CHH Initiation Report-Final

Choice Hotels International (CHH)

Choice Hotels International operates in the lodging industry, with a focus on economy and midscale hotels. 20% of its revenue comes from outside the U.S. market. Among all its competitors, Choice has the most franchise business. This translates into a higher margin and an asset-light business model.

Key Drivers

•Positive lodging industry outlook brings favorable environment.

•Choice’s chain scale shift strategy to the industry’s most quickly recovered segment: upper midscale.

•Franchise business model brings strong financial performance.

Investment Risk

•Chain-Scale Challenge.

•Negative Equity.

•High Reliance on Franchise Business Model.

Valuation

The stock traded at $55.4 per share . Our estimation is $42.5, well below current price. As a result, we are initiating with a SELL recommendation.

INITIATION REPORT DEC 2014

CHOICE HOTELS INTERNATIONAL KEY STATS

Current Price (as of Nov 28, 2014) $55.41

Fair Value Price $39.80

Market Cap ($ billion) 3.18

EPS (2013) $2.23

PEG 3.16

EV/ Adj. EBITDA (2014) 16.5x

ROIC 32.0%

Dividend $0.74

Dividend Yield 1.3%

CHOICE HOTELS INTERNATIONAL OUTLOOK

($ million)

2014 2015 2016 2017 2018 2019

Revenue $774 $860 $932 $1,002 $1,065 $1,118

Growth 10.9% 9.0% 8.0% 7.0% 6.0% 5.0%

EBITDA $236 $256 $278 $299 $317 $333

Growth 15.5% 8.8% 8.4% 7.5% 6.3% 5.0%

EPS $2.23 $2.48 $2.74 $3.03 $3.25 $3.44

ROIC 32.0% 32.9% 34.1% 44.8% 43.5% 41.9%

CHOICE HOTELS INTERNATIONAL STOCK DATA

Average Daily Share Vol. (3 months) 139.397

52 Week High $57.4

52 Week Low $43.4

Target Price $42.5

Investment Summary

U.S. Economy Recovery Provides Great Macro Environment. GDP in 3Q2014 was up 4.6%. Unemployment rate dropped to below 6%. Consumer Confidence Index was 94.1 in October.

Positive Lodging Industry Outlook. With demand outstripping supply, occupancy rate is expected to rise above historical high. ADR is expected to grow at 4.7% and 6.2% for the next 2 years, while RevPAR at 8.2% and 7.4%.

Chain Scale Shift Opportunity. As the economy recovery progresses, upper midscale and upscale segments have outpaced economy segment to experience the highest demand increase for current and future years. This chain scale demand shift in U.S. lodging industry suits the company’s strategy to shift focus on higher-end hotel construction.

Franchise Business Model. Choice has a 100% franchise business model. This translates to a 35.2% ROIC and $1.91 EPS.

Investment Risk

Chain-Scale Challenge. Choice Hotel’s chain-scale is focused on economy and midscale. Now the company is moving towards a higher end to include more midscale and upper midscale hotels. Although this is a smart move, since we perceive more profits and faster recovery in these two segments. The strategy might bring risk with reduced demand. Currently the company is constructing new hotels with higher standards. On the other hand, it is also closing hotels that do not meet their requirements. More hotels are closed than built. We feel to reduce supply in such a great period will not help Choice take advantage of the favorable industry cycle, therefore bring more risk than return.

Negative Equity. The company has negative equity result from treasury share purchases and special cash dividend for couple years. Choice Hotel has paid approximately $600.7 million on 2012 for special cash dividend. A reduction in share repurchases or stop in special cash dividend in the future can hurt the stock.

High Reliance on Franchise Business Model. Choice Hotel’s business model is 100% of franchise. The revenue highly depends on franchise fees they charged. The number of properties and rooms franchised significantly affects the revenue. The successful to achieve growth in number of franchised hotel is unknown that might impact company’s margins negatively. When it comes to the possibility of existing franchisees to terminate the franchise agreements, there is termination fees will be paid to Choice Hotels but the termination fees will not be able to cover the loss from the fees the company would have received. In addition, the failure of franchisees to make investments necessary to maintain or improve the properties could make Choice’s brand preference and reputation suffer.

Investment Summary

Choice Hotels InternationalCompany Overview

Choice Hotels International is one of the largest hotel franchisors in the world with a portfolio of 6,340 hotels, 503 under construction, awaiting conversion or approved of development as of end of 2013 and 506,058 rooms, 38,957 rooms under construction, awaiting conversion or approved of development. The ten collective “ Choice brands” (Comfort Inn, Comfort Suite, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suite, Surburban Extended Stay Hotel, Cambria Suite and Ascend Hotel are located over 35 countries and territories.

Global tourism is on the rise. There is substantial opportunity for Choice’s portfolio to expand internationally. In 2014, Ascend Hotel Collection expands in Caribbean and continues international expansion in Turkey. Still in 2014, Choice Hotels expanded international Footprint Introducing Clarion And Quality Brands In China. The development will begin in Hangzhou, one of China's most popular tourist destinations. The global market has high potential growth, especially in Europe, Canada, Mexico and Australia. In 2013, Choice Hotels added five more hotels to its UK and Ireland portfolio. Ascend is expanding in Europe and added its first hotel in Australia.

Brand Analysis: Building Strong BrandsChoice Hotels franchises lodging properties under 11 proprietary brand names of Comfort Inn, Comfort Suites, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites, Suburban Extended Stay Hotel, Cambria Suites, and Ascend Hotel Collection.

Choice Hotels International (CHH) Page 4| 44

Choice Hotel is the largest hotel franchisor in the world.

Overseas expansion footprint:

-Ascend: Turkey, Caribbean

-Clarion & Quality: China

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Based on statistics as of December 31, 2013, brands contribution to total company performance is demonstrated in the two graphs below (measured in revenue and room number, respectively).

Revenue Share: Comfort Inn & Suites, Quality are Top 3

From the left graph, top 3 brands are: Comfort Inn (30%); Quality Inn (25%); Comfort Suites (17%). These 3 brands constitute 72% of total company revenue.

Revenue Share

8%1%

6%5%4%

25% 17%

30%

Comfort Inn Comfort SuitesQuality Inn AscendClarion Sleep InnMainStay Suites Econo LodgeRodeway Inn Suburban

*Source: Data from CHH 10K

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# of Rooms Share: Comfort, Quality, Econo Lodge are Top 3

From the left graph, top 4 brands are: Comfort Inn (25%); Quality Inn (25%); Econo Lodge (13%); Comfort Suites (11%). These 4 brands constitute 74% of total company room numbers.

Franchise System

Some of Choice’s franchisees don’t have hotel experience before. They benefit from the support and service that Choice provided. Franchising model has a major advantage over the model of independent hotels, particularly when it comes to booking. Having access to the technology that franchisees can get through a leading franchise system like Choice is really something that allows them to compete in the market place in a way that they themselves just can’t while being independent.

The value Choice offers to its franchisees is based on three things. First is sales people who are doing a hard work trying to put employees of companies into hotels under Choice brand. Choice Hotel also has a marketing department that is improving the brand recognition across the country and helping the owners with advertising. What’s more, Choice has an Operation Department that helps hotels operators manage the hotel in a more efficient and profitable manner.


# of Rooms Share

2%8%

16%

1%7%

4%24%

11%

25%

Comfort Inn Comfort SuiteQuality ClarionSleep Inn Mainstay SuiteEcono Lodge Rodeway InnSuburban CambriaAscend

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*Source: Data from CHH 10K

Choice Hotels International (CHH)Choice Hotels International (CHH) Page 7 | 44

Target CustomerCurrent Customer: Middle Income Leisure Travelers

Choice brands are predominantly targeted to the middle income customers – more to leisure travelers than business travelers. The company made its first foray into the upscale hotel segment with the Cambria Suites brand, leading itself against significant competitions from the likes of Starwood Hotels & Resorts Worldwide, Marriott International, and Hilton Hotels in the upscale segment. Apart from these two brands with focus on the business travel market, most of the other nine brands are historically oriented to leisure business.

