Introduction The The purp purpos ose e of this this repo report rt is to pres presen entt the the anal analysi ysis s and and su suit itab able le recommendations towards the decision of whether Project Chariot should be impl implem emen ente ted d at Marri Marriot ottt Corp Corpor orat atio ion n (MC) (MC) or not. not. This This proj projec ectt invo involv lves es splitting up the company into two separate entities, Marriott International Incorporated (MII) and Host Marriott Corporation (HMC) in order to minimize debt and improve the financial health of the company after severe effects from real estate market crash and slowdown in the business. The description of Marriott Corporation, key issues faced by the corporation, details about the propos proposed ed Projec Projectt Chario Chariott and the altern alternati atives ves and conseq consequen uences ces of implementing Project Chariot is reported in the following sections. Finally, with
the
sup su pport
of
financ ancial
data ata
supplied
in
the
case,
suitabl able
recommendations are mentioned in the last sections of the report.
Description of firm and situation J. W. Marriott Sr. founded the Marriott Corporation (MC) in 1927 and shaped the company’s path towards huge growth and success. Marriott’s main strategy in those days was to develop hotel properties around the world and sell these properties to outside investors while retaining long-term management contracts. MC was a conservative company and it stressed the themes of careful attention to details, the organization and its employees. Quality was one of the highest priorities set by the founder himself. In 1953 MC went public, selling one-third of its shares in its Initial Public Offering. Although they continued to sell public stock, the Marriott family always kept 25% ownership over the business. J. W. Marriott Sr. resigned in 1964, and his son J. W. Marriott Jr. took over from then and immediately took a diversion from his father’s conservative financial policies. In the 1970s MC began to use bank credit and unsecured debt instead of mortgages to the finance development which was considered beneficial at that time due to substantial higher higher cash cash flows flows than than the intere interest st charge charges. s. Later, Later, MC experi experienc enced ed two financial crises, which were due to limited partnerships in 1989, where MC
experienced a sharp drop in income and the 1990 real estate market crash. This resulted in MC’s stock prices to fall more than two-thirds, which means a drop of $2 billion in market capitalization. This was the first time that investor-owned Marriott hotels went bankrupt.
Key issues that the decision maker must address In order to improve and bring back the financial stability and also improve the financial condition of MC, the then CFO proposed restructuring the company under a project named Project Chariot. This case deals with the analysis of the financial condition of MC and setting up relevant background information, financial data and other considerations required to analyze the pros and cons of implementing Project Chariot at MC. Due to the economic downturn in the early '90s and the Tax Reform Act of 1986, MC had limited ability to raise funds. This resulted in large interest payments on property, which basically left Marriott Corporation with lots of debt. This left the organization with nothing but a fast restructuring of its debt policy and with it a restructuring of the company itself. Stephen Bollenbach, the new chief financial officer, planned on doing this change by inventing Project Chariot. Under Project Chariot, MC would become two separate companies. One is called Marriott International, Inc (MII), which would comprise MC's lodging, food, and facilities management businesses. The other one was to be named Host Marriott Corporation (HMC), which would retain MC's real estate holdings and its concessions on toll roads and at the airports.
Discuss
any
important
constraints
or
opportunities
that
the
company faces Under Project Chariot, MII and HMC would have different and independent management teams. For MII, this means that the new spin off would include little long term debt and therefore more it would be more profitable, whereas for HMC this separation would mean that they would retain the real estate holdings, including retaining the most of the long term
debt from MC. To every upside there is a downside and in this case the bondholders would not be satisfied with this move. This split would lead that bond rating agencies would lower MC's long-term bonds to a level below investment grade, whereas the stockholders will very likely benefit from this new project. By saying this, leveraged buyouts (LBOs) had provided stockholders, in the past, with large profits from tender offers at premium prices, while creating losses for bondholders in the reduced market value of their newly speculative investments. So called "event-risk" covenants would have blocked Project Chariot or at least required any measures to protect bondholders from its potentially adverse effects, which they often did so, but at the cost of lower interest.
Discuss the alternatives available to management The management could either choose to go with Project Chariot and split the company into two separate entities or they could stay within the same structure and try to improve the financial condition of the company. In order to choose the best solution to this problem the financial statements and data of the company is studied.
Based upon MC's historical financial information for 1991, the value of the company is estimated at $3,658,000. The same calculations can be done for the two companies formed from the Project Chariot spin-off: HMC and MII based upon a projected pro forma basis, equity and debt figures for the two new entities. HMC's value is estimated at $2,600,000,000 and MII's value is estimated to be $1,200,000,000.
