two cities mainly we expect that it is mainly because that the business activities in these areas has been slowing down without a competitive activities in other commercial activities as well as in leisures. And in the lower tier cities like tier 3, we are happy to see that the RevPAR actually continue to hold up in the lower tiered cities.

Billy Ng -- Bank of America -- Analyst

Would you mind to tell us that for July and August, you would see similar trend as well and the overall RevPAR trend for July and August?

Teo Nee Chuan -- Chief Financial Officer

Okay. Although it is still too early to call, but having said that -- is that in July, we see a softness in the overall demand as well. And I will say that in August is -- the first week was pretty good. But except that -- in the, I think from the August 10, is that there was a typhoon that was hitting the Shanghai and a good part of the eastern coast, which should also affected the -- I would say, that the peak period of our demand. But having said that, it is too early to call, we would need to -- we need a couple of more weeks to see that -- when the numbers would fall.

Billy Ng -- Bank of America -- Analyst

I see. Thanks. And my second question actually is related to your Madison Grand. Can you tell us how many of your Madison pipeline could be leased and operated hotel and if so, whether there will be any impact on the opening expense for the next few quarters?

Min Zhang -- Chief Executive Officer

Also in the existing pipeline of Madison and Grand Madison, there are three leased hotels and the rest are manachised or franchised hotels. This is our Upscale soft brand. We expected in those few become a innovator in how we manage the Upscale hotels, especially the food service line. It is once that [Technical Issues] provides, we will be able to consolidate a [Technical Issues].

Billy Ng -- Bank of America -- Analyst

Okay. And just to follow-up on that because like we understand in the last few quarters, the Joya brand actually contributes to most of the increase of the pre-opening expense. I just want to clarify or whether we will see a significant increase of pre-opening expense due to the pushing of this new brand?

Teo Nee Chuan -- Chief Financial Officer

Well, in fact, yeah, although there will be some leased and operated on the Madison brand, but for this brand is that the whole objective is that we try to retain as much as possible the existing structures and renovations of the existing hotels, which we've seen normally they've been a good quality. So the investment is put expenditure into these -- even the leased hotel is, as you see, minimum. But the objective that the purpose of this plan is actually to consolidate the three to four star hotels, existing hotels on the using the manachised models.

Billy Ng -- Bank of America -- Analyst

Okay. Thanks. Thanks a lot.

Operator

The next question comes from the line of Dylan Chu from CLSA. Please go ahead.

Dylan Chu -- CLSA -- Analyst

Thanks very much. Good morning. And this is Dylan from CLSA. I have very quick few questions, and ask them one by one. Number one is on your updated revenue guidance for 3Q and full year. Could you please also help us update the same hotel ramp up assumptions that you have behind then updated revenue guidance and just related to that just any thoughts or color on the margins particularly for 3Q, which is a peak quarter? That would be very helpful.

Teo Nee Chuan -- Chief Financial Officer

Okay. Under the revised revenue guidance we expect that the same hotel ramp up or actually will be slightly, I would say, that in the lower-single digit in the negative territory. We have -- we feel a little bit uncertain, because of the -- I would say that the events happening in China and US trade disputes which, one time in June, it seems to be recovered, then subsequently in July and August that even like two days ago turned -- that the event has turned out pretty badly. And that actually the trade dispute appears to escalate again. So, and because we see that the -- due to these uncertainties, so we were not very sure that the original expectations that the overall demand will -- as well recent activities will recover in the second half or even before. So as a result of that, we decided to lower down our revenue guidance as well as RevPAR expectations.

As to the -- to answer your questions on the margin, is that we have been -- the one good thing about our growth model is shrewd asset-light business model. So because the majority of our openings are the asset-light model, so we expect that the revenue that's coming in from the franchised, manachised model is that will help to actually bolster the decline in our leased hotel operating margins.

Dylan Chu -- CLSA -- Analyst

Okay, and great. Thanks, Teo. And the second question just in terms of costs, mainly about [Phonetic] next year. In addition to pre-opening and development team investments which should normalize, do we see any further areas where we can achieve more cost efficiency if opening environment continue to be quite subdued? Just any areas we can identify and sort of anything we could quantify would be very helpful?