Change of Focus

• Leisure Customers to Business Customers

• Urban Markets rather than Green-fields

• Upscale Hotels Construction

On its 60th annual franchise conference this year, Choice Hotels International announced its new focus to drive more business travelers to its Comfort Inn and Comfort Suites brands. Specifically, the company thinks that business travelers book more room nights and pay a higher rate than leisure travelers.

In order to attract business customers, the Comfort brands need to be retooled. Last year, the company committed up to $40 million in incentives to owners to upgrade their properties and over $250 million in total is estimated to be invested in renovating hotels to meet new brand standards by the end of 2014. Besides, the company recently launched an incentive program for new development that will waive royalty payments for up to three years for qualified new-build Comfort Inn and Suites projects. The Comfort brand has 23 new properties under construction in the United States.

Cambria is also a focus in Choice’s strategy since the brand targets high-end customers and urban markets. Right now, there are 20 Cambria properties open across the country and 30 under development. Most Cambria hotels are located in business centers like Washington DC, Phoenix, Manhattan and Chelsea in New York etc. Cambria hotels are known for their

Changes of customer focus and brand image are a reflection of lodging industry trend


unique designs, which meet special and modern taste of Millennium program target customers.

Break Down of Customer Type

We group the customer segments of lodging industry into two major types – business travelers and leisure travelers (backpackers, solo travelers, couples and families). According to the “2014 Lodging Industry Profile” published by American Hotel & Lodging Association (AH&LA), business and leisure travelers account for 59% and 41% of total customers with their average expense per room per night of $143 and $123, respectively. Together with the percentage for length of stay, each business traveler has a weighted average expense of $282 per trip, versus $214 for a leisure traveler. According to DKSA report, throughout 2013, business travel demand has kept growing with the convention and seminar/ training business increasing while transient business remaining unchanged. Also, business demand is highest on Tuesday and leisure demand peak is on Saturday; 1/3 of Sunday demand is business. For Choice hotel brands, this means that the transition to attract business travelers can improve room occupancy during mid-week.

Business travel demand growing

Business travelers spend more per journey

THE TYPICAL LODGING CUSTOMER IN 2013Typical “room night” stay Business travelers (59%) Leisure travelers (41%)Gender Male (64%) Two people (54%)Age 35-54 (52%) 35-54 (43%), 55+ (32%)Occupation Professional/managerial (61%)Avg. income $127,000 $96,000# of people travel together Alone (77%) Two (54%)Reservation 96% 94%Travel method N/A Auto (82%)Expense on room/ night $143 $123One night stay 40% 50%Two nights stay 23% 26%Three or more nights 37% 24%Weighted avg. exp/ traveler $282 $214

*Source: D.K. Shifflet & Associates, Ltd.

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Primary Research – Discrepancy Between Industry and Company Level

To gain a better idea of client types of Choice, we carried out primary research on TripAdvisor. Considering the large number of domestic properties, the research mainly consolidated statistics from four cities - Buffalo, New York, Los Angeles and San Diego, two in west and two in east coast. Results show that 85% of Choice customers are solo, couple or family and only 15% are business travelers, indicating a strong inclination to leisure travelers. Compared to industry leisure and business travelers proportion of 41% and 59%, Choice hotels have not fully dived into the business traveler market.

Short-term Growth by Chain Scale. In 2015, all chain scales demand will have lower growth rates than in 2014, except for luxury lines. Under the economic recovery, growth at year 2014 is high for lower-end segments from independent to midscale. However, their growth cannot continue at the similar high pace in 2015. On the other hand, Upper midscale and Upscale hotels see the highest demand increase for both years. These two trends provide a relatively larger market for Choice's new focus on Comfort reintroduction and Cambria.

Stronger demand growth in Upper midscale and Upscale segments

Chain Scale Demand Annual Change

2014

2015

0.0% 1.8% 3.5% 5.3% 7.0%

2.1%

1.8%

2%

3.6%

5.2%

6.9%

3.7%

4.4%

1.9%

3.4%

2%

4.1%

0.9%

3.7%

Independent Hotels Economy Midscale Upper MidscaleUpscale Upper upscale Luxury

*Source: PwC, based on STR data


New core customer group. Millennial (also as Gen Y, a segment of the population that came to maturity around the year 2000) will become the core customer of the lodging industry over the next five to ten years. Willing to pay more for a greater experience, "foodies" are a prevalent subset of this market; looking for an overall gourmet experience for a reasonable price will cause the industry to revamp their lobby bars, restaurants and food service. Internet bloggers and culture buffs looking for a unique experience will command change within the market. Following the trend, Choice is digging deeper into hotel experiences from its upscale brands of Cambria and Ascend. Additionally, a new Choice digital application called “connected bar” will also come soon, which allows drivers to search and book hotels through verbal commands.

Loyalty ProgramChoice’s loyalty program is called Choice Privileges. As other hotel loyalty programs, members earn points through frequent stays and spending levels, also through participation in affiliated partners’ programs (e.g. services offered by credit card companies). Members could redeem points to free hotel stays (Choice brand properties) and other rewards (earn airline miles, gift certificates at participating retailers).

Through this loss costly, more targeted marketing strategy, incremental businesses are delivered to franchised hotels. Revenue contribution in 2013 is about 1/3 of domestic gross room revenues. Currently over 19 million members worldwide are enrolled in this program. Both the revenue generated and the member number are gradually increasing every year, demonstrating the positive driving effect of this loyalty program.

Millennials - experience, gourmet, and Internet

Member type

Required Nights/ Year

Elite Point Bonus

Extended Booking Window for Reward Nights

Gold 1 10 5Platinum 2 25 7Diamond 4 50 10

*Source: Choice Privilege Website


Industry Insights

Most big brands in lodging industry have offered customer loyalty programs as a booking incentive. The revenue increase brought from these programs did rose by 20% for the past two years. As an example from Starwood, its loyalty program SPG members account for over 50% of hotel occupancy on any given day.

As shown in the survey results below, Choice Privilege ranked middle among 7 relatively well-known hotel loyalty programs. This means that when booking, Choice Privilege does have a bigger impact on customer decision than most of its peers do, which is a good thing. Additionally, the company uses half of its homepage on website for the loyalty program. This gives program members more convenience and is also an effective way to grow membership.

!

LOYALTY PROGRAM EFFECTIVENESS: 2009-2011

Company 2009 2010 2011(Q1&Q2)

Hilton 34.6% 35.8% 39.2%

Starwood 31.8% 35.4% 37.7%

Marriott 35% 36.2% 35.2%

Choice 26.8% 24.8% 26%

InterContinental 25.8% 23.6% 25.4%

Hyatt 17% 21.3% 21%

Wyndham 16.5% 14.9% 13.5%

Industry 32.7% 34.5% 34.5%

*Source: Choice Privilege

*Source: Market Metrix


The customer group breakdown of importance perception about loyalty programs gives a clearer picture. Specifically, loyalty programs have a stronger impact on casinos (48%) and luxury (38%) than on economy hotels (20%). Also, younger customers (Gen Y) tend to consider loyalty programs more (34%) than elder ones (18.60%). This is consistent with Choice’s current chain scale shift so that we expect Choice Privilege to bring increasing revenue in the future, following

Loyalty programs more popular in higher-end hotel segments and among younger consumers - Choice’s new shift of brand image upgrade and customer focus will bring Choice Privilege

PERCENT OF GUESTS WHO CHOOSE A HOTEL

BECAUSE OF THE LOYALTY PROGRAM

Asia

Europe

Americas

0% 1.5% 3% 4.5% 6%

5.8%

2.5%

1.4%

Percentage of guestsImportance of Loyalty Programs

0%

12.5%

25%

37.5%

50%

18.6%

30%

34%

30%32%31%

34%

20%

38%

48%

Casino Lux Economy Pleasure Business Female Male 19-31 44-62 79+

Segment Purpose Gender Age

*Source: statista.com


SkyTouch: Wait to See the Break-even Point

SkyTouch Technology was spun off from Choice Hotels in 2013. Currently the company is 100% owned by Choice. SkyTouch remains a separate operating division, and has 200 employees.

