Hyatt's Problem Just what I don't need groaned Valerie Ferguson as she hung up the phone late one cold afternoon in December of 1993. Bad enough the weather stinks, and it gets dark by 4:30P, now this!" A friend in the real estate business had just called to ask if she was aware that a rumor affecting her hotel was circulating in the Atlanta real estate community. It seemed that a potential buyer had recently surfaced for the long-vacant a former federal office building, known locally as the IRS building," just north of the Hyatt Regency Atlanta (HRA). The scuttlebutt was that the developer intended to re- develop the former office building into an all-suites hotel with a national chain affiliation. Valerie was a Hyatt veteran. Since joining the company as a reservations agent at HRA, she had progressed swiftly through a series of assignments around the Hyatt system culminating with her recent promotion to General Manager of the Hyatt Regency Atlanta (HRA), one of Hyatt's largest and most important hotels. Since arriving in Atlanta, Valerie had been under enormous pressure to arrest the declining profitability of the hotel and improve its occupancy. The construction of a 280-room all-suites hotel next door was likely to further erode her corporate transient customer base and make the turn-around more difficult. "I've got to go see Tim." Tim Lindgren, Hyatt's Divisional Vice-President -Southeast Division, whose offices were in the hotel, was an intense, competitive, and pragmatic individual. His response, on hearing the news was "We can't let this happen! We've got to come up with some options we can present to the Pritzker family" (the owners of Hyatt and of HRA) Background As many in the hotel industry know, the Hyatt Regency Atlanta was the first modern atrium hotel in the United States. The vision of a local Atlanta architect, John Portman (who had also invested in the development) the project had foundered. Over budget and short of capital, construction had stopped in 1966, and new investors were earnestly sought. Those from within the hotel industry - Sheraton, Marriott, Hilton, and others - came to look, but the reaction of all was summed up by Conrad Hilton: "That concrete monster will never fly!" It should be noted here that in those days it was the norm for hotel companies to own, or at minimum hold a very significant ownership interest in the facilities they operated. The Management Contract of today, in which management companies operate facilities owned by others, was relatively rare. Through real estate circles, the Atlanta project came to the attention of A. N. Pritzker, scion of the Pritzker family of Chicago. The Pritzkers, among their many other holdings were the owners of Hyatt House Hotels, a regional operator of airport motels, mostly on the West Coast. a Then, as now, the Pritzker family members were opportunistic investors. In 1957 they stumbled into the hotel business. Jay Pritzker, son of A. N., found himself stuck, because of flight delays, in a motel near the Los Angeles airport (LAX). It was called the Hyatt House, and was owned and operated by the gregarious and hands-on Hyatt Von Dehn. Jay and Von Dehn struck up a conversation in the motel's coffee shop, Fat Eddie's. The topic- the potential of airport motels in that era of rapidly growing air travel, especially on the West Coast. The conversation led, within several hours, to an agreement between Jay and Hyatt for the Pritzkers to purchase the Hyatt House at LAX and the Hyatt name. Jay's charismatic brother Don, just out of the military, would volunteer to run the operation. The LAX deal led to others, mostly in airport locations up and down the West Coast, such that by 1965 Hyatt had 6 hotels with 1856 rooms and an expanded reach that included properties in Chicago, Des Moines, and Albany NY. As the company grew it focused on the individual business traveler - even then, a prized customer. In addition to targeted brand advertising, recognition programs such as "HERS [Hyatt Executive Reservations Service] - a reward program for secretaries who referred business to Hyatt - were enormously successful. On seeing the incomplete Regency Hotel (as it was then called) both A. N. and Jay were taken by its audacity - and its scale. Though Jay later held that the numbers looked promising, he admitted that they had bought Portman's vision - it could be great, and the down side didn't look too bad. When looking at deals - both inside and outside the hotel business - Jay used to say "You have to assume that the project will cost more than anyone believes, and that the returns won't be as good. That way you won't be disappointed. The art, of course, is in being able to judge the potential extent of both ranges. Jay was extremely good at this both because of an innate knack, but also because he took care to surround himself with the best talent he could find. The 800 room hotel, with extensive meeting and convention space, two restaurants and a bar at the atrium level, and the first rooftop revolving restaurant and bar since the Seattle Space Needle, opened for business on May 1, 1967 at 8:00 AM. No one showed up! Jay, Don, Ed Sullivan (General Manager), and others were scared to death - Where was everybody???? The next day