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Marriott Corporation (A) 9-394-085 R E V : A P R I L 2 8 , 2 0 0 6 ________________________________________________________________________________________________________________ Professor Lynn Sharp Paine and Research Associate Charles A. Nichols III prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 1993 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. Marriott Corporation (A) Over the next few years we will place special emphasis on enhancing our strong customer preference, increasing operating cash flow and reducing debt. — Chairman’s letter to shareholders, Marriott Corporation 1990 Annual Report, p. 3 Priorities for the next few years: Reduce our long-term debt to about $2 billion by the end of 1994, by maximizing cash flow and selling assets. — Chairman’s letter to shareholders, Marriott Corporation 1991 Annual Report, p. 5 [Third in a list of four priorities.] J.W. Marriott, Jr., chairman of the board and president of Marriott Corporation (MC), had weathered difficult times in the last few years. The company his father had founded in 1927 had grown explosively during the 1980s, developing hotel properties around the world and selling them to outside investors while retaining lucrative long-term management contracts. However, the economic slowdown in the late 1980s and the 1990 real estate market crash left MC owning many newly developed properties for which there were no buyers, together with a massive burden of debt. As Marriott had promised in successive annual reports over the last few years, the company was working to sell properties and reduce that burden, but progress was slow. Looking ahead to the end of 1992, three months away, financial results promised to be only slightly better than for 1991, although still a significant improvement over the low point reached in 1990. For the foreseeable future, MC’s ability to raise funds in the capital markets would be severely limited. But Marriott now faced a decision that had the potential to change this situation completely. He was considering a radical restructuring of the company proposed by Stephen Bollenbach, the new chief financial officer, under which the bulk of MC’s service businesses would be split off from its property holdings—and debt. A new company would be created for the service businesses, with existing shareowners of MC receiving a share of stock in the new company to match each share they owned in the old one. The new company would have the financial strength to raise capital to take advantage of investment opportunities. The old one, valued for the chance of appreciation in its property holdings when the real estate market recovered, and not on the basis of earnings, would be under less pressure to sell properties at depressed prices. Bollenbach had served as treasurer of MC in the early 1980s at the beginning of its period of rapid growth. After leaving in the middle of the decade, he had built a reputation for creating innovative financial structures in the hotel industry with the 1987 recapitalization of Holiday Corporation (later named Promus Companies, Inc.), and then with his rescue of Donald Trump’s heavily indebted real For the exclusive use of J. Bates, 2020. This document is authorized for use only by Jennifer Bates in FNCE 6310 Financial Decisions and Policies Spring 2020 taught by John Byrd, University of Colorado - Denver from Jan 2020 to Jul 2020. 394-085 Marriott Corporation (A) 2 estate holdings. Bollenbach returned to MC as CFO in February 1992. His proposed restructuring, called “Project Chariot,” reflected the imaginative and innovative thinking characteristic of the financial advisors who had contributed so much to MC’s growth in the 1980s. Project Chariot seemed like the perfect solution to the company’s problems. Was it the right step to take now? MC’s board of directors would be meeting soon, and Marriott needed to decide what to recommend. Company and Industry Background1 Founding and early years With 202,000 employees at the end of 1991, MC was ranked as the 12th largest employer in the United States.2 The company traced its beginnings to 1927, when J.W. Marriott, Sr., opened a small root beer stand in Washington, D.C. The business soon began to sell food and was renamed the Hot Shoppe restaurant. Working with his wife Alice, Marriott, Sr., saw the business grow throughout the 1930s and 1940s to a family-owned chain of 45 restaurants in nine states. The Marriotts also acquired contracts to run cafeterias and company kitchens, as well as to supply food to the airline industry. Growth and success were based upon a policy of careful attention to details and centralized and standardized operating procedures. Initial public offering MC went public