Teo Nee Chuan -- Chief Financial Officer

Okay. You may in fact -- that this year in 2019 we made a significant investment in a couple of areas. Number one is the development team areas, as well as our IT resources as well as for the sales teams. This has put, I would say, that the additional investment approximate RMB30 million of the people cost every quarter, OK. And we currently -- that we do not expect this quantity, the number of headcount to increase much further or significantly, much further. So we expect that these costs we'll retain and will remain in this year as well as next year.

But on the other hand, that the pre operating expenses that are related to our investment in our Upscale hotels, the additional pre-operating expense of about RMB200 million is that at -- up until this moment is that we have not met any new, I would say, the investment in the high-end hotels, which will require such a high capital, tight capital expenditure as well as pre-operating expenses in 2020. So we expect that the pre-operating expenses in 2020 will be lower compared to 2019.

Dylan Chu -- CLSA -- Analyst

Okay. Yeah. Okay. Thanks. Final question just on the buyback program, so you just mentioned that we also had a view in terms of our long term value. Just curios, it's obviously no obligation, it's highly discretionary. But what kind of price range would you be interested in terms of buying back? Would they bear any sort of selling price about which you wouldn't consider, just any color on that would be helpful? And sort of relate to your capital allocation, obviously, there could be compelling M&A opportunities opening up. What kind of maximum leverage would you consider if you do see a compelling candidate? That would be helpful. And also, would you consider a potential using equity to fund any bigger acquisitions?

Teo Nee Chuan -- Chief Financial Officer

Okay. Number one, that on relating to the pricing, the pricing question, is then unfit? I am not able to answer the questions, because it's actually totally up to the management and it's not appropriate to answer, to provide answer to the public. As to the capital allocation, is that we are pretty open. The reason why we put in place a share buyback is because that is -- because we have existing shares, we have existing cash as well as the credit facilities in place. In fact, that we will also -- due to our bad debt [Phonetic] credibility that we are able to increase our credit facility further in -- at the end -- by the end of this year.

So we do have the cash resources to deploy. So the first and foremost important thing is that we would like to grow this Company. So if there is an attractive M&A opportunities, we will first utilize the cash to pay to -- for the M&A activities. But having said that is that we also believe that what we have been doing in -- in the last few years has to, actually in 2019 is that they will have a bearing on -- that there will be a pressure on the profitability, which some of the investors may not appreciate that because of the low operating margins. But we believe that by doing this investment, our profit margin and growth potential will accelerate in the coming years. So we think that, we would use some of our cash to buy back these shares when the market, I would say, that did not react well in some of the profit situations. And then that we will consider to reissue the stocks in the future.

Dylan Chu -- CLSA -- Analyst

Okay. Great. Thank you very much.

Operator

Thank you. The next question comes from the line of Lina Yan from HSBC. Please go ahead.

Lina Yan -- HSBC -- Analyst

Hi, management. Thanks very much for taking my questions. I have two questions. So first question is regarding your guidance on revenue growth in 3Q is like three percentage point deceleration versus a 13% revenue growth in 2Q. You just mentioned you're still expecting like low single-digit negative same hotel RevPAR in like the second half of the year. So I am wondering if you are going to have a more temporary closure of owned and leased stores like in 3Q or second half for upgrades, while we have so much micro uncertainties? Thank you.

Teo Nee Chuan -- Chief Financial Officer

I will say that our upgrading, OK, put this way then, our upgrading -- we closed some of our hotels for upgrading, this is actually part of our long-term plan to actually upgrade the hotels. You see that in a good time is that the opportunity caused to upgrade is bigger, because there is actually lots of opportunity to make the revenue. But having said that, in the slow economy, it's actually good timing. But we will also consider that there'll be a number of activities coming up, for example, the Beijing Olympic is going forward in the next couple years. And as we see that some of the government meetings will actually affect the timing of the renovations. So we need to seize the opportunities to do some upgrades of our leased and operated hotels, so that when after the cloud and miss [Phonetic] and that has been cleared, we're in a bad position to actually attract more market share into our hotels.

Lina Yan -- HSBC -- Analyst

Is there a target for upgrades like for owned and leased and specifically to HanTing 3.0?

Teo Nee Chuan -- Chief Financial Officer

Okay. We -- at least that we do have some specific target in doing that by depth. Our plan, our upgrading and the maintenance plan was according to our original plan that has been set, I would say that, at beginning of 2019.