SkyTouch is a Property Management System (PMS) that helps perform guest check-ins, housekeeping services, dynamic rate management and distribution management.

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Choice has been working on the SkyTouch platform for 10 years, and rolled it out to 5,700 hotels in 7 countries.

SkyTouch has two strengths. One is cost-efficiency, due to its subscription nature. It saves by paying less up-front fees ($5 per room per month), no need to have a host on-site or a maintenance team. Main competitiveness lies in its cloud technology, which enables access to data whenever and wherever. Cloud technology brings flexibility and economy of scale, currently SkyTouch is ahead of its competitors in this regard.

However, we see more risk than strengths associated with SkyTouch. For one thing, they are trying to compete against Oracle, who has the largest market share in PMS. Even though Oracle’s product is not cloud-based at this time, it would not take long for them to add the feature. For the other, switching from existing PMS to another is time-consuming and money-consuming, making it a difficult decision, especially for big hotel groups with thousands of hotels under management. Hence, even a great product like SkyTouch, it is difficult for it to expand customer base. Last year, the SkyTouch division harmed EBITDA by a loss of $10 million. This year, the number is expected to be $18 million. Given the business only accounts for 5% of total revenue, we recommend wait for a quarter or two, to decide when the break-even point will be reached.

Stock Repurchase: Likely to Continue in the Future

Previously the company has been returning value to its shareholders through two ways: special dividends and share repurchases. Since the program’s inception in1998, Choice has repurchased 45.3 million shares (including 33 million prior to the 2-for-1 stock split in October 2005). According to the company’s repurchase plan, there are still 1.4 million shares left to be repurchased. But there has been a recent shift from open market repurchase to more specified group, such as Stewart Bainum, Chairman of Board of Directors.

Leveraged recap. In 2012, Choice carried out a leveraged recap. The company borrowed $595 million debt and paid out

Given the difficulty to expand customer and fierce competition, we recommend wait and see when the break-even point of SkyTouch will be reached.


a special dividend of $600.7 million. Main motivation behind this recap was to take advantage of the favorable financing environment to return value to shareholders. The company’s leverage (Debt-to-EBITDA ratio) was beyond four in 2012. Now the ratio is 3.89, slightly higher than its target of 3 to 3.5 range.

The management does not believe in programmatic share repurchase, instead, they believe in opportunistic share repurchase. Since the company’s leverage is still higher than target, and with investment opportunities such as SkyTouch and Cambria ahead, we do not think there will be another leveraged recap in the foreseeable future.

We do not predict a leveraged recap in the near future, with leverage still high and investment opportunities in SkyTouch.

IndustryOverview: Mature, Cyclical, Currently in Recovery

The lodging industry is a mature industry marked by intense competition, making it a less attractive target for new entrants. The high requirement of capital expenditures creates a high barrier for companies to enter and exit. The introduction of transportation leads the way of lodging industry for growth into a dynamic industry, and provides multiple services to different groups of customers. In early 1990s, a number of hotel brands including Hilton, Starwood and Wyndham emerged in U.S. market. These large brands accelerated activities in capital markets for capital expenditures, mainly focus on U.S. domestic market.

The Global Lodging IndustryGlobal lodging consumption has seen gradual growth recent years with the sustained economic recovery bringing back people’s disposable income level. Regional performance is strong especially in US, Canada and Latin America.

In 2013, the global lodging industry achieved total revenue of $400 billion with annual room growth of 1.5-2.0% and RevPAR growth of 3-4%. As can be seen from the left graph, France received the most international tourists in 2013. Still, U.S. is the second largest market for international travelers with 70 million arrivals, bringing a large demand of leisure-purpose hotel stays.

Global Trend #1: More International Outbound Arrivals

With the development of emerging market, BRIC’s outbound tourism industry has grown exponentially. For example, outbound travels in China increased at a compound annual growth rate of 18.5% during last decade from 10.5 million to 57.4 million


International Tourist Arrivals (2013, in millions)

0

23

45

68

90

2728313238

485661

7083

France US SpainChina Italy TurkeyGermany UK Russian FederationThailand


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Global Trend #2: US Has a Diminishing Proportion

US hospitality market accounts for more than 1/3 of the total revenues of global market, and the US proportion dropped by continuous 5 years since 2008. This is mostly because that 2008’s credit crisis signaled lodging industry has stepped into a recession.


This statistic shows the international tourist arrivals in the Americas from 2010 to 2013, by region. In 2013, there were 110.1 million international tourist arrivals in the region of North America. In the past 4 year, the international arrivals in the Americas have steady up by single digit growth rates. It solids our confidence about Lodging’s future pattern.

International Tourist Arrivals in the Americas by Region (from 2010 to 2013, in millions)

0

45

90

135

180

2010 2011 2012 2013

9.28.98.37.9 21.220.720.119.5 27.426.725.523.6110.1106.4102.199.5

North America South America CARIBBEAN Central America

Global vs US Revenue (in $Billions)

0

200

400

600

800

2008 2009 2010 2011 2012 2013

400

550

457419

395447

163155.5153.3142133.3155.6

Revenue of US hotel Revenue of Global Hotel



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U.S. Lodging IndustryThe U.S. lodging industry ended year 2013 with a 0.7% rise in property number to 52,887 and a 0.5% increase in room number to 4,926,543.The annual total revenue reached $163 billion, an increase of 5.4% from 2012.

US Lodging: Currently in Recovery

Over the past 15 years, there have been two downturns, in 2001 due to the credit crisis, and in 2008 due to the financial crisis. During both cycles, RevPAR increased from a negative growth rate as low as 17.0% to a positive growth rate as high as 8.0%. Occupancy rate fluctuates in a cyclical pattern between 54.5% (in 2009) and 63.5% (in 2000) . ADR kept increasing, also in a cyclical pattern, with the highest price appreciation occurred in 2009 of 8.2%.

US Lodging: Demand Outruns Supply

Supply is gaining momentum. Supply growth is the growth rate of number of properties in the hospitality industry. This figure is a lag indicator, as hotels take time to build, and once they are in construction, companies cannot leave them unfinished. As seen from the chart below, the effect of the 2008 financial crisis did not show until year 2010. Since then, hotel supply has been gaining momentum. In 2013, the supply growth was 0.7%. We expect the trend to continue, with supply growth being 0.9% and 1.4% in 2014 and 2015, respectively.


In 2013, Lodging industry added 358 properties; and another 26 thousand rooms up to 5 million rooms in total. Large property base with slow movements decides a continuously low supply growth since 2008.

# of Properties (from 2004 to 2013)

46,000

48,250

50,500

52,750

55,000

-1.5%

0.0%

1.5%

3.0%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Supply Growth # of Properties

52,88752,529

51,21451,01550,800

49,505

48,06247,13547,59047,598

0.7%

2.6%

0.4%0.4%

2.6%3.0%

2.0%

-1.0%

0.0%0.0%0.0% 0.0%

-1.0%

2.0%

3.0%2.6%

0.4% 0.4%

2.6%

0.7%

*Source: AHLA (American Hotel & Lodging Association)

Demand outruns supply. Demand, on the other hand, changes with current economy. Based on data from PwC, demand has outrun supply for a fourth year in 2013. While supply is moving to historical average of 1.9%, this trend is expected to continue. This gap is the motivation for an increased occupancy rate. Occupancy in 2013 was 62.2%. We expect it to rise to 64.2% in 2014, and 64.9% in 2015, surpassing the historical high of 64.5% (in 1997).


