We are working from the point of J.W. Marriott Jr. the chairman of the board and president of Marriott
Corporation (MC). MC is now known for developing hotel properties globally, selling them to outside investors
while retaining lucrative long-term management contracts. It started in 1927 as J. Willard Marriott’s root beer stand,
then it grew into one of the leading lodging and food service companies. It first stepped into the hotel business in
1956. As the founder, J. W. Marriott Sr. stepped down, his son, J.W. Marriott Jr. has chosen a more aggressive
expansion with major borrowing and developed the business strategies of the joint venture of hotel management.
Marriot has a company culture that focused on people, not only the customer but more importantly their employees
and to entrust them will take good care of the customers. They have earned a high reputation for quality and
reliability of service; this along with the careful site selection procedures and hotel sizing has given Marriott the
benefit of high occupancy rate, which is about 10% over the industry average by 1992. The Economic Recovery Tax
Act of 1981 provides further incentives for ownership of real estate, thus there is more opportunity for Marriott’s
real estate limited partnership model. Marriot has then introduced mid-price lodging “Courtyard” hotels, “compact
hotels” for smaller city markets, full-suite hotels, longer-term inns, and “Fairfield Inns” as budget hotels.
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 a 25% ownership over the business. Due to the aforementioned
economic downturn in the early '90s and the Tax Reform Act of 1986, MC had limited ability to raise funds. It has
sold or discontinued some business operation and froze capital spending. Since Marriot was borrowing a lot
previously to continue its high-paced development activities, Marriot is saddled with large interest payments on
properties it was unable to sell, which left MC with a huge amount of debt.
MC has tried to focus on contract and management opportunities that require less capital outlay such as
captive foodservice market, while actively trying to sell their properties. While financial results are expected to only
be marginally better than 1991, but still a significant improvement over 1990. However, the investors are mostly not
so optimistic, believing there would be still years of slow recovery ahead before it could begin to grow again. The
massive debt burden is still alerting, caused by the previous aggressive borrowing financial policy and low asset
overturn now. With little room for more borrowing, Marriot is going to face sever FCF issue in close future and at
the close edge for bankruptcy.
A new solution, Project Chariot was proposed by Stephen Bollenback. He is the ex-treasurer and current
CFO of the company. He is known for creating innovative financial restructuring. He is now proposing that MC’s
service business is split off from its property holdings and debt to become “pure play” companies. After the spin-off,
we would have a real estate and properties holdings company, HMC, and a lodging and service management
company, MII. This spin-off will allow the new company, MII to have the financial strength to raise capital and
pursue investments, while HMC would be valued based on the appreciation of property holdings when the RE
market recovered. The owner of each MC share receives a stock dividend of one share in the new company, MII.
There will two separate management and board of directors for the two companies, with Marriott Jr being the CEO,
president, chairman of MIL and Richard Marriott being chairman of HMC. MIl would have the right to purchase up
to 20% of HMC’s voting stock at market value in the event of a change in control of HMC. MIl would also have
right of first refusal if HMC offered its toll road and airport concessions for sale. HMC would retain MC’s long-term
debt of nearly $3 billion, has access to a revolver of $600 million from Mil through December 1997.
The decision is up to J.W. Marriott Jr. to think about whether to recommend the Project Chariot to the board of
directors. He can choose to either keep status-quo or to go along with the spin-off. To choose between the two
alternatives, he must first consider the pros and cons of such reformation, especially its impact on shareholders,
along with bondholders.
For stockholders, Project Chariot is favourable, as it creates two “pure play” companies, thus easy for
investors to evaluate and allows them to specialize. As the management has mentioned, it will allow the investors to
separate hotel management business from hotel real estate investment business, and potentially increase the stock
price as separate companies. In addition, it will relax the pressure to sell properties at depressed prices for HMC as it
will be valued on the basis of the chances of appreciation in its property holds rather than expected income. Second
of all, MII is unburdened by debt and gains the flexibility to pursue other investment opportunities and issue new
debt. It will relax the debt overhang given current bond rating is bottom investment rating already and improve MII
access to the capital market, which gives it the ability to pursue new positive NPV investment opportunities. The
shareholder is going to gain in shares of the new company, share value as the stock was undervalued as a diversified
company, expected appreciation of stock and stock options and two pure-play companies in their portfolio. For
management or employees, it will create management promotion opportunities with more position available in two
companies.