Lina Yan -- HSBC -- Analyst

Okay. Thank you. And my second question is regarding the expenses. So as I understand your investment into the IT development team and the pre-opening reflected in the SG&A and pre-opening expense. But when I look at the other expense under hotel operating expense, actually the YoY growth in first half was still quite like significant. So may I know what's the reason for that? Thank you.

Teo Nee Chuan -- Chief Financial Officer

Okay. The other operating income, after other operating expense is reflective of couple of things. Number one, is that we do have an IT company which is called Mangwang [Phonetic] which generate revenue from our external customers. So their costs is actually the cost in servicing those customers are actually reflected in that. And of course, the revenue for Mangwang was also reflected in the other revenue in the revenue line.

Lina Yan -- HSBC -- Analyst

Okay. That's the only reason. Right. Thank you very much. Yeah.

Operator

Thank you. The next question comes from the line of Tian Hou from TH Capital. Please go ahead.

Tian Hou -- TH Capital -- Analyst

Yeah. Good morning, management. So the question is related to your expansion. So in your press release, you mentioned that you have about more than 1,000, the star -- the hotels in the pipeline for you guys to -- you know what if you are on board. So I wonder where those hotels are in terms of tier, i.e, tier 1, tier 2, the region. And also that is one major -- it's the one angle to look at it. The angles, the other angles to look at it is that, what's the portion of the hotels are much more like a higher tier, so [Indecipherable] what are the middle tier or lower tier? So that's the classification of your pipeline.

And another question related is to China hotel market. So if I look at 2019, we have like almost of 300 million room nights already and hotel for 300 million room nights, and I wonder if that's already penetrated, saturated, so when you expand, is that consolidating the existent or it's the market expansion, what exactly it is? Thank you so much.

Teo Nee Chuan -- Chief Financial Officer

Okay. Let's -- so to answer the question regarding the tier of cities. Is that approximately the 3% of pipelines are in tier 1, and then is that in tier 2, we have approximately 36% and the balance in the lower tier cities, OK.

Regarding that we see that the -- is that [Indecipherable] is that we -- our -- the number of hotels that we have, now currently have is, as a percentage of the total market is actually pretty small. We're talking about like 2.5% to 3%, is very, very, very small. What we have been seeing is that our expansion is we would like to expand in the market where the penetration is low. And then if you would like to convert the existing hotels into our own brands, and because we think that we can operate the hotels in the better way at appropriate pricing and appropriate quality to our customers. So we see that our opportunity is very, very small. To give you an example, is that even the total penetrations of the all the brand of hotels include not only us, but also other, like the bigger brands like whether its BTG or whether its Jin Jiang, in the Marriott, Hilton, everyone. Those brand of hotels is that, approximately 20% in the market. So if you look into the US, it's 70-odd percent. Assuming that, because of the fragmented nature in China is that we can go up to 50%. We still need to grow at least 2.5 times more, at least. So we were seeing is that the opportunity to do that is much bigger. So that's the reason why we have been putting in place the appropriate brands, including introduction of the Madison brand to further consolidate this market in the good locations.

Tian Hou -- TH Capital -- Analyst

Thank you. That's clear.

Operator

Thank you. The next question comes from the line of Praveen Choudhary from Morgan Stanley. Please go ahead.

Praveen Choudhary -- Morgan Stanley -- Analyst

Thank you. Hi, Jenny. Hi Mr. Teo. A couple of questions from me. One, you mentioned that the IT investment Upscale and business development took 3% of your margin in this quarter. I am just wondering that in 2020, when these investments will go away, how should I think about the pressure on your margin, would that 3% completely go away to 0% or will there always be some pressure on adding Upscale hotels, so maybe 1% lower than what it could be?

Teo Nee Chuan -- Chief Financial Officer

Okay. I would say that the pressure -- I wouldn't characterize the investment as a pressure, but I would say that it's actually a fit for growth, OK. So we -- the investment that we put in place for development team, it will bring growth to our Company to increasing, especially the manachised hotels, through the hotel expansions on -- particularly on the asset light franchised models. So this revenue will come in. But having said that is that we do not expect the team to grow much bigger as compared to like -- that's what we have added the resources in 2019 compared to 2018. So we see that in 2020, is that our resources in this area will actually remain approximate the same number. So in other words we said, the revenue that has been -- that this team will be bringing in to the network [Phonetic] Hotel will be more than offset in the years coming forward.