# of Guest Rooms (from 2004 to 2013)

4,200,000

4,400,000

4,600,000

4,800,000

5,000,000

-1.0%

0.5%

2.0%

3.5%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Supply Growth # of Properties

4,926,5434,900,6424,874,8374,801,8904,762,095

4,626,348

4,476,1914,389,4434,402,4664,411,908 0.5%0.5%

1.5%

0.8%

2.9%3.4%

2%

-0.3%-0.2%-0.1%-0.1% -0.2% -0.3%

2%

3.4%2.9%

0.8%

1.5%

0.5% 0.5%

US Lodging Demand vs Supply

0.00%

2.25%

4.50%

6.75%

9.00%

2010 2011 2012 2013

7.20%

0.50%

0.40% 0.70%1.70%

4.60%

2.80%2.10%

Supply Change Demand Change

Growing demand in the face of very limited new supply create profit growth for the whole industry.


*Source: PwC Hospitality Direction Outlook Table

Macro Economy: Recovering GDP

The GDP has been steady in the 3% range from 2010, and a trend is continued at the 2014 third quarter as 4.7% increase. While the economy is moving forward, the pace of growth translates into the improvements in the labor market.

Labor Market

The lodging industry is a cyclical industry and is heavily dependent on the overall health of the U.S economy. As the U.S economy plunged into a recession in 2008, unemployment hovering near 10%, many people have been struggling to pay for the necessities of life, let alone travel that have significant negatively impact on the profitability of the lodging industry.


Unemployment Rate in Labor Force Seasonally

0

2.5

5

7.5

10

11/30/2009 9/30/2010 7/31/2011 5/31/2012 3/31/2013 1/31/2014

U.S. GDP (from 2007 to 2014 Q3)

0

4,500

9,000

13,500

18,000

2007 2008 2009 2010 2011 2012 2013 2014 Q3

17,53516,76816,16315,51814,96414,41914,71914,478


*Source: U.S. Bureau of Labor Statistics

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Consumer Confidence Index (CCI)

Indeed, the Conference Board’s consumer confidence index climbed to the highest level at 2014, which indicates people might be willing to spare more money on their travel plan.

Disposal Personal Income (DPI)

As the disposable income increases and a reduction in unemployment rate for 2% would help keep improving and lay the ground for gains in spending. Overall, these positive trends in macroeconomic of United States give the lodging industry strong support to grow in the near future.


Disposable Personal Income (DPI) (Billions of Dollars)

10,000

10,750

11,500

12,250

13,000

2008 2009 2010 2011 2012 2013

12,50512,384

11,801

11,23810,94310,994

Consumer Confidence Index (from 2008 to 2014)

0

25

50

75

100

1/31/20082/28/20093/31/20104/30/20115/31/20126/30/20137/31/2014*Source: the Conference Board

*Source: IBISWorld

Key Drivers: RevPAR is Our Strength As AlwaysRevPAR has been a key driver in lodging industry for years. We decomposed RevPAR of occupancy rate and ADR and tracked their past performances.

Below chart showed that ADR increased at a moderate and slow pace in the last 5 years, almost paralleled to the path of RevPAR. While Occupancy rate, as expected, emerged a deep drop in 2008 reacting to the financial crisis. From then on, occupancy rate went up considerably to a rate even above that before the recession. Thus, the diminishing RevPAR is more attributed to the falling occupancy rate under a slow increase in room rate. RevPAR in 2013 was $69, we expect it to grow 8.2% to $74 in 2014, and 7.4% to $80 in 2015.

Average Daily Rate (ADR)

Average daily rate (ADR) continues to significantly drive revenue RevPAR growth up 6.1 percent based on current reservations on the books in comparison to last year. Group and transient segments are contributing to occupancy growth, with ADR increases of 4.3 percent and 7 percent respectively in comparison to the same time last year according to travel click. ADR in 2014 was $110. We expect an upward trend in the following years, with ADR in 2014 increase to $116 (up 4.7%), and to $123 in 2015 (up 6.2%).


US Lodging: ADR, RevPAR & Occupancy (from 2004 to 2013)

$0

$28

$55

$83

$110

50.0%

56.7%

63.3%

70.0%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Occupancy ADR RevPAR

69656156546566625753

1101061029898107104

979186

62%61%60%

58%

55%

60%

63%63%63%61%61%

63% 63% 63%

60%

55%

58%

60%61% 62%


Occupancy Rate

Favorable macroeconomic environment supports the demand to climb up. Supply growth rate is still below 2%, the historic average. New hotel room supply growth will remain constrained due to limited debt availability for new construction and long construction period for new development. This may set the stage. Occupancy in 2013 was 62.2%. Due to increasing demand (outrun supply), we expect occupancy to increase in the next 2 years, to 64.2% and 64.9%.

Comments:

We made a 10 x 10 sensitive table to explore the effect of change in occupancy rate (every 1%) and ADR (every $2) on RevPAR. Grey shade area tells 2013 Occupancy rate and ADR. ADR and Occupancy rate have positive correlation with RevPAR. Additionally, increase in ADR has smaller effects than occupancy rate unit increases, which explains why RevPAR dropped when occupancy rate fell and ADR went along with the move of RevPAR.

Our Forecast for Lodging IndustryWe expect to see an increase in disposable income and resuming GDP, global travel sector will pick up. We believe these economic indicators are favorable for lodging industry. We expect to see an increasing number of travelers in the states, as well as international outbound will generate greater more travel expenditures. In 2014, travel activity picked up significantly, pulling up occupancy rates and average daily rate levels up. Thus, our group strongly believe RevPar will not disappoint current and potential investors.


Room Mix by Grography (in 000s)

0

175

350

525

700

CHH IHG WYN HLT

Americas ASPAC EMEA

Our Position: Ordinary but ProfoundIn general, while hit hard after the recession, the US industry is recovering quickly and is back to pre-recession occupancy, ADR and RevPAR (and we expect this to continue to improve).

U.S. Lodging Market Share: Choice Ranks #5

Here, the U.S. lodging market shares are measured by each group’s number of rooms as a percentage of total number of rooms in the U.S. lodging industry.

As shown by the left chart, the seven major players take up more than half of the U.S. lodging market. The biggest player is Hilton, followed closely by Marriott. Both have market shares of around 11%. InterContinental and Wyndham are the third and fourth biggest player, taking up 9% of the total market, separately.

Choice Hotels International falls in the fifth rank, occupying 8% of total number of rooms in the industry. Still, the market share is way above that of Starwood and Hyatt. The difference between Hilton and Choice’s market share represents a gap of 126,703 rooms, 24% of Hilton’s total rooms in the U.S.

Geographic Presence: Choice is Least Diversified

Among the seven players, InterContinental has the most number of rooms in Asia Pacific (ASPAC) and Europe, Middle East and Africa (EMEA), totaling 225,441 rooms, 33% of the company’s total number of rooms. Starwood’s global room footprint resembles that of InterContinental, 58% of rooms are located in Americas, 25% in Asia Pacific, 18% in EMEA.

Choice and Hilton have similar global room footprint. 81% of Choice’s hotels are focused in the Americas, while Asia Pacific 8%, EMEA 11%. Hilton has 83% of its hotels in the Americas.

Wyndham and Hyatt are somewhere between the most globalized Starwood, and the least globalized Hilton. But they both have great presence in Asia: 15% of Wyndham’s rooms are in Asia Pacific, and for Hyatt, the figure is 16%. Since the Asia market will be growing faster than any other global


U.S. Lodging Market Share

46%

11% 3%9%

11%

9%4%

8%

CHH HOT IHGMAR WYN HHLT Others


*Source: Data from Company 10K

markets in the lodging industry, Choice should increase its exposure in Asia Pacific countries as the way Wyndham and Hyatt do.

Chain Scale: From Economy to Upscale

As we can see from the below chart, Marriott has the biggest ADR range. Choice mainly operates in the Economy, Midscale, Upper Midscale, and Upscale. Wyndham and InterContinental are the company’s most direct competitors, as they all have presence in the whole chain scale that Choice operates in, especially in the Economy chain scale. Starwood, Hyatt and Hilton are relatively focused on the luxury end, with presence in Upper Upscale and Upscale.

Choice brands are mostly low priced and small in size, with fewer than 50,000 rooms. Wyndham, Choice’s existing direct competitor, adopts a two-way strategy in the economy scale: one is low price and small sized, the other being low priced but big sized (around 150,000 rooms). InterContinental also has some big brands, with rooms ranging between 140,000 and 200,000. Starwood is notable for its three high-end brands with ADRs over $225. Hyatt, Hilton and Marriott’s brands are really similar to each other in their market positions.


