University of Lausanne
Corporate Finance
April 2015
Jocelyn Chappuis
Yehouda Trabelsi
Jonathan Lutz
Corporate Finance
Case study 3
Marriott Corporation
Jonathan Lutz N°11421047
Yehouda Trabelsi N°11423514
Jocelyn Chappuis N°10423432
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University of Lausanne
EMF - Finance Master
April 2015
Jocelyn Chappuis
Yehouda Trabelsi
Jonathan Lutz
Question 1: Project Chariot
J.W Marriot founded Marriot Corporation in 1927. This company experienced an intensive growth
during the 1930s and the 1940s. It was culminating during its IPO in 1953, where one-third of the
company’s shares were sold to the public. At the beginning, Marriot’s main business was to acquire
restaurants and cafeterias and manage them, as well as supplying food to the airline industry. In the
years following the IPO, the company was able to further expand its business by opening its first hotel
in 1956 and growing internationally in the hospitality industry. The company had a virtue of a
conservative strategy in terms of financial policy and an attentive care of the services’ quality and
details.
In 1964, J.W. Marriott Sr. resigned and his position was taken by his son, whose financial approach
diverged greatly from his father’s. In fact, the company began heavy borrowing from banks and other
financial institutions of both senior and unsecured debt; this allowed MC to engage in a business where
they were developing hotel properties around the world and selling them to outside investors, retaining
at the same time long-term management contracts and outperforming its competitors in terms of
occupancy rates.
At the beginning of the 1990s, this boom ended. First because of the diminishing of new limited
partnership opportunities, then with the collapse of the real estate market. This resulted in an important
drop in the company’s income and in the stock price falling more than two-thirds from its pre-crisis
value. The company’s financial condition impoverished, in order to reduce the debt burden. This forced
the management to start selling properties at fire-sale prices.
The CFO of Marriott proposed a solution to this situation: Project Chariot. The Project Chariot’s core
was to split MC in two separate companies:
Firstly Marriott International, Inc. (MII): this retains MC’s businesses of lodging, food and facility
management. Secondly, Host Marriott Corporation (HMC): this comprised MC’s real estate and toll
roads concessions.
The aim of the project was to separate the different businesses in order to alleviate the long-term debt
pressure brought by the real estate businesses on the other segments. In fact, HMC would retain most of
the long-term debt of MC; roughly $3bn and MII would exploit a revolving line of credit of $600mn,
with access guaranteed to HMC through 1997, even though it would remain a under-leveraged company.
Transferring long-term debt from MC would help the company to improve its efficiency and its ability
to raise new capital, allowing the company to save the more profitable line segment (MII) in case HMC
went bankrupt and to seek expansion opportunities.
Question 2: Impact of Project Chariot on the wealth position of shareholders
When considering the possible impact of Project Chariot on the wealth position of the shareholders,
there are several issues that should be addressed. First of all, given the troubled situation of the
company, it is likely that the announcement of the spinoff, with the publication of the pro-forma of the
MII and HMC, will have a positive impact on the MC’s stock price, which will immediately return a
gain to its shareholders.
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University of Lausanne
EMF - Finance Master
April 2015
Jocelyn Chappuis
Yehouda Trabelsi
Jonathan Lutz
Given the data in pro-forma, but lacking other information, we tried to calculate the Enterprise Value for
both MII and HMC after they start trading and compared it to the one of the entire company before the
spin-off. We used the well-known definition of Enterprise value as a sum of the company’s debt market
value and the equity market value, and the number of outstanding shares for 1992 provided in the
Spreadsheet. To make the calculations, we assumed a range of possible stock prices for the both MII and
HMC once they started to trade publicly. Concerning HMC, given the really poor fundamentals, a range
between $2-$5 seems reasonable. Regarding MII instead, we believe a reasonable lower bound would be
the MC’s price in 1992 ($16) and an upper bound can be derived by making use of the EPS of MII (1.4)
to be compared to the same EPS value when the company was still profitable (EPS = 1.4, Share Price =
$30, 1987 data); however, taking into account that the market needs some time to regain confidence in
the company, because at the moment the restructured company starts trading it may be below $30, we
assumed a maximum bound of $25.
Given the stock dividend, the number of shares in both MII and HMC will be the same. Given also that
after the spin-off HMC debt will most likely be downgraded, to find the market value of debt we simply
computed what percentage of MC’s debt is assigned to each company and multiplied by MC market
value of debt in case it is downgraded to B rating. For MII we assumed the rating stays at BBB. The
results are presented below
As shown, the Enterprise Value of MII plus HMC is higher than MC alone, benefiting shareholders.
Another issue to be addressed is the benefit in terms of diversification that would result for the
company’s shareholders: given that any existing shareholder would receive a stock dividend matching
the stock they hold in MC, no cash is involved in the spin-off, bringing a gain for investors in terms of
risk diversification. In fact, even if HMC would result in a highly leveraged company, and it debt
expected to be downgraded from BBB to B (high probability of default), shareholders would still have
positive cash inflows from MII operations, since the latter company could sustain high growth thanks to
low level of long-term debt and good ability to raise capital. Therefore even if HMC would go bankrupt,
investors would still keep the benefits from ownership of MII.
Finally, it is worth noticing that the Marriott family still owns 25% of the shares of the company; a
solution to the company’s difficult situation that would avoid the issue of new shares, and thus the
dilution of the ownership (the proposed spinoff), would be beneficial to their wish to maintain this stake.
Question 3: Management should be concerned by the loss of the market value of the
bonds if the project is implemented?
As we have mentioned in Question 1, the main aim of the proposed spin-off is to move most of the
troubled assets (hotels, toll roads and airport concessions) to Host Marriot, and with those, also the debt
associated.