The IT team is a same thing as well. As far as the pre-operating expenses, as I mentioned earlier, that we had not securing any more major strategic hotels in the good location where that we bring -- with a very high rental cost at this moment. So we don't -- we expect that the pre-operating expenses will be coming down in the year to come in 2020.

Praveen Choudhary -- Morgan Stanley -- Analyst

I understand Mr. Teo, I think you have explained that. My question was particularly on 3% margin that you have shown in your presentation very clearly, that in Q2 your margin could have been 3% higher. My question is that 3% goes to 1% or 0% when I look in 2020?

Teo Nee Chuan -- Chief Financial Officer

Okay. I would say that we have not providing the revenue guidance for 2020 yet, but we do expect that because as for the absolute amount of expenses were around -- would be approximately what current stage is. So we expect the percentage of these expenses will be coming down going forward.

Praveen Choudhary -- Morgan Stanley -- Analyst

Okay. That's helpful. Quickly on the second question is related to your pipeline. You mentioned -- your pipeline has grown over time, which is a good news. It is also grown as a percentage of your installed number of rooms, but your net opening guidance have remained same. So what I wanted to understand why? And the second is how much of these net openings in second half '19 and in 2020 would be from Huazhu or as well as H Hotel?

Teo Nee Chuan -- Chief Financial Officer

I would say that all our pipelines are only related to the hotels that's been listed in our discourses. H Hotel is not within our consolidation scope, and is not included in our prime hotels, zero.

Okay. Number two is that we expect that in order -- normally is that for our pipeline hotels is that we're opening it up in -- within the next 12 months. As you may see that with our pipeline hotels in the beginning of the year. And now what we -- our target opening is approximately the same. And the reason why we have not been increasing the pipeline hotel, the opening time that is -- that you never know, because that -- and particularly in the -- particularly during -- at end of the year coming to the third and fourth quarter of the year, there may be some meetings, there may be some timing of the issuance of the fire certificate license. They may actually cause the deviation of the timing of opening. So we -- it is -- we prefer to stick to our current target and we see how it goes. If that opening target were to be -- is that actual openings would be higher than what we expect that we revised that in Q3.

Praveen Choudhary -- Morgan Stanley -- Analyst

Okay. Great. And then on Upscale hotel, if I may ask the question, are you seeing RevPAR trend in Upscale hotels to be similar to what you have seen in your own hotel? Meaning business travelers are traveling whereas RevPAR is declining. And if that's the case, your entry into this segment, is it a good thing or a bad thing for your business?

Min Zhang -- Chief Executive Officer

And Upscale segment this year has seen or [Indecipherable] some RevPAR decline. And currently we have a very tiny weight in the Upscale segment in China. Given our main business model is to do management and the franchised, I think it's the perfect opportunity for us to enter into this segment. As a newcomer, we come into this segment with more efficiency tools that will help this segment to improve their profitability, where is their current suffering point across the industry. And because of the significant revenue base, each upscale hotel is going to contribute more management fee than the small economy hotels. Therefore, we believe, number one, there is a demand for our capability, and number two, there is a good profit base for us to expand into. We think this is the perfect timing.

Praveen Choudhary -- Morgan Stanley -- Analyst

Yeah. Thanks, Jenny. And I liked all your idea, innovations, those hotels really look great. So congratulations and all the best.

Min Zhang -- Chief Executive Officer

Thank you.

Operator

Thank you. The next question comes from the line of Carlton Lai from Daiwa. Please go ahead.

Carlton Lai -- Daiwa -- Analyst

Hi, management. Thanks for taking my question. Just one quick one, can you just comment a bit about the trends and the take rate, and if we're seeing any pressure, given the kind of rising competition from a lot of new hotel chains we're seeing right now in China? Thank you.

Teo Nee Chuan -- Chief Financial Officer

You may -- OK. Hi, Carlton. Now, what we have been seeing is that we have been putting a lot of effort in actually increasing our, how to put it, our take rate, obviously our take rate, I would say that we have been putting a lot pressure here, I think we're putting -- we increased our central reservation systems, and the traffic that goes through our central reservation systems.

And at this moment is that we are -- we will -- actually we will continue to maintain our take rate, our management fees on the base fees. And I would say, royalty, management fees on the management -- on the franchised hotels and we -- and through the higher traffic that flows through our central reservation systems we expect that our take rate will creep up a little bit by little bit. So we have actually experienced a similar pressure before, I would say that back in 2015, 2016. But having said that is that we -- because our franchisees have been seeing value in our management. So at this moment, we have not seen any pressure on our overall base fee take rate yet.

