Marriott Case - Brief Summary and Background Information

BRIEF SUMMARY AND BACKGROUND INFORMATION

Marriott initiated a financial reform process during the mid 1970s which was very successful in bringing the company back on a solid foot by 1980. The four year plan included steps to introduce fiscal discipline and maintain certain limits on debt to capital ratio, rating and fund raising activities. Also growth in hotel management fees and cash inflows from selling stakes in low return operations generated an excess amount of cash for the firm. The firm strongly believed in investing its cashflows as it believed in the operating model and the fact that investors would gain higher returns than if dividends were paid out. This higher cash inflow led to reduced need to raise debt. Also this excess cash could be used to pay down outstanding debt (expected to be $125 million by 1883). On the other hand the firm's equity value was rising and this led to a declining leverage ratio.

CFO Gary Wilson believed in having a stable leverage ratio (40-45%). He equally disliked low and high debt ratios. Given the huge cash inflow, it was expected that the debt ratio of Marriott would fall to nearly 20% by 1983, something Gary was very much against. His argued that given this is the forecast, the company should raise debt and use that to buy back shares in the market. This would have two benefits - one, the debt ratio would rise and come back to the comfort level and two, the stock which has been undervalued for a long time could see a rebound. Price to earnings ratio was nine compared to fifty in 1973. He argued debt reduces the cost of capital and increases the returns to shareholders. We can have two views regarding the future path of the company. We can view Marriott as conservative and in a mature stage with a good long term debt rating. Also the firm's distress cost is going to rise with the new debt issuance. But we can also see it as a growth company, especially in the current circumstances which clearly spell an advantage for Marriott over its competitors. We agree with Gary that the firm should be aggressive and bother more about the growth opportunities than be conservative and try to maintain its ratings. Few years down the line, with the increased cash inflow, they can pay back the extra debt and bring the company back to a comfort zone in terms of debt ratios. They should make full use of the advantage they currently have over Marriott's peers.

Marriott proposed to repurchase 10 million of the 32 million outstanding shares with a goal to enhance Marriott's EPS. According to the Pro Forma statements based on the proposed share repurchase, the 1980 estimated EPS is projected to increase from $1.96 to $2.14. In table 1, we calculated Marriot's P/E ratio with the included information.

With the projected increase in EPS, the stockholders will have to pay a higher price to maintain