MARRIOTT INTERNATIONAL, INC. is a leading worldwide hospitality company, with operating units in the United States and 53 other countries and territories. Major businesses include hotels operated and franchised under the Marriott and other International brands, restaurants, and food service distribution. The company headquarters are in Washington, D. C.
The vice president of project finance at Marriott Corporation, prepares recommendations annually for the hurdle rates at each of the firm’s three divisions. In this reflective case, the company’s policies and strategies related with hurdle rates and cost of capital are discussed. In the above context, the company’s policy of repurchasing its shares is also reviewed ; particularly, it focuses on the financial effects there may be if there is a 30% repurchase of the common stock.
For practical purposes, this paper is organized in four sections : first, a review of the financial performance of the company as a background for the general discussion ; the second section refers to the common stock of the company including the evolution of Marriott’s shares in the market and repurchasing policy ; a third section focuses on the company’s policies for project evaluation ; and finally cost of capital and capital structure is boarded in the fourth section. All the four sections refer to the ten-year period from 1978 to 1987 in accordance with the information provided by the text case, and it is assumed that if there were a 30% repurchase of Marriott’s common stock it would be done in 1988.
This section reviews Marriott’s financial performance based upon ratio analysis. In regards to the assets turnover, Marriott’s ratio has grown from 1.17 in 1979 to 1.40 in 1982 (see exhibit 1), while from 1983 this ratio diminished to 1.29 and it was more stable. It is my assumption that assets turnover ratio diminished due to new hotels, restaurants and other fixed assets acquisitions made by the company as part of its growing strategy.
As exhibit 1 also shows, debt ratio has constantly grown from 0.58 in 1978 to 0.85 in 1987, and debt-equity ratio has grown from 1.39 to 5.62 in the same period. It is my assumption that this debt growth is a result of the company’s shares-repurchasing policy, because they had to raise funds by long-term debt in order to pay such shares, as it is discussed later in this paper.
Even when debt and debt-equity ratios had grown, the company has been able to keep its interest coverage capability going from a 4.52 ratio in 1978 to 5.41 in 1987. Also showed in exhibit 1, net profit margin has been stable ranging 0.04 - 0.05 for the nine-year period before 1987, diminishing to 0.34 in 1987. It is my assumption that 1987 was not as successful a year as the others due the impact that external events may have had in the company such as the stock-market crash.
Marriott’s common stock price grew constantly in the ten-year period 1978-1987, from $2.43 per share at the end of 1978 to $30 at the end of 1987 (see exhibit 2) at an average rate of 35% per year. Using the Myron Gordon’s Growth Model for the ten-year period 1978-1987, Marriott’s expected return of common stock ranges 22% - 23% annual, while the cost of common stock for the company ranges 12% - 18% (see exhibit 3 for calculations).
Marriott has the policy of repurchasing shares of its common stock when they believe that they are undervalued in the market. In 1987, Marriott repurchased 13.6 million shares for $429 million, which represents a price of $31.54 per-share. If they were to repurchase 30% of its common stock, it is assumed that they would have to pay more than the $31.54 per-share they paid last time because market price would continue growing as it had constantly grown before. The 30% of its common stock represents 35.64 million shares (118.8 million at the end of 1987 times 0.30) and that equals $1,124 million (at $31.54 per-share price). That is a considerable amount of money, representing more than 138% of the $810.8 million shareholders’ equity at the end of 1987, and 20% of its $5,370.5 million assets at the same date. The company would need to raise more debt, because there is not enough money to cover this repurchase solely with its own resources (as it has happened before, as explained earlier in this paper when discussing debt ratios growth). Assuming that all funds needed for this repurchase were raised by debt, Marriott’s debt ratio would raise to 85% ($2,498.8 long-term debt by the end of 1987 plus $1,124, divided by $4,247.8 total capital at the same date). Usually, a company that has a debt rate higher than its optimal, has to pay a higher interest rate due to its elevated risk. Assuming that Marriott is in its optimal debt-rate range in 1987, the repurchase of 30% of its common stock would cause an increase in the company’s cost of debt. Consequently, the cost of capital would reach undesirably high levels, and in the long-term that would cause severe financial problems due to the company’s lack of interest covering ability, and eventually, the company’s bankruptcy.
For hurdle rates calculation purposes, Marriott has determined a beta of 1.11 for the hole company. According to calculations shown in exhibit 4, pondering each division in accordance to its respective sales, each divisions betas result in 1.1935 for lodging, 1.05 for contract services and 1.0389 for restaurants. Marriot should take in account those betas when evaluating projects, in addition to considering the global beta.
5. Cost of Capital and Capital Structure
Exhibit 5 shows company’s long-term debt versus total capital. It is observed that the company’s capital structure is composed by a 60% long-term debt, 40% stock in 1987. When comparing this to previous years, long-term debt has increased from 38% of total capital to 59% in the 1978-1987 period. As discussed earlier in this paper when talking about stock repurchases, if there were a repurchase of 30% of Marriott’s common stock, company’s debt ratio would raise to 85%. As shown in exhibit 6, Marriott’s weighted average cost of capital (WACC) would change from 6.51% to 7.66% if repurchase were done.
It is fare to say that Marriott’s common-stock repurchasing policy has been successful so far, given the continuous growth of its share’s market price, continuous profit generated by operation before and after interests and income tax, and interest coverage ratios obtained for the ten-year period 1978-1987. But that doesn’t mean that the policy can be sustainable with success at any level. Repurchasing 30% of its common stock all at one time is very likely to cause financial problems to the company due to interest expense and risk increases, and it could result in bankruptcy in the long-term.
Marriott should keep its optimal cost of capital related structure in order to maintain its profitability and attractiveness for investors. Marriott also should take into account each division’s betas as well as global beta when evaluating projects.