Min Zhang -- Chief Executive Officer

There is an accounting truth I want to remind everyone that I think it's beginning of this year, right, the initial franchise fee is amortized into the lifetime of the franchise agreement. This is the significant change, because we used to recognize the revenue as a hotel opening. This has caused a significant mismatch, when we open a new manachised or franchised hotel, because the spending in development and the service of opening that hotel will be expensed immediately into our books. But the revenue, according to the new US GAAP rules, need to be amortized this through many years. So when we accelerate the opening of the -- the opening scheme that we will have to absorb more expenses compared -- as a percentage of revenue, compared with previous years. I would just want to bring that to your awareness.

Operator

Can we move to the next question? The next question comes from the line of Yue Wen Liu from SWS Research. Please go ahead.

Yue Wen Liu -- SWS Research -- Analyst

Okay. Thank you. I have two questions. First one, I read our second quarter report and say it's like we have like increased bank charge for online payment and a higher commission fee to online travel sales, travel agencies. So could you explain like, what's the increase like in -- like our commission fees to OTA, what's kind of the new percentage that we have to pay. And about the bargaining power over fee [Indecipherable] like me to add?

Teo Nee Chuan -- Chief Financial Officer

Right. I would say that the one-off -- as you mentioned, that there's somehow cut off [Phonetic] the increase in selling expenses was actually due to the increase in commissions. So as bank charges for -- to the banks. This is mainly due to a couple of things. Number one is that we have a bigger number of hotels now. We have a larger number of hotels today. So is that -- as a result is that the -- due to the new openings, is that we would need some OTAs to help to fill up our rooms. So as a result is that the OTAs' contribution has also increased by one percentage point compared to the last quarter. So the commissions payable to the OTA has increased. But having said that, is that the rate that we pay to the OTAs remain the same. There was no increase in the rate that's been under discussion right now. This is number one.

Number two is that because there is an increasing number of our customers also using the credit cards or the online payment versus using cash. So the bank charges related to their transactions has also increased.

Yue Wen Liu -- SWS Research -- Analyst

Okay. Thank you and I have...

Min Zhang -- Chief Executive Officer

Yeah. Just to add to Teo's point, we want to confirm, number one, there is no rate increase in both banking charge and OTA fees. And actually we are gradually negotiating the bank charges down and we have achieved some success recently. So that increasing expenses you have seen are purely due to volume increase. And in addition to the increase, the number of hotels we are having, is driving this volume growth. There's another driver, it's primarily because they are more and more central booking and a payment through our own central reservation system. And we have been recognizing the revenue of -- the bank charge we paid on behalf of the franchisee in the revenue line and the expenses of them in the selling expense line. So there has also, of course, some volume increase recognized in our book on that SG&A line.

Yue Wen Liu -- SWS Research -- Analyst

Okay. Thank you and I have my second question. And I also notice that approximately 84% of our room nights was through our direct channel. So it's a bit lower than last year, which is like 86%. So that mean like we have more like midscale hotels and midscale hotels rely more on the OTA channel?

Teo Nee Chuan -- Chief Financial Officer

The increase in the online -- the OTA contribution estimation is that because we're opening a lot more new hotels, usually in the hotel expansion, in newer [Phonetic] expansion is that we need the help from OTAs to have them to fill up the rooms. So as a result of that, the percentage has also increased. The main reason is because we need the help to having to fill the rooms at the beginning of the [Indecipherable].

Yue Wen Liu -- SWS Research -- Analyst

Okay. Thank you.

Operator

[Operator Closing Remarks]

Duration: 62 minutes

Call participants:

Yu Ida -- Senior Manager Investor Relations

Min Zhang -- Chief Executive Officer

Teo Nee Chuan -- Chief Financial Officer

Justin Kwok -- Goldman Sachs -- Analyst

Billy Ng -- Bank of America -- Analyst

Dylan Chu -- CLSA -- Analyst

Lina Yan -- HSBC -- Analyst

Tian Hou -- TH Capital -- Analyst

Praveen Choudhary -- Morgan Stanley -- Analyst

Carlton Lai -- Daiwa -- Analyst

Yue Wen Liu -- SWS Research -- Analyst

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