But Wyndham is more similar to Choice than Marriott, in terms of the chain scale they operate in.


Business Model: 100% Franchised

As shown by the left chart, Choice is the biggest hotel franchiser, with 100% of its hotels franchised. Wyndham, who has 99.2% of franchised properties, adopts a similar business model. Starwood and Hyatt, on the other hand, have most of their hotels managed. Compared with managed hotels, franchising is an asset-light business model that generates high financial return.

Choice’s EBITDA is $236 million, the least in absolute value because of the low ADR they charge. But in terms of EBITDA margins, Choice ranks only the second to InterContinental. InterContinental’s high EBITDA is mainly due to its global presence and high RevPAR. Wyndham is the third highest in EBITDA margin, further indicating the profitability of franchise model.

Unlike other firms, Choice EBITDA mainly comes from its operating income generated by franchisees (initial fees and royalty fees). Other companies have at least 20% of their EBITDA coming from depreciation and amortization. For example, for Hyatt, only 32% of its EBITDA comes from EBIT; for Hilton, it is 57%.


Business Model Comparison

0

2,000

4,000

6,000

8,000

CHH HOT IHG MAR WYN H HLT

Franchise ManagementOwned & Leased Other



Other Key Players in the Industry

Starwood (HOT) was founded in 1969 and headquartered in Stamford, CT. The company owns, operates, and franchises luxury and upscale full-service hotels, resorts, residences, retreats, select-service hotels, and extended stay hotels. Brands include W, Westin, Sheraton, Four Points, by Sheraton. As of December 31, 2013, Starwood has 1,175 properties and 346,800 rooms in 100 countries.

InterContinental (IHG) was founded in 1967 and headquartered in Denham, the United Kingdom. The company owns, manages, franchises, and leases hotels and resorts worldwide, from economy scale to upper scale. Brands include InterContinental, Hotel Indigo, Crowne Plaza, Holiday Inn, Holiday Inn Express, Candlewood Suites, EVEN, and HUALUXE Hotels and Resorts. As of December 31, 2013, InterContinental has 4,697 properties and 686,873 rooms in 100 countries.

Marriott (MAR) was founded in 1971 and headquartered in Bethesda, MD. Marriott operates, franchises, and licenses hotels and timeshare properties worldwide. Hotels fall in the range between upper mid-scale and Luxury. Brands include Ritz Carlton, Marriott, Courtyard, Fair field Inn and Towneplace Suites. As of December 31, 2013, Marriott has 3,916 properties and 675,623 rooms in 78 countries.

Wyndham (WYN) dates back to 1990 and is headquartered in Parsippany, NJ. The company operates through three segments of Lodging, Vacation Exchange and Rentals, and Vacation Ownership. The Lodging segment franchises hotels


Major players in this industry have room numbers of around 650,000.

InterContinental has great global exposure. Plus, the company is listed in London Stock Exchange.

Choice considers Marriott as its direct competitor.

But Wyndham is more similar to Choice than Marriott, in terms of the

EBITDA & EBITDA Margins by Group (2013)

0

500

1,000

1,500

2,000

0%

15%

30%

45%

60%

CHH HOT IHG MAR WYN H HLTEBITDA Margin EBITDA

1,921

733

1,1321,2091,1191,150

20420%18%

23%

9%

59%

19%28%28%

19%

59%

9%

23%18% 20%


in the upscale, upper midscale, midscale, economy, and extended stay segments. Brands include Wyndham Hotels and Resorts, Ramada, Days Inn, Super 8 and Microtel. As of December 31, 2013, Wyndham has 7,485 properties and 645,423 rooms.

Hyatt (H) was founded in 1957 and headquartered in Chicago, IL. The company manages, franchises, owns, and develops hotels in upper midscale, upscale and upper upscale. Brands include Hyatt, Park Hyatt, Andaz, Grand Hyatt, Hyatt Regency, Hyatt Place, Hyatt House, Hyatt Zilara, and Hyatt Ziva. As of December 31, 2013, Hyatt has 548 properties and 147,388 rooms in 48 countries.

Hilton (HLT) was founded in 1919 and headquartered in McLean, VA. The company operates hotels under the brand names of Hilton Hotels & Resorts, Waldorf Astoria Hotels & Resorts, Conrad Hotels & Resorts, DoubleTree by Hilton, Embassy Suites Hotels, Hilton Garden Inn, Hampton Inn, Homewood Suites by Hilton, and Home2 Suites by Hilton. As of December 31, 2013, Hilton has 4,115 properties and 678,630 rooms.

Conclusion

Choice Hotel is not among the most well known brands in the world. It is more focused on the U.S. market, and it targets more on leisure traveling and mid scales customers. Compared with other world-famous public hotel companies, Choice might not be the most attractive one to invest. However, their unique business model supports a strong profitability. With the positive lodging industry outlook ahead, Choice does have some potential.


Hyatt is smaller in size (fewer number of rooms), and has most of its hotels managed.


ValuationRecent Stock Performance

In the Short-run: CHH Outperforms Market but Underperforms Competitors

Over the past year, Choice Hotels International (CHH) improved from underperforming the market to outperforming. This is mainly because Choice is a US-focused company, and the US economy has been performing better than other economies in the past quarter. The company also adopted a price lifting strategy after its underperformance in the first quarter in 2014. Reason for Starwood’s underperformance was due to its high international exposure. Marriott ranked first among all competitors, due to its ability to grow earnings and beat analyst estimation. As for ranking, Choice’s return ranked No.5 among all competitors.

In the Long-run: CHH Outperforms Both the Market and Competitors

In the long-run (over 11 years period), we can see that Choice Hotels has long been performing better than the market. The company’s stock offers a return of 238%, while S&P 500 index only has a return of 72%. As compared with its competitors, Choice is also the most profitable stock, offers 22% more return than the second best performer, Marriott.

CHH outperforms market both in the short and long term. CHH underperforms peers in the short term, but outperforms in the long term.

*Source: Yahoo Finance

Historical Analysis

Great Liquidity. Liquidity improves as current ratio improves from 0.97 in 2009 to 1.48 in 2013 and quick ratio improves accordingly from 0.83 to 1.27, as compared to the industry average of 0.31.

Solvency is not as positive as the company borrowed $595 million long-term debt in 2012 for building more hotels worldwide, lifting the debt ratio from 1.34 to 1.86. Normally, the debt ratio in this industry would be 1.45.

Profitability. Choice has rather a high operating margin compared with the industry average of around 18.5%. It keeps stable at around 26% to 27%. Year 2014 has seen a higher margin of 29.0%. EBITDA grew quickly from $156.4 million in 2009, to $233.8 million in 2014. The profitability has been driven by the company’s unit growth and improvement in operating performance.

Efficiency. Asset turnover decreased from 3.32 in 2009 to 1.5 in 2013, indicating that increase in total assets does not bring consistent sales growth. There are two reasons behind this. One, the company holds on too much cash, even though it pays out dividends and carries out repurchase plans. The other is the company borrows much long-term debt, but does not use it efficiently. Compare with the industry average


*Source: Yahoo Finance

asset turnover, which is 0.59. CHH seems to utilize its assets more efficiently.

Leverage lifted up. Choice Hotel has increased its long-term debt significantly since 2012 due to its strategic plan of hotel building worldwide and the one-time special dividend. The percentage increase from 2011 to 2012 is 236% and debt remained at this level in 2013. Total/Equity was negative in all 5 years, meaning that the company’s debt is more than its asset. This is because in the real estate area because the building was purchased long time ago and the book value of the building is high below its market value.