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University of Lausanne
EMF - Finance Master
April 2015
Jocelyn Chappuis
Yehouda Trabelsi
Jonathan Lutz
In fact, HMC will hold approximately all the debt of $3bn (specifically $2.6bn), with a debt as
percentage of capital of 76%, while MII will be left with only 33%. As a result, the market value of debt
will decrease since the worthier collateral would be moved to MII; despite the management’s confidence
in the ability of HMC to be solvent, considering also the line of credit provided through MII, it is likely
that HMC debt will be downgraded, according to the Appendix A1 provided by the case with respect to
bonds rating. Given the available information, it is likely that the rating agencies will downgrade MC’s
debt to a rating below investment grade. In order to compute the loss to bondholders that this would
imply, we calculated the market value of debt corresponding to different rating (and consequently
yields), using a weighted average of maturities of the debt outstanding, the interest payment as coupon
and the total book value of debt as face value. The results are shown in the table below:
This development may also have an impact to the institutional representation among debt holders. In
fact, as mentioned in the case, banks, insurance companies and pension funds are obliged by law to limit
the amount of noninvestment grade securities to own in their portfolios. A sale caused by these
restrictions and probably accentuated by the downgrading will most likely decrease the value of debt
even further, causing bondholders to lose higher amounts, and increasing the cost of debt capital.
On the other hand, however, it is worth mentioning that when the company issued the bonds, no
restrictions were posed regarding possible spin-offs. Thus the yields bondholders received might already
include the risk of this type of restructuring, implying that they have been compensated in some form.
Question 4: Is Project Chariot a matter of survival for Marriott in the fall of 1992?
Assumptions
Annual growth of sales through existing units: To forecast annual growth of sales we refer to Exhibit 3
of the case, Sales section. We see that sales are divided into the lodging and the contract services
segment, where the lodging is again divided into 3 lines: rooms, food and beverages and other for the
years 1989, 1990, 1991. Thus we perform the growth sales for each of the segments and business line
and then, after computing the average of the two, we forecast future sales separately. We decide to
proceed in this way because the two segments have and will have different growth rates. In fact the
lodging segment is the prosperous one, as they say in the case, while the contract service one is not
growing anymore (average growth of negative 0,24%) after the real estate crises. Finally we sum up all
the individual sales forecast to obtain total sales (All computations are shown in sheet 2 of excel
spreadsheet).
Net income in 1992: September 1992 data from case, we have the estimated earnings per share (EPS)
and P/E ratios. Assuming Marriott Corporation in October 1992 does not announce Project Chariot,
there will not be a big change in the stock price by the end of the fiscal year (December 1992), which
implies that we can use the September stock price P=$16. Therefore we can apply the following
equality:
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University of Lausanne
EMF - Finance Master
April 2015
Jocelyn Chappuis
Yehouda Trabelsi
Jonathan Lutz
Once we have net income proceeding backward we find EBIT. Finally since we already forecasted
future sales, we can find the ratio EBIT as % of sales, which we find to be equal to 4%.
EBIT as % of sales: To forecast EBIT as % of sales for the years subsequent to 1992, we first look at the
ratio for the years 1990 and 1991 provided in the case in Exhibit 6, and for 1992 we computed as
specified above. Subsequently we look at the operating costs for the years 1989, 1990, 1991 and 1992
and we see that in 1991 and in 1992 they grow more than the forecasted sales (on average 8,2%). It can
be possible that costs grow at a slightly higher rate than sales since they are trying to expand the lodging
segment while maintaining at the same scale the contract service, by offering discounts in room business
for instance, as specified in the case. Therefore it follows that EBIT will grow at a lower rate than sales.
Given that a steady growth of costs at 8,2% is not reasonable and we assume that as time passes the
company will manage to lower operating costs and profitability (assuming it will be enough liquid for
meeting its obligations), we assume that from 1993 to 1995 EBIT as % of sales will stay fixed at 4%.
Dividends: The company will pay steady dividends as in the period 1989-1991 ($27 million every year)
in order to compensate shareholders for supporting the company (since Project Chariot which would
have probably been beneficial to investors was not implemented anymore). Assuming the company
manages to repay $650 million of debt as expected in September 1992 (see exhibit 2 of the case), the
interest bearing debt of the company in 1992 will be:
Therefore if these assumptions hold, in 1992 MC has to sell $240 million of assets held for sale (which
is approximately 16% of total assets held for sale) and then in the subsequent years, the minimum
amount of assets it has to sell in order to break even is 13 in 1993 and zero in 1994 and 1995. This
means that they will be able to generate extra cash without having to sell assets. In this way we see that
the company by repaying off its debt as expected in September 1992 and then reducing selling assets
still manages to reduce debt as % of capital from 82% to 74%. This means that debt to capital ratio can
be better reduced if the company sells more assets than the minimum required to break even at year-end.
The first main consideration to be made is that MC might have to sell assets at a discount price because
of the real estate crises and frozen market. This situation would probably push MC to be conservative in
selling its own properties. Second, the quantity of assets MC should sell depends also on the ability or
not of the company to maintain a debt rating of BBB. In 1991 its debt as % of capital ratio is 82%,
which should correspond to speculative bond according to Exhibit A-2 in the case. However we know
that MC debt is rated BBB by S&P and Baa3 by Moody’s in the same year. This means that, since we do
not really know how rating agencies assign bond rating as specified in the case as well, we can assume
that if in the following years rating agencies will still assign investment grade to such high ratios, MC
can sell the minimum quantity of assets to break-even, the ratio will slowly lower from 82% in 1991 to
76% in 1995 and the company will manage to survive, without incurring in any downgrading nor in any
spin-out.
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