allayed their fears. The place was mobbed - and stayed that way for several years as people flocked to see for themselves an entirely new type of urban hotel. HRA was extensively covered in feature articles in national newspapers and magazines, was featured in major films, and was carefully studied by academics in city planning and urban design. The impact on the company was enormous. Never before, nor since, has a major U.S. hotel company been able to move up-market so rapidly. Hyatt House, a small chain of airport motor hotels suddenly became the urban luxury hotel operator of choice. The huge success of HRA, and the publicity that it generated for Atlanta as a whole, led to deals to develop similar Portman-designed Atrium hotels; in Chicago at O'Hare International Airport, and in San Francisco at the Embarcadero. Soon other city mayors and managers clamored to create the incentives needed to attract a Hyatt Regency Hotel to their communities. The impact of the Hyatt Regency Atlanta on Hyatt, and the industry as a whole, cannot be overstated. For the Pritzkers, Hyatt became the family's public image. HRA also quickly 2 became the "cash cow" that made possible still more deals. In addition to the many new projects in various cities around the United States, within a year design was started for a 200-room addition to HRA, to be constructed on an adjoining parcel on Ivy Street. Completed in 1971, this addition connected HRA to Peachtree Center, Portman's mixed- use office and retail center just south of the hotel. The addition's unique round tower featured pie shaped rooms which, though tight, helped satisfy the continued strong transient and group demand. Because HRA was so busy, so profitable, and the company's and the city's flagship, many of the best and brightest in the industry were attracted there. In this environment it is not surprising that many industry innovations were created - some as solutions to operational problems. A good example is Regency Club, Hyatt's Concierge Level. The concept of a hotel within a hotel was created at HRA as a way of giving special attention to frequent corporate travelers who enjoyed the style and flair of the Hyatt experience, but didn't want to deal with the inconveniences inherent in a large and busy convention hotel. Many of these services are taken for granted today, but back then, the idea of a separate registration area, keyed access to special floors, a private lounge with food and beverage service, and concierge services was a major innovation, and very popular with Hyatt's most profitable guests. Competitors enter the market In business, success is quickly followed by competition. So it was that within a few years plans were being drawn by John Portman's office for the 1068 room 70 story Westin Peachtree Plaza two blocks south of HRA on Peachtree Street. Importantly, this property contained 57,000 SF of meeting space including a 22,100 SF ballroom, then the city's largest. Opened in 1974, it was for a time the tallest hotel in the world. Two years later the Atlanta Hilton & Towers opened. Though undistinguished architecturally, the 1224 room hotel featured more than 70,000 SF of meeting space. Hyatt responded to competitive pressures -in particular the growth in size of many groups loyal to the hotel - with a second addition to HRA in 1982 of 247 rooms and 16,000 SF of meeting space. The addition remedied a number of functional shortcomings in the original building, and provided substantial additional meeting space. For various reasons the 1982 expansion never achieved the financial performance originally forecast to justify the project. Because the site only permitted the construction of a 12,000 SF ballroom, the hotel's major meeting room remained its original 17,000 SF ballroom. Overall, it's meeting facilities remained third best in a highly competitive market. The situation really deteriorated with the 1986 opening of the 1674 Room Marriott Marquis just behind the Hyatt. Also designed by John Portman, the Marriott contains the world's tallest hotel atrium and the largest ballroom in Atlanta - 28,884 SF in one column-free space. Even more problematic, from Hyatt's perspective, was the hotel's total of 120,000 SF of meeting space, or 71.86 SF/Room - high by industry standards. Exhibit A contains a summary of meeting facilities by hotel. Downtown Atlanta Though Atlanta's downtown district has not experienced the explosive growth of the surrounding suburbs such as Buckhead and the Perimeter, it has largely avoided the "hollowing out" that has devastated so many urban centers as the impact of the automobile has taken hold. Growth in commercial real estate has been substantial. Since 1967 several major corporations have made downtown Atlanta home. These corporations include Georgia Pacific, Bank South, First Atlanta Corporation, Sun Trust and The Southern Company. In addition, a substantial number of new office buildings have been constructed, both inside and outside Portman's Peachtree Center complex, to accommodate the growth of companies already headquartered in downtown Atlanta. Supporting this growth have been significant improvements in Atlanta's infrastructure. The freeways serving downtown and the surrounding region have been substantially