Comparable Valuation: 16.4x Multiple is a BIG THING

Based on Competitor multiples analysis, Choice has a comparable high P/E ratio of 26.6, which is not appealing for investors. Regarding to competitors, Choice has the highest sales multiple, EBITDA & adjusted EBITDA multiple, indicating a potential overpricing. It is an industry practice to use Adjusted EBITDA in comparable valuation. So we mainly look at EBITDA multiples and Adjusted EBITDA multiples in our analysis. Conclusion of using comparable valuation is $44.0 price per share (13.6x Adjusted EBITDA in 2014), 24.8% down from the previous close price on Nov 28, 2014. Such multiple is fair enough compared with competitors such as Hilton (15.2x) and Starwood (12.3x). Current price of $55.4 suggests an EBITDA multiple of 16.4x, which, we think, is high.

DCF Analysis

In our DCF analysis, we discounted estimated cash flow for the next 5 years with estimated terminal value using 2.8% perpetual growth rate. In conclusion, we generated an intrinsic value of $40.5 per share in year 2015, 27% down from previous day close.

Comparable valuation generates a target price of $44.0 (13.6x EBITDA).

DCF analysis gives an intrinsic value of $40.5.



Price can be very sensitive to growth. In our DCF analysis, we used a perpetual growth rate of 2.8%, somewhere between the industry average 2.1% and the company its own growth rate of 2.9% over the past 10 years. Weighted average cost of capital is also influential. If Choice was able to lower its cost of capital from current 9.7% to 9.0% by reducing leverage, which is exactly what the company has been doing, intrinsic value would increase to $47.2 per share.

Target Price: $42.5 Per Share

In conclusion, we think the stock is currently overpriced. By weighting the price we get from comparable valuation and DCF analysis, we obtained a target price of $42.5 per share. This price represents an EBITDA multiple of 13.3x, which is fair among competitors. But it also reflects a 23.3% downturn risk from the stock’s current price.

Target price is $42.5 (13.3x EBITDA).

8.5% 9.0% 9.5% 10.0% 10.5%

1.5% 41.2 37.8 34.9 32.3 30.0

2.0% 44.3 40.5 37.2 34.3 31.7

2.5% 48.0 43.6 39.9 36.6 33.7

3.0% 52.3 47.2 42.9 39.2 36.0

3.5% 57.5 51.5 46.5 42.2 38.6

4.0% 63.9 56.6 50.7 45.7 41.5


Stock Recommendation We are initiation on Choice Hotel International with a SELL rating and a $42.5 price target. The lodging industry has shown a positive outlook with demand is outstripping supply and a stronger U.S economy. Key drivers such as RevPAR keeps going up. Combined with the 100% franchise business model that is asset light, Choice has a promising future growth for the next two to five years.

However, there are concerns we hold about the company. Choice has mentioned to change their chain-scale strategy and will gradually move to upper scale. This strategy, although it follows the trend of the industry, would put Choice to intense competition, making the company difficult to manage. There is also doubt about when the SkyTouch Division will reach its break-even point.

Through our valuation, we get CHH’s target stock price, $42.5 over share, which is way below current market price of $55.4. Thus, we believe that the current market price of Choice Hotels has been overvalued. Taking into consideration of the risks mentioned above, we offer a rating for SELL.

Tareget Price: $42.5.

We have concerns over chain scale upward strategy and SkyTouch division.

Choice Hotels International (CHH)Appendix 1-1: DCF Calculation

2015 2016 2017 2018 2019Sales 859,827 932,191 1,002,147 1,064,979 1,118,228-COGS 616,264 667,525 717,091 761,633 799,414EBITD 243,564 264,666 285,055 303,346 318,813-Depreciation 9,387 9,573 9,763 9,957 10,155+Interest and other investment Income - - - - - + other comprehensive income gross of taxes - - - - - - Income Taxes 59,138 65,415 72,225 77,590 82,125+ Depreication 9,387 9,573 9,763 9,957 10,155- Increase in Cash 21,885 18,429 -87,794 31,262 32,670- Increase in A/R 6,326 5,347 5,169 4,643 3,935- Increase in Income taxes receivable - - - - - - Increase in Deferred Income taxes(Asset) 606 512 495 445 377+ Increase in A/P 5,245 4,031 3,898 3,503 2,971+ Increase in Accured Expense 1,284 1,284 1,284 1,284 1,284+ Deferred Rev 2,783 2,783 2,783 2,783 2,783+ Increase in Deferred compensation and retirement 251 212 205 184 156+ Increase in Deferred Income taxes(Lia) - - - - - + Increase in Income taxes payable - - - - - +Increase in Deferred compensation and retirement plan obligations 2,617 2,213 2,139 1,921 1,628

+ Increase in Other Liabilities - - - - - - Increase in Investment, employee benefit plans, at fair value 94 95 95 96 96

- Capital Spending 15,544 15,544 15,544 15,544 15,544- Increase in Goodwill - - - - - CFA 152,153 169,847 289,629 183,441 192,890+Increase in Cash 21,885 18,429 -87,794 31,262 32,670+ Increase in Investment - - - - - - ITS 12,367 12,289 12,198 11,364 11,361- after tax Interest and other investment income - - - - - - after tax other comperhensive income - - - - - FCF 161,670 175,987 189,637 203,339 214,198Terminal Value 3,209,951PV of Terminal Value 2,219,775PV of all FCF $713,276Firm Value 2,933,051Total Debt 772,728Cash 211,705Net Debt 561,023Equity Value (in 000s) 2,372,028# of shares outstanding 58,638,863Price per share 40.45

Choice Hotels International (CHH)Appendix 1-2: WACC Calculation

Re 11.14% Rd 4.12% Tax rate 28.24% Price (as of Oct 15) 48.52 # of shares outstanding 58,638,863 MVE ($Million) 2,845 BVD ($Million) 626 WACC 9.66% Industry Data # of rooms # of properties Revenue ($Billion) RevPar 2013 Data 4,900,642 52,529 $155.50 $65.16 2004 Data 4,415,696 47,584 $105.30 $52.90 Industry growth 1.05% 0.99% 3.98% 2.11% Average growth rate 2.03% Choice Data

# of rooms # of properties Revenue (in thousands) RevPar

2013 Data 506,058 6,340 724,307 42.08 2004 Data 403,806 4,977 428,806 35.95 CHH growth 2.28% 2.45% 5.38% 1.59% Average growth rate 2.93% Assumptions WACC 9.66% Perpetual growth 2.50%

Choice Hotels International (CHH)Appendix 2-1: Comparable Valuation

All fiscal year ended on Dec 31 2013, except Hyatt on Jan 31st, 2014* Hilton is listed in 2014, so there is no historical data in 2009$ Million, except # of shares outstanding

CHH Starwood InterContinental Marriott ($ m) WyndhamHyatt (Jan 31,

2014) Hilton 2013 2009 2013 2009 2013 2009 2013 2009 2013 2009 2013 2009 2013 2009Sales 724 564 6,115 4,702 1,903 1,538 12,784 10,908 5,009 3,750 4,184 3,332 9,735 EBIT 194 148 925 26 678 (10) 988 (152) 910 594 233 48 1,102 EBITDA 204 156 1,150 335 1,119 296 1,209 33 1,132 772 733 318 1,921 Adjusted EBITDA 210 N/A 1,263 N/A N/A N/A 1,325 N/A N/A N/A 680 406 2,210 Net Income 113 98 635 71 372 214 626 (346) 433 293 30 (43) 460 BV of Assets 540 340 8,762 8,761 2,953 2,893 6,794 7,933 9,741 9,352 8,177 7,155 26,562 BV of Equity (464) (114) 3,363 1,824 -74 156 (1,415) 1,142 1,625 2,688 4,777 5,016 4,276 ST debt 10 0 99 5 16 106 6 64 233 384 194 12 52 LT Debt 783 278 1,523 2,955 1,854 1,016 3,147 2,234 4,608 3,138 1,289 840 12,671 Cash 168 68 616 87 136 40 126 115 194 155 454 1,327 594 Net Debt 626 210 1,006 87 1,734 1082 3,027 2,183 4,647 3,677 1,029 (475) 12,129 Preferred STK 0 0 0 0 0 0 0 0 0 0 0 0 0 # of shares o/s 58.6 59.7 191.9 186.8 428.4 43.8 294.8 358.5 128.1 178.8 155.9 173.9 984.6 Share price 51.11 32 75.5 33.28 35.45 14.12 62.79 48.88 76.24 20.17 58.18 29.81 22.81 MV of Equity 2,996 1,890 14,488 6,216 15,187 618 18,512 17,525 9,770 3,607 9,071 5,183 22,459 Minority Interest 60.62 60.62 3 21 8 4.74 0 0 0 0 0 0 0 Enterprise Value 3,683 2,161 15,497 6,324 16,929 1,705 21,539 19,708 14,417 7,284 10,100 4,708 34,588