The shareholders are happy; the management is happy, but someone has to bear the cost. While the
management claims that they are confident that they are able to pay off the interest and principal based on their
previous interest coverage ratio, but it still affects the security of bondholders, and HMC may be in need of finding a
new market for debt issuances. The spin-off will result in one company having most of the asset while the other
bears most of the debt. Therefore, less income and asset will be available to meet payments. The bond is likely to be
lowered to below investment grade (under BBB). The prudent person rule has given a limit on the amount of noninvestment grade debt institutions can hold and it will urge the institutional investors to sell MC debt. More
importantly, MC’s debt lacks event risk covenants. This means that the impacts upon the market prices of a stock are
unforeseen for such corporate reorganization. Such event risks should be considered as extreme portfolio risks due
to substantial changes in market price. Based on Exhibit A-1, we can tell that the downgrade from BB to BB did not
increase the yield by a significant portion comparing to downgrading from A to BBB, thus not a lot of compensation
for the risk. The bond price is doomed to drop to reflect the compensation that the market demand for higher risk.
While the bondholder’s interest is hurt, there isn’t that much ground for legal complaints, since it was them that
choose the higher interest over the protective covenant when they bought in the bonds.
In the case, it is described that there are two conceptions of manager responsibilities. Managers have a
responsibility to shareholders, which is to promote shareholder interests. They have a responsibility to institutions,
which has a good faith effort to maximize the corporation’s long-term wealth creating capacity. If the first
responsibility is focused, then the managers would refer to restricting since it will create value for them, but at the
expense of expropriation of wealth from bondholder. If managers favour the corporation and to maximize firm
value, then they should have concessions to bondholders. Since the downgrading with the spin-off will harm MC’s
reputation and public trust. At the end of the day, MC still wants continued access to capital. This beneficial in the
long run to shareholders too as ultimately all stakeholders benefit from the increase in firm value. Even though the
case states there are no legal concerns about the spin-off, it is still worth mentioning the Delaware Court ruling,
which indicating courts paying more attention to company ethics when dealing with bondholders.
Still, I would recommend Marriot to go along with the plan because it is overall good for the business
growth in the long run and it increases the stock price. But they do need to soothe the bondholders to avoid legal
fights and bad publications. They should offer concessions such as to increase their interest rate or offer some stock
options. That being said, the situation would likely to change if Marriot has included an event risk covenant in their
debt contracts. Calculating from the given spin-off companies data, we get the asset and debt amount. To
incorporate risk, we assume two equally likely outcomes and we also assume that assets (securities) are valued at
their expected values. This gives the initial values of debt and equity of $2.7B and $4.5B, respectively. Then,
following Project Chariot, MC will split into MII, which gets $2.6B of assets, and a $0.4B debt obligation and HMC
that gets $4.6B of assets, and a $2.6B debt obligation. Based on the example, we can then see that MC’s debt value
changes by $ 0.4B+2B-2.7B = -$0.3B while MC’s equity value changes by $2.2B+2.6B – 4.5B = $0.3B. It is all
shown in Exhibit 1.
Suppose there is an “event risk” covenant giving bondholders the right to demand full repayment in the
event of a restructuring. While the restructuring has positive NPV, which satisfies the shareholder, the covenant will
come into play. The shareholders will need a plan that leaves bondholders (at least) indifferent. The company has to
maintain debt value at the current $2.7B. The shareholders have to transfer 0.3B to the bondholders. This covenant
will result in less expropriation of wealth from bondholders and less favour of restructuring from management.
Suppose that in addition to the effects above, the restructuring is expected to create additional value in the MII
division -- specifically, MII’s asset values are expected to increase by 20% (with each outcome). The value of MII
increases by $0.5B. This leads to Exhibit 2. We are to Increase face value of speculative HMC debt by $0.6B which
is the same as increasing interest rate so an extra $0.6B is due. In Exhibit 3, we make another assumption, to
increase the debt of MII by 0.5, which would again maintain the debt as $2.7B. The covenant implies the
bondholders can block the restructuring so the company has to renegotiate debt terms to address the $300M transfer.
Shareholders make $0.5B, while bondholders remain “whole”.
The covenant is going to transfer part of what would be given to shareholders to bondholders to secure the
bond. It is recommended when there is no synergy from restructuring, such a covenant to be included. There is little
incentive for the spin-off as it does not create value, such a covenant to be put in place can result in a lower interest
rate that benefits the company. When there is synergy, it is favoured not to have such a covenant that would block
restructuring but covenant that only require measures to protect the bondholder’s interest. As long as the bond is
secured, the bondholders would be happy. In this case, for the restructuring plan, the covenant is expected to
increase the expected value of equity and assets. Bondholders would not gain while equity holders benefit
completely. Management would greatly favour the restructuring with high gain. MII may lend money to HMC later.
In reality, even though the company may not be bounded by the covenant to protect bondholder’s interest, they still
have to compensate them in order to maintain reputation. They might have to alter the interest rate, restore finance
(retire some debt or convert them to equity), or sell off some assets to retire debt.
Exhibit A-1
Exhibit 1
Exhibit 2
Exhibit 3