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Lentuo Releases 2013 Chairman Letter

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SOURCE Lentuo International Inc.

Improving margins in new car sales

Expansion into pre-owned cars with O2O platform

Expansion into premium car sales

BEIJING, May 22, 2014 /PRNewswire/ --

Dear Shareholders,

China, as a nation, is only beginning its love affair with the road. In 2013, we saw double-digit growth in car sales, rising 14% to 22 million vehicles, according to the China Association of Automobile Manufacturers, after two years of relatively weak, single-digit growth in the world's largest auto market.

This is part of a process, as car ownership spreads from the sophisticated urban base of China's capital, Beijing, and its coastal cities, to the fast-growing second and third-tier cities of China's interior. We expect 2014 to be another strong year. A range of factors is boosting demand – rapid urbanization, economic stimulus measures, and falling car prices. The last phenomenon is an effect of higher levels of local content in cars produced by joint manufacturing ventures under international brands, making car ownership more affordable for China's aspirational middle-class consumers. Based on estimates by the consulting firm McKinsey & Company, by 2022 China's middle class will increase by 100 million people to 357 million, and 54% of Chinese households will have disposable annual income of between RMB 106,000 and RMB 229,000 (US$17,191 to US$37,141).

A good year, and new directions for Lentuo

This is all good news for Lentuo International, as one of China's largest non-state owned auto retailers. For the full year we had net income of RMB 23.8 million (US$3.9 million) on revenues of RMB 3.3 billion (US$540.6 million). A compelling measure of our success is that we saw increases in gross margin in both auto sales and repair and maintenance services, at 4.9% and 42.4% respectively, even though overall revenues were flat.

To provide more color to our revenue profile, car sales actually increased by 3.9% to 17,561 vehicles in 2013. In previous years, this might have translated into higher revenues with no change in gross margins. In 2013, we saw three parallel developments. As manufacturers responded to competition, they reduced prices by introducing new models with higher margins and lower prices. At the same time, an increasing number of car models previously imported are now manufactured domestically, with lower costs of production translating into lower retail prices. A third piece of the story is that Lentuo introduced discounts on older models in order to clear inventory and stimulate sales on behalf of the auto manufacturers; for which the Company was compensated for.

Our principal market remains Beijing, where nine of our 12 dealerships are located. Beijing is China's largest urban auto market, with about 5.4 million vehicles, or 245 cars per thousand people, roughly 35% the level of the United States. This means that while there is room for additional growth at the high end of the market, car owners from the initial boom in car sales four to five years ago are beginning to look for replacement vehicles as well as the means to realize value through the sale of their existing vehicles. There are plenty of cars available for recycling in China, with a total stock of 137 million as of the end of 2013. 

We intend to explore this emerging market for pre-owned vehicles from its epicenter. Beijing, always the trendsetter in China's domestic auto market, over the past few years has emerged as the leader in the pre-owned car business. As early as August 2012, pre-owned car sales in Beijing exceeded the sales of new vehicles by about 5,000 vehicles per month, according to Automotive News China, the respected industry journal. In 2013, the national market for used passenger sedans rose by 12% to 3 million, while used Sports Utility Vehicle (SUV) sales increased by 50% to 175,000, based on numbers from the China Automobile Dealers Association. The actual number of pre-owned car sales may be much higher, but the ratio of pre-owned car sales to new car sales, with 16 used cars to every 100 new cars sold, is nowhere near the level of the US, where 270 used cars are sold to every 100 new ones.

We believe the emerging pre-owned car market represents a huge opportunity for us, for a number of reasons. First, the Lentuo brand is already associated with the kind of high-end, concierge-like service that customers of high-end brand cars, whether new or pre-owned, have come to want and expect. Second, the existing pre-owned car business offers close to zero protection for consumers, suffers from a lack of transparency and consists mainly of informal markets and deals between family members and friends. We can help the market take a big step up, by providing our trademark immaculate vehicle testing prior to sale and our own certification system for any car that is sold within our network. Third, because we can offer strong assurances of safety, mechanical integrity, and reliability in our pre-owned car business, we are able to bring flexibility to customers in financing their purchases that they may not find elsewhere. Finally, Lentuo is working with its partners to bring a new level of customizable online search capability to pre-owned car customers in an innovative "Online to Offline" (O2O) business associated with its first center for pre-owned cars in Beijing in 2014.

From our perspective, beyond the issue of rising demand for pre-owned cars, and our own unique advantages in the market, there are pull factors that affect all market entrants. These are no secret, and while we have first mover advantage in some respects at the mid and high ends of the market, the market is already crowded at the low end because of these pull factors, or highly attractive characteristics of the market.

On an average unit basis, gross margins in the pre-owned car business range between 10% and 15%. This is much higher than gross margins for new cars, among other things because we share the margins with manufacturers. At the same time, the pre-owned car business generates revenues and profits from ancillary businesses, such as finance, insurance, and warranties. Here too, margins tend to be higher than in the new car market because of the higher risks assumed by the providers in the second-hand market. Because of our vertically integrated business model, these margins will accrue to Lentuo and our partners, rather than third-party service providers.

But, there are push factors in the pre-owned car business that have to be mentioned as well. Currently in eight cities across China, local governments are introducing licensing quotas for new cars, in order to ease congestion as well as air pollution in China's largest cities. The first city to introduce such restrictions was Beijing, which introduced a lottery for new auto licenses in 2011, with an annual quota of 240,000, about one-third the level of car sales the previous year. At the beginning of 2014, Beijing reduced the quota to 150,000. By 2017, the municipal government has said it will offer only 90,000 license plates annually to ordinary cars, while the rest will go to cars using clean fuel or electricity. These restrictions have greatly increased incentives for purchases of pre-owned cars, which do not have to give up their licenses at the time of sale. At Lentuo, we look at this as a healthy development that should over time bring cleaner skies to China's capital as well as better controls and reliability to the secondary market for auto sales.

