Financial Strategy

The four key elements of Marriott's financial strategy were:

Manage rather than own hotel assets;

Invest in projects that increase shareholder value;

Optimize the use of debt in the capital structure; and

Repurchase undervalued shares.

Manage rather than own hotel assets In 1987, Marriott developed more than $1 billion worth of

hotel properties, making it one of the ten largest commercial real estate developers in the United

States. With a fully integrated development process, Marriott identified markets, created

development plans, designed projects, and evaluated potential profitability.

After development, the company sold the hotel assets to limited partners while retaining

operating control as the general partner under a long-term management contract. Management fees

typically equalled 3% of revenues plus 20% of the profits before depreciation and debt service. The

3% of revenues usually covered the overhead cost of managing the hotel. Marriott's 20% of profits

before depreciation and debt service often required it to "stand aside" until investors earned a

prespecified return. Marriott also guaranteed a portion of the partnership's debt. During 1987, three

Marriott hotels and 70 Courtyard hotels were syndicated for $890 million. In total, the company

operated about $7 billion worth of syndicated hotels.Invest in projects that increase shareholder value The company used discounted cash flow

techniques to evaluate potential investments. The hurdle rate assigned to a specific project was based

on market interest rates, project risk, and estimates of risk premiums. Cash flow forecasts

incorporated standard companywide assumptions that instilled some consistency across projects. As

one Marriott executive put it:

Our projects are like a lot of similar little boxes. This similarity disciplines

the pro forma analysis. There are corporate macro data on inflation, margins, project

lives, terminal values, percent of sales required to remodel, and so on. Projects are

audited throughout their lives to check and update these standard pro forma

template assumptions. Divisional managers still have discretion over unit-specific

assumptions, but they must conform to the corporate templates.

Optimize the use of debt in the capital structure Marriott determined the amount of debt in its

capital structure by focusing on its ability to service its debt. It used an interest coverage target

instead of a target debt-to-equity ratio. In 1987, Marriott had about $2.5 billion of debt, 59% of its total

capital.

Repurchase undervalued shares Marriott regularly calculated a "warranted equity value" for its

common shares and was committed to repurchasing its stock whenever its market price fell

substantially below that value. The warranted equity value was calculated by discounting the firm's

equity cash flows by its equity cost of capital. It was checked by comparing Marriott's stock price

with that of comparable companies using price/earnings ratios for each business and by valuing each

business under alternative ownership structures, such as a leveraged buyout. Marriott had more

confidence in its measure of warranted value than in the day-to-day market price of its stock. A gap

between warranted value and market price, therefore, usually triggered repurchases instead of a

revision in the warranted value by, for example, revising the hurdle rate. Furthermore, the company

believed that repurchases of shares below warranted equity value were a better use of its cash flow

and debt capacity than acquisitions or owning real estate. In 1987, Marriott repurchased 13.6 million

shares of its common stock for $429 million.

Describe the role that "hurdle rate" plays in Marriott's financial strategy? In particular discuss the danger of directly applying the hurdle rate of the firm as a whole to its divisions.