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Timeshare Business Unwelcome Guest at Marriott International

Given the global economic landscape, Marriott International can no longer rationalize its timeshare business. Going forward, the company expects to continue to license and manage luxury residential projects developed by others, but chief financial officer Carl Berquist told analysts on the third-quarter earnings call the hotelier does not anticipate putting its own capital into the development of new luxury timeshare projects. In my opinion, these decisive strategy adjustments had more to do with mobilizing cash to lower debt default risk and less to do with market conditions of timeshare real estate.
The timeshare segment accounted for just 13 percent of total sales in the last quarter, but its operating losses of $681 million wiped out the $160 million in pre-tax gains from lodging, the business segment which includes a collection of well-known brands primarily serving business and leisure upper-scale travelers (such as Marriott, Ritz-Carlton, and Renaissance Hotels) and properties catering to the more budget-conscious travelers (such as the Fairfield Inn & Suites). In fact, amid slumping sales demand and fewer opportunities to sell packaged timeshare receivables, the timeshare business has been a drain on cash flow for three years running: net operating cash flows for the segment totaled -$398 million in 2008, -$155 million in 2007, and -$104 million in 2006, according to the 2008 annual report.

Marriott learned the hard way that moving from a cash-based business like lodging to a financing-based business like timeshares wasn't without risk -- especially when consumers go bust and credit markets dry up. As my colleague Barbara Hernandez astutely pointed out in a BNET Travel post two weeks back: "there's something to be said for just selling rooms one day at a time."

Marriott's credit profile sits on the cusp between investment and junk bond status, with a 'BBB-' debt rating assigned to its long-term debt by Fitch Ratings in February 2009. The credit rating agency said the rating reflected the company's ability to navigate the sluggish environment for lodging operators. In the near-term, Marriott is able to fund unprofitable operations through a combination of borrowing capacity of approximately $1.7 billion (consisting of access to about $1.57 billion available on its $2.4 billion revolver and its unrestricted cash balance of $130 million) at September 11, free cash flow profile (less timeshare segment), and no significant debt maturities until May 2012.

Fitch's rating and analysis of Marriott's near-term working capital requirements -- and ability to cover debt service -- favored existing sources of liquidity relative to inaccessible external sources of financing, such as a closed-off market for its commercial paper. The current 'BBB-' rating somberly recognizes the company's highly levered balance sheet, as long-term debt (of $2.67 billion) is 2.71 times more than shareholder equity of $985 million. More worrisome, in my opinion, all bets are off on the company's ability to cure potential defaults on both senior notes and debt outstanding should the company violate its key loan covenant key: its leverage ratio. As set forth under terms of the original revolver terms in a June 2005 regulatory 8-K filing with the SEC, the company must maintain a leverage ratio -- adjusted total debt to consolidated EBITDA -- of not greater than 4.0 to 1.0 for any trailing four fiscal quarters.

Notwithstanding Marriott's singular commitment to maintaining an investment-grade credit rating, global economic uncertainty continues to pressure profit margins as business and leisure customers cut back on planned travels. Year-on-year comparables in the third quarter disappointed, as revenue per available room (RevPar) fell 21.1 percent to $94.06, occupancy rates dropped 540 basis points to 68.1 percent, and average daily room rates declined 14.9 percent to $138.03, according to the quarterly earnings filing.

Amid the chilled economic environment, resultant EBITDA is plunging, too, from $86 million in the first quarter to an aggregate loss of $348 million for the nine months ended September 11. Adjusted leverage in 2008 was 2.2 times adjusted EBTDA of $1.3 billion.

To avoid triggering its debt leverage covenant, management needs to aggressively manage costs and accelerate debt reduction. Chief operating officer Arne Sorenson predicted on the earnings call that cost cutting at the property level -- combined with the delay/elimination of new timeshare projects -- will lead to annual pre-tax savings of $70 million to $80 million in 2009 and a projected savings of $95 million to $105 million in first half 2010. However, boosting margins from continuing efficiency improvements pales in comparison to unlocking the $1.5 billion in timeshare inventory, of which $650 million is in finished timeshare and residential goods, $280 million in work-in-process, and the balance in land and infrastructure.

Although it's tempting to improve financial leverage and cash flow by accelerating sales of timeshare assets, reality dictates that an already significant supply of luxury residential real estate on the market will force Marriott to engage in laddered sales of inventory. The company hopes stimulating demand for existing fractional units at Marriott Vacations Club Resorts by reducing prices (up to 35 percent) and by spurring higher-end sales of its luxury fractional inventory as part of the new portfolio membership program in the Ritz Carlton Destination Club will increase cash flow, too.

All said, however, risk systemic to the lodging industry could still undermine the best efforts of Marriott to boost cash flow and avoid debt defaults. Although industry watchers "sense" a recovery is imminent for the hotel industry, key performance metrics for the U.S. market continue to disappoint. In year-over-year measurements for week ending October 10, the industry's occupancy fell 5.4 percent to 59.8 percent; average daily rate dropped seven percent to finish the week at $99.21, and revenue per available room decreased 12 percent to finish at $59.28, according to data from lodging consultant Smith Travel Research.

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