EV/Sales Multiple

5.09

3.83

2.53

1.34

8.90

1.11

1.68

1.81

2.88

1.94

2.41

1.41

3.55

EV/EBIT Multiple

18.98

14.60

16.75

243.23

24.97 (171)

21.80 (130)

15.84

12.26

43.35

98.08

31.39

EV/EBITDA Multiple

18.05

13.85

13.48

18.88

15.13

5.76

17.82

597.21

12.74

9.44

13.78

14.81

18.01 EV/Adjusted EBITDA Multiple

17.54 N/A

12.27 N/A N/A N/A

16.26 N/A N/A N/A

14.85

11.60

15.65

P/E 26.51 19.29 22.82 87.55 40.83 2.89 29.57 (51) 22.56 12.31 302.37 (121) 48.82 Trailing PE (ttm) 25.66 25.21 19.32 19.32 29.31 19.32 42.28 39.06 Forward PE (fye Dec 31, 2015) 23.92 23.09 15.34 15.34 21.82 15.34 41.86 27.48 PEG (5yr expected) 3.16 2.76 1.36 1.36 1.54 1.36 3.56 1.52 Capital Structure

D/E 26.47% 14.71% 11.20% 47.62% 12.31%181.55

% 17.03% 13.11% 49.55% 97.64% 16.35% 16.44% 56.65%

Choice Hotels International (CHH)Appendix 2-2: Comparable Valuation

Comparable valuation using all competitorsComparable valuation using close competitors (MAR,

WYN, H)

Sales EBIT EBITDAAdj.

EBITDA P/E Sales EBIT EBITDAAdj.

EBITDA P/E

Mean Multiple 3.66 25.68 15.16 14.76 32.92 Mean Multiple 2.33 27.00 14.78 15.55 26.07

CHH Data 724 194 204 210 113 CHH Data 724 194 204 210 113

FV 2,650 4,983 3,092 3,099 4,346 FV 1,684 5,237 3,014 3,266 3,572

- Net Debt 626 626 626 626 626 - Net Debt 626 626 626 626 626

Equity Value 2,024 4,357 2,466 2,473 3,720 Equity Value 1,058 4,611 2,388 2,640 2,946

# of Shares o/s 58.6 58.6 58.6 58.6 58.6# of Shares o/s 58.6 58.6 58.6 58.6 58.6

Pirce/Share 34.51 74.29 42.05 42.17 63.44 Pirce/Share 18.04 78.64 40.73 45.03 50.23

Comparable valuation using all competitorsComparable valuation using close competitors (MAR,

WYN, H)

Sales EBIT EBITDAAdj.

EBITDA P/E Sales EBIT EBITDAAdj.

EBITDA P/E

Median Multiple 2.71 23.38 14.45 15.25 35.20Median Multiple 2.41 21.80 13.78 15.55 29.57

CHH Data 724 194 204 210 113 CHH Data 724 194 204 210 113

FV 1,959 4,537 2,949 3,203 4,603 FV 1,748 4,229 2,811 3,266 3,968

- Net Debt 626 626 626 626 626 - Net Debt 626 626 626 626 626

Equity Value 1,333 3,911 2,323 2,577 3,977 Equity Value 1,122 3,603 2,185 2,640 3,342

# of Shares o/s 58.6 58.6 58.6 58.6 58.6# of Shares o/s 58.6 58.6 58.6 58.6 58.6

Pirce/Share 22.74 66.69 39.61 43.94 67.83 Pirce/Share 19.13 61.45 37.26 45.03 56.99

Choice Hotels International (CHH)Appendix 3-1: Income Statement Assumption

Assumption 2009 2010 2011 2012 2013 2014 E 2015 E 2016 E 2017 E 2018 E 2019 ERoyalty fee growth 5.56% 6.66% 6.26% 2.47% 10.92% 9.0% 8.0% 7.0% 6.0% 5%Initial franchise and relicensing fees growth

-28.03% 51.18% 1.07% 31.56% -8.9% 20% 15% 15% 10% 5%

Procurement services (% of royalty & relicensing fee)

7.62% 7.19% 6.98% 6.53% 7.23% 7.78% 7.78% 2014 level

Market & reservation fee (% of royalty & relicensing fee)

132.26% 137.53% 134.51% 139.93% 140.99% 131.47% 136.89% 5 year average

Hotel operations (% of royalty fee)

1.79% 1.68% 1.68% 1.66% 1.67% 4.33% 2.21% 5 year average

Others (% of royalty & reclicensing fee)

2.67% 2.59% 3.01% 3.35% 3.45% 3.45% 3.45% 2013 level

SG&A (% of total revenue) 17.59% 15.86% 16.66% 14.73% 15.68% 15.21% 15.21% 2014

level

D & A growth 1.99% 5 year CAGR

Hotel Operations Margin

23.84% 20.96% 20.43% 23.35% 22.96% 22.31% 22.31% 5 year average

Other income & expenses, net, exclude interest expense (% of revenue)

-1.24% -0.69% 0.14% -0.46% -0.68% -0.22% -0.39% 5 year average

Tax rate 34.78% 32.09% 30.15% 28.66% 28.24% 28.93% 28.61% 28.61% 28.61% 28.61% 28.61%

Choice Hotels International (CHH)Appendix 4-1: Balance Sheet Assumptions

Assumptions 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019Receivables (DSO, % of total revenue) 27.11 29.17 30.29 27.59 26.97 26.97 26.97 level in

2013All taxes (% of total revenue) 3.92% 4.17% 3.55% 3.22% 3.80% 3.73% 3.73% 5 year

averageNon-current deferred income taxes (avg % of all taxes)

63.93% 98.27% 100.00% 69.18% 73.75% 81.03% 81.03% 5 year average

Other current assets (% of total revenue)

1.79% 4.07% 3.54% 5.30% 4.10% 4.27% 4.26% 5 year average

Investments, employee benefits (% of total investment & employee benefits)

100.00% 100.00% 49.13% 78.54% 97.55% 85.0% 5 year average

Total investments & employee benefits growth 11.63% 1.74% -31.68% 0.67% 0.67% Level in

2013

DPO 29.70 34.52 30.01 28.35 28.70 28.70 Level in 2013

Total deferred compensation and retirement (% of SG&A)

38.04% 40.47% 37.15% 22.50% 22.03% 22.03% Level in 2013

Non-current deferred compensation and retirement (% of total deferred compensation)

92.59% 93.33% 52.10% 89.00% 90.04% 91.24%

4 year average, exclude

2011 data

Additional paid-in capital growth 2.25% 10.66% 7.38% 6.82% 6.78% 5 year

average

Choice Hotels International (CHH)Appendix 4-2: Balance Sheet Pro Forma

Choice Hotels International (CHH)Appendix 5-1: Cash Flow Statement Pro Forma

Assumptions 2009 2010 2011 2012 2013 2014 E 2015 E 2016 E 2017 E 2018 E

Provsion for bad debts (% of SG&A) 2.6% 3.8% 2.0% 2.8% 2.4% 2.7% 5 year

average Dividends received from equity method investments growth -13.6% -1.4% 15.0% 10.3% 5.0%