The key element in the restructuring plan was that HMC was to keep the debt associated with its assets, rounding to about $2.9 billion. Marriott International would then only have modest debt after restructuring. To help alleviate HMC's position, MII was to provide a $630 million line of credit to HMC, though the expiration date of the line was sooner than the maturities of many of the bond issues outstanding. It is important to know that by transferring debt the company will improve their efficiency. Since the end of the 1980's,
MC's debt continuously had increased. Project Chariot could make some opportunities for HMC and MII. For HMC, it would be under less pressure of selling off the hotels at lower price from other investors. On the other hand, the MII does not take a lot of debts, and it would have the ability to raise additional capital and finance growth.
Looking at the numbers in Exhibit 5 Cash Flow from operating activities just experienced a drop in 1990. In 1991 they were back up to $552 (millions of dollars). Furthermore by issuing the convertible preferred stock of $195 in 1991 the number of cash and equivalents, end of year went down, but would have been up at $229.
As mentioned before the stockholders would gain from the change, since no cash would actually be transferred. It will also diversify the portfolio. Looking at the secured investment in the case Host Marriott Corporation will default on its debt.
The returns of the bondholders are now attached to a heavily indebted firm with massive leverage in comparison with its parent company. The lower security rating to show for it (from a BBB - Adequate capacity to pay for Marriott Corporation, to a single B - Greater vulnerability to default, but currently has capacity to pay for Host Marriott Corporation. Bondholders were never informed of such corporate restructuring plans before they bought bonds from Marriott when it is arguable that the corporation must have already been planning months before for such a major move. The central issue now is that bondholders' wealth was expropriated in favor of stockholders and it is natural that the both parties act in the way they did.
Recommendation and Conclusion According to the above calculation it becomes obvious that by adopting "Project Chariot" have its advantages and disadvantages. The value of the company is much higher with the restructuring. Beginning debts might be high in comparison with the profits, something that usually happens when
adopting a new system. However, in the long run the situation turns around and the company can start to gain benefits. With making two companies out of one, the debt issue is also divided. While MI can start with basically no (or lower) debt, HMC will take over the old debt from MC, which makes at least one of the two more profitable. Furthermore, the cash flows mentioned will propel HMC so far that it will be more than adequate to cover the debt in the future. Looking at the Stockholders, who will gain from this new project, through diversification of the portfolio, the only negative thing that would leave us, would be the bondholders. The greatest risk associated with Project Chariot appears to be the fact that HMC would assume almost the entire existing debt burden associated with the existing organization, while MII, with the greatest cash flow potential would emerge essentially debt free. While this strategy may bode well for MII, HMC emerges from Project Chariot as a debt encumbered entity with an anticipated net loss of $66 million annually. The primary sources of the existing long-term debt of the Marriot Corporation have been issued in the form of secured and unsecured bond notes. Project Chariot does little to address the impact of the organizational restructuring on bondholders. While management seems confident that the emerging HMC firm will sustain enough financial strength to make all payments to bondholders, the negative net revenues are likely to result in a reassessment by the bond rating agencies. It appears likely that the ratings for existing bonds will be lowered to below investment grade due to the increased investment risk which will require some institutional creditors to sell their holdings. In conclusion Project Chariot should be implemented at Marriott Corporation after careful consideration of Bond Risk. The management can consider distributing the debt in MII and HMC a little more fairly so as the overall debt burden do not affect the bond rating subsequently. MC has been for years a very successful business and impressed not only its shareholders, but also the public interest with positive business doing. Changes are definitely needed in the company due to its high debt due to systematic
risks, as economic breakdown in the real estate market as well as several different Tax Acts that threw MC back for a bit, but not as much so that they will have to stop continuing business. Diversifying its product line, if one can say so, meaning by implementing MI and HMC, will make the MC just more competitive in their field and it will help them get up the economic ladder faster. Quantitative Data
1. The following table provides a break-down of some critical information comparing the value of the existing firm MC and the two firms proposed, HMC and MII, proposed by Project Chariot: MC Number of Employees 202,000 Equity
HMC
MII
23,000
182,000
$679,000,000
$600,000,000
$800,000,000 Debt
$2,979,000,000
Value
$2,000,000,000
$3,658,000,000 $1,200,000,000
$400,000,000
$2,600,000,000