2013 in review

Before going into more detail on our strategy going forward, it is opportune to mention some of our achievements in the past year.

In May 2013, we received approval from the Beijing Municipal Commission of Commerce for our joint venture with Itochu Corp., the trading company that owns 25.7% of Yanase &Co., the auto dealership network that opened the Japanese auto market to western brands. Itochu's RMB 300 million investment in the joint venture gives it 40% equity in the new Beijing Lentuo Autong Automobile Trading Co., which will help us to expand the sales and service network in the high-end car segment in China. Itochu's investment will also help us complete our new Audi 4S dealership in Beijing, whose construction began in November 2012.

Also in May, we opened our twelfth dealership. This is the new FAW-Volkswagen dealership, in the Wangsiying township near Beijing's East Fourth Ring Road, next to a high-volume shopping mall and entertainment center as well as a luxury residential district. We expect this new flagship dealer to increase visibility not only for our premium car business but also our emerging pre-owned car business, which will follow the business model and high standards of our existing auto retail operations. It includes a full suite of auto sales, maintenance and repair, after-service, finance, insurance, leasing, and pre-owned car sales, with a 7,000 sq.m. showroom that is able to showcase 22 cars. Service operations at this facility were a significant factor in our return to profitability in 2013, with revenues from automobile repair and maintenance services rising by 8.2% during the year to RMB 351.5 million (US$58.1 million), or 10.7% of revenues. The new flagship store is a critical first step in our network expansion, and further deepens our long-term relationship with FAW Group and its subsidiary First Automobile Finance.

As part of our strategy to expand our presence outside Beijing, in June we signed a letter of intent with Hailin City in Heilongjiang Province to develop an auto mall for 4S dealers with a footprint of 266,000 sq m. This will give us a stronghold in northeastern China, in one of three national level development zones in the province. We are in the process of acquiring land rights and seeking strategic investors for this project.

A glimpse of the future

Over the coming year, we expect to devote significant management resources and attention to development of the pre-owned car business. We believe this push is both timely and complements our existing strategy. The pre-owned car market in China reminds us of the free markets that sprang up in the early era of China's market opening. There are no entry barriers, no standard certification, and no guarantees for buyers. If customers want to test the vehicles, they have to drive them elsewhere and pay for mechanics to look them over.

We think the market will respond positively to the paradigm shift that Lentuo offers. People are used to thinking of the pre-owned car market as second class. We will be giving it first-class treatment. Not only will we provide complete testing for our pre-owned cars, we will give them our certificates of guarantee and sell them only if they meet the highest standard of vehicle quality and integrity. In terms of marketing, pre-owned cars will also get premium treatment.

One of the important cornerstones of this new business will be trade-ins. In Europe and North America, vehicle recycling promotes the new car business as much as providing supply for the second-hand market. Buyers of new cars essentially view the trade-in value as part of a discount on a new model. Lack of certification and standards have been major obstacles to this aspect of the secondary auto market in China. We will be removing these obstacles by putting our own name and reputation on the line with each pre-owned car that we sell.

As one example of premium treatment we will provide in this business, we will introduce O2O technology for second hand cars. Online virtual showrooms will be linked to our physical dealership, so that customers can view the profile of our pre-owned vehicles as easily as they can view online profiles and shop our virtual showroom for new cars.

We expect the O2O business will have a first-mover advantage, since O2O channels are relatively new to China and buyers still need to test-drive vehicles from a physical dealership. Web-based auto forums exist that serve as matchmakers for buyers and sellers, but they are essentially online versions of the existing informal markets for second-hand cars.

Our pre-owned car retail strategy will unfold quickly. We plan to convert an existing new car showroom in South Beijing, inside the Beijing Economic and Technological Development Area. This will serve as a flagship store for mid-to-high end cars from Lentuo and a number of high-quality, third-party dealers. We have signed an agreement to finance this new showroom with China Orient Tiantong Capital Management Ltd., a subsidiary of state-owned financial manager China Orient Asset Management. The expectation is that China Orient will provide the financial depth for this new aspect of our business, as well as support its expansion across China, giving priority to the 26 cities where China Orient maintains branch offices. It will make it possible as well to offer adequate financing to pre-owned car buyers, by leveraging China Orient's institutional reach and financial depth.

In April, we launched our new Lentuo Pre-Owned Car Quality Certification Program. Under the program, all of our mid- to high-end pre-owned cars will receive a complete technical inspection and analysis to ensure that there is no frame or internal damage, are in working order, and meet or exceed standards for a given make or model. Cars will have to pass this inspection before they are offered for sale.

At the same time, we have signed an agreement with one of China's largest online auto information providers to create a fully integrated O2O platform for our pre-owned car business, which will serve as a sales platform for our "Lentuo Certified Quality" pre-owned cars. We announced this new marketing arrangement in March 2014, under which Lentuo will also serve as the exclusive after-sales service provider for the online platform.

With all these new elements in the mix, we are very confident about the future – from the expansion of domestic demand for autos to new urban markets in the interior, to the emergence of a brand-new paradigm – the Lentuo paradigm – in the pre-owned car industry. With our financial partnerships with China Orient and Itochu, we are in a strong position to carry out the two wings of our strategy – national expansion of our existing premium car auto retail business, as well as creating a new business in pre-owned car sales. It's a very exciting time to be a manager or employee at Lentuo, and we hope that it will be equally rewarding for you as our shareholders. We thank you for your loyalty, and welcome you to join us on the road to come.

Hetong Guo

Founder and Chairman, Lentuo International

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