in 1953, selling one-third of its shares. Although the company continued to sell stock to the public over the years, in 1992 the Marriott family still owned 25% of the company. In the first five years after the initial stock offering, it had doubled in size. In 1956 it opened its first hotel, in Washington, and in the next eight years had grown to 120 Hot Shoppes and 12 hotels. J.W. Marriott, Sr., resigned the position of president in 1964, passing it to his son J.W. Marriott, Jr., then only 32. Under the son’s leadership MC abandoned the father’s conservative financial policies. It turned to major borrowing to finance expansion that would maintain its historical 20% annual revenue growth rate. In the 1970s MC began to use bank credit and unsecured debt instead of mortgages to finance development. According to new financial thinking developing in the company, borrowing was acceptable so long as cash flow was maintained at a sufficient multiple of interest charges. The company acquired restaurant chains and entered new businesses, such as theme park development and operation. Joint ventures In 1978 MC embarked upon its first joint venture, constructing a group of hotels and then selling them to the Equitable Life Assurance Society, a major insurance company. Thus began a powerful growth strategy in which the company would plan and develop hotels, sell the properties to investors, and retain long-term management contracts. By 1980, following a five- year period of 30% annual growth, 70% of MC’s hotel rooms were owned by outside investors. MC possessed an enviable reputation for quality and reliability in service, and together with careful site selection procedures and hotel sizing, this reputation translated into occupancy rates 4%-6% above industry averages. This gap had widened to more than 10% by 1992; when the industry average was only around 65%, MC’s rate was 76%–80%.3 The Economic Recovery Tax Act of 1981 created new incentives for the ownership of real estate, which further fueled MC’s hotel-developing activities. Its first real estate limited partnership, offered 1Much of the material in this section is based upon Keith F. Girard’s, “What the Hell Happened to Marriott?,” Regardies, April- May 1991, pp. 71–91. 2Dun’s Business Rankings, 1993. 3Joseph J. Doyle, CFA, Marriott Corporation, Smith Barney Research Report (released December 18, 1992). For the exclusive use of J. Bates, 2020. This document is authorized for use only by Jennifer Bates in FNCE 6310 Financial Decisions and Policies Spring 2020 taught by John Byrd, University of Colorado - Denver from Jan 2020 to Jul 2020. Marriott Corporation (A) 394-085 3 in that year, gave investors $9 in tax writeoffs for every $1 invested. Beginning in 1983, MC also branched out into the mid-price lodging market with “Courtyard” hotels, which were bundled into groups of 50 or more for limited partnership offerings. In 1985, scaled-down but full-service “compact hotels” for smaller city markets, as well as all-suite hotels and longer-term residence inns were introduced; MC entered the budget hotel market with “Fairfield Inns” in 1987. MC also continued to acquire restaurant chains, including Gino’s in 1982 and Howard Johnson’s in 1985, although its success in establishing a national business in this area was limited. In 1984 the company discontinued its theme park operations. End of the boom In 1986, the Tax Reform Act ended most of the tax incentives for real estate investment, but MC, relying on the strong economy and its own reputation, continued its high-paced development activities. However, the market for its limited partnerships was drying up, and in 1989 the company experienced a sharp drop in income. It froze capital expenditures, which had increased threefold over the previous six years, sold off its airline in-flight catering business, and discontinued its restaurant operations. In 1990 the real estate market collapsed. MC’s income plummeted and its year-end stock price fell by more than two-thirds—a drop of over $2 billion in market capitalization. For the first time, investor-owned Marriott hotels went bankrupt. MC was saddled with large interest payments on properties it was unable to sell. Industry excess capacity led to low occupancy rates and deep discounting on room rates, resulting in large losses for many of MC’s competitors and even bankruptcies in some cases. In 1991 MC intensified its focus on contract and management opportunities that required less capital outlay. These included captive food service markets such as hospitals, office buildings, and turnpike service plazas, as well as management of golf courses. The development and management of “life-care” community facilities for senior citizens was also a high-growth market that MC