CONSOLIDATED STATEMENTS OF CASH FLOW CASH FLOWS FROM OPERATING ACTIVITIES 2009 2010 2011 2012 2013 2014 E 2015 E 2016 E 2017 E 2018 E Net income 98,250 107,441 110,396 120,687 112,601 125,493 138,148 150,004 163,738 174,456 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 8,336 8,342 8,024 8,226 9,469 9,707 9,952 10,202 10,459 10,722 Provision for bad debts, net 2,578 3,547 2,160 2,896 2,724 3,381 3,643 3,888 4,134 4,360 Non-cash stock compensation and other charges 13,761 9,304 14,511 12,375 11,271 11,271 11,271 11,271 11,271 11,271 Non-cash interest and other (income) loss (5,403) (1,711) 2,208 292 1,545 - - - - - Loss on extinguishment of debt - - - 526 - - - - - - Dividends received from equity method investments 1,337 1,155 1,139 1,310 1,445

1,517

1,593

1,673

1,756

1,844

Deferred income taxes 5,553 -2,381 5,514 (540) (8,024) - - - - - Equity in net income of affiliates (1,113) (1,226) (269) (212) (634) (634) (634) (634) (634) (634) Changes in assets and liabilities: Receivables (796) (9,229) (7,785) (5,239) (6,730) (4,974) (4,531) (4,235) (4,249) (3,908) Advances to/from marketing and reservation activities, net (12,232) 4,654 623 30,313 42,405

- - - - -

Forgivable notes receivable, net - 5,744 (3,475) (10,898) (8,347) (4,244) (4,244) (4,244) (4,244) (4,244)

Accounts payable (8,279) 10,630 (1,851) 11 2,304 3,841

3,485

3,259

3,270

3,010

Accrued expenses (1,289) (1,417) 6,346 12,376 (9,595) 1,284

1,284

1,284

1,284

1,284

Income taxes payable/receivable 8,163 (2,381) (4,562) (3,193) 4,807 - - - - -

Deferred revenue 4,650 15,413 1,523 2,188 (9,861) 2,783

2,783

2,783

2,783

2,783

Other assets 3,041 (12,705) (3,162) (3,476) (3,197) (3,278) (3,278) (3,278) (3,278) (3,278) Other liabilities (4,341) 7,374 29 (17,520) 9,857 - - - - - Net cash provided by operating activities 112,216 144,935 131,369 150,122 152,040 146,147 159,471 171,972 186,290 197,666

Choice Hotels International (CHH)Appendix 5-2: Cash Flow Statement Pro Forma

CASH FLOWS FROM INVESTING ACTIVITIES Investment in property and equipment (11,135) (24,368) (10,924) (15,443) (31,524) (15,468) (19,545) (18,581) (20,112) (21,046) Equity method investments - - (5,000) (20,285) (5,685) (5,685) (5,685) (5,685) (5,685) (5,685)

Issuance of mezzanine and other notes receivable (1,995) (11,786) (12,766) (23,736) (1,095) (1,095) (1,095) (1,095) (1,095) (1,095)

Collections of mezzanine and other notes receivable 324 5,083 4,754 3,270 9,748 5,714 5,714 5,714 5,714 5,714

Purchases of investments, employee benefit plans (3,854)

- (1,602) (1,697) (2,676) (1,952) 94 95 95 96

Proceeds from sales of investments, employee benefit plans 13,895 1,649 644 11,223 4,168

- - - - -

Proceeds from sale of assets - - 1,654 - 243 - - - - -

Acquisitions, net of cash acquired - (466) - - - - - - - -

Other items, net (584) (319) (564) (433) (728) (526) (526) (526) (526) (526) Net cash used in investing activities (3,349) (32,155) (20,329) (47,101) (27,549) (19,012) (21,043) (20,078) (21,609) (22,542) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from the issuance of long-term debt

- 247,733 75 543,500 3360

- - - - -

Net borrowings (repayments) pursuant to revolving credit facilities (6,700) (277,500) (200) 57,000 (57,000) (56,880) (56,880) (56,880) (56,880) (56,880) Principal payments on long-term debt - (25) (297) (4,422) (8,204) (10,743) (12,619) (119,065) (340) (340)

Settlement of forward starting interest rate swap agreement (8,663)

- - - - - -

Debt issuance costs - (800) (2,356) (4,759) - - - - - -

Excess tax benefits from stock-based compensation 5,834 625 1,227 1,559 1,460 2,141 2141 2141 2141 2141 Purchase of treasury stock (59,128) (11,212) (53,617) (22,586) (3,965) - - - - -

Dividends paid (44,274) (43,808) (43,747) (654,092) (32,799) (41,157) (41,157) (41,157) (41,157) (41,157) Proceeds from exercise of stock options 9,158 2,457 3,845 7,090 8,864 - - - - -

Net cash used in financing activities (95,110) (91,193) (95,070) (76,710) (88,284) (106,639) (108,515) (214,961) (96,236) (96,236)

Choice Hotels International (CHH)Appendix 6: Franchise System

! As!of!and!For!the!Year!Ended!December!31, ! !COMBINED)DOMESTIC)FRANCHISE)SYSTEM 2008 2009 2010 2011 2012 Number!of!proper>es,!end!of!period 4,716 4,906 4,993 5,001 5,083 ! ! 4.03% 1.77% 0.16% 1.64% Number!of!rooms,!end!of!period 373,884 388,594 393,535 392,826 396,102 Royalty!fees!($000) 220,411 196,406 206,049 220,047 235,502 ! ! L10.89% 4.91% 6.79% 7.02% Average!royalty!rate(1) 4.20% 4.25% 4.29% 4.32% 4.33% Average!occupancy!percentage(1) 55.30% 49.40% 51.30% 53.50% 55.50% Average!daily!room!rate!(ADR)(1) 74.11 71.24 70.5 71.83 73.6 Revenue!per!available!room!(RevPAR)(1),(2) 40.98 35.18 36.18 38.44 40.84 ! ! ! ! ! ! ) As!of!and!For!the!Year!Ended!December!31, ! !COMBINED)INTERNATIONAL)FRANCHISE)SYSTEM 2008 2009 2010 2011 2012 Number!of!proper>es,!end!of!period 1,111 1,115 1,149 1,177 1,160 Number!of!rooms,!end!of!period 98,642 98,816 101,610 104,379 103,151 Royalty!fees!($000) 23,916 19,351 21,647 25,175 25,066 ! ! ! ! ! ! ini>al!and!relicensing!fees 12,916.00 9,295.00 14,052.00 14,203.00 18,686.00 change!in!proper>es ! 190! 87! 8! 82! ! 2.74 1.89 2.81 2.84 3.68 ! 17.06 21.13 14.66 15.49 12.60 ! ! 48.92 161.52 1775.38 227.88

Choice Hotels International (CHH)Appendix 7: Debt Schedule

Year%Ending

Senior%Notes%(In%thousands) Interest

Capital%Lease Interest

Revolving%Credit%

Facili=es Interest%avg

Other%Notes%Payable Interest

Economic%Development%Loan%(10%year%since%2013) Interest

Total%principal%repayment

Total%Interest

% 5.94% % % % 2.66% % % % % % % % 6.19% % 3.18% % 2.17% 2.42% % % 3% % % %

2014 $0 $39,209 $1,017 $84 $9,375 $3,351 $11 % $340% $102% $10,743 $42,745 2015 % $39,209 1,017 $51 11,250 $3,124 12 % $340% $92% $12,619 $42,476 2016 % $39,209 594 $19 118,125 $2,853 6 % $340% $82% $119,065 $42,162 2017 % $39,209 % % % % % % $340% $71% $340 $39,280 2018 % $39,209 % % % % % % $340% $61% $340 $39,270

ThereaSer 649,572 % % % % % 3,360 % 1700 % % % Total%payments 649,572 % 2,628 % 138,750 % 3,389 % 3400 % % % % 400,000 % % % % % % % % % % % % 249,572 % % % % % % % % % % % Less:%Amount%represen=ng%es=mated%executory%costs % % (701) % % % % % % % % % Less:%Amounts%represen=ng%interest % % (79) % % % % % % % % % Net%principal%payments $649,572 % $1,848 % $138,750 % $3,389 % $3,400% % % %

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CHH Initiation Report-Final