expanded, and a from-scratch regional heavy rail/subway system, MARTA, was opened in 1979. a Atlanta Convention Facilities Atlanta has always been a meeting place. Founded as a rail juncture in the 19th century, Atlanta is now one of the nation's largest airline hubs, home to Delta Airlines. The 1981 completion of the new mid-field terminal complex at Hartsfield International helped to accommodate the traffic of an airline hub that consistently vies with Chicago's O'Hare for the honor of the World's Busiest Airport. Supporting Atlanta's roll as a meeting place, has been the frequent expansion and renovation of the World Congress Center, Atlanta's convention center. Comprising some 2,000,000 square feet of meeting and exhibit space, adjoined by both the 15,000 seat Omni Center Arena (recently replaced by the 20,000 seat Philips Arena) and the 72,000 seat Georgia Dome, Atlanta is able to offer one of the most extensive and complete convention facilities in the United States. The availability of this space, coupled with an extremely favorable exhibition cost environment, and attractive hotel rates, makes downtown Atlanta one of the best Convention values in the Country. Brand Segmentation & Hyatt's Position In the mid-1980's the hotel industry was looking for ways to grow, in what many then considered an almost-saturated market. This desire was fueled by a convergence of needs: the need of publicly traded hotel companies to show earnings growth, the need of financial institutions to lend money at high rates with attractive up front fees, and the need of developers to develop. The mutually attractive solution was to declare that customers were really looking for different products -limited service facilities for a better price, all-suites for a better business working environment on the road, and a larger suite (almost an apartment) for extended stays. In order for these differing concepts to be viable financially, tradeoffs would have to be made. To afford the additional space required for all-suites, some of the amenities customers had come to expect in full service hotels would have to be sacrificed - room service, restaurants, indoor parking and, importantly, meeting facilities. At this time Hyatt had commissioned a serious survey of the market to determine whether it too should consider diversifying it's offerings. The research suggested - one is never fully confident of these results - that neither a limited service nor an extended stay a concept was consistent with Hyatt's sophisticated brand image, but that an all-suite concept should be considered. This result may have been influenced by the fact that the industry-leading all-suite brand at the time was Embassy Suites. Their shotgun suite" (from outside in: bedroom, bath, living room) required the incorporation of a sky-lit atrium to provide natural light to the living room that adjoined the public corridor/balcony. Jay Pritzker was skeptical. Limited service and all suite hotels with few supporting facilities are great when demand is strong and competition limited. In fact, they can be extremely profitable - because they are inexpensive to build and, with limited facilities, can operate with low overhead and generate high operating profits. The problem is that demand can quickly change. With barriers to entry low, a strongly performing hotel is likely to be flanked by competitors before long. Then what do you do? Jay's view: We should stick to our knitting - full service hotels & resorts." The research did confirm that Hyatt's core competency, serving the large corporate and association group market, was extremely viable. Importantly, it had the advantage of providing underlying strength during periods of downturn in the economy, since groups tend to need to meet, regardless of cutbacks in individual travel. "Economic cycles obviously have an impact on our meeting schedules. When times are tough we might forgo a training meeting or a benefits workshop, but we still have to incent our sales people - after all they are driving our success. For them we want the best, and that usually means a Hyatt venue" said Lila Friday, Prudential's corporate meeting planner. These and other comments were welcome news, given Hyatt's commitment to this market. Hyatt and the Pritzker Family For most of its history, the Pritzker family of Chicago has privately owned Hyatt Hotels Corporation. One of a number of large enterprises owned by the family, Hyatt has for many years been the best known and most public of the family's holdings. Led by the scion of the family A. N. Pritzker, ably supported by his son Jay, the growth of Hyatt has been opportunistic, "deal" oriented, and relatively conservative. Whenever possible, growth came through the negotiation of long term management agreements - wherein Hyatt agreed to manage, for a fee, an asset constructed and owned by a third party - frequently a large investment pool such as an insurance company or pension fund. In certain cases the family invested its own funds in a project and took a substantial ownership in the real estate. Whenever Pritzker investment decisions are made, the evaluation used is quite conservative. Everyone involved is well aware of the "down-side" risk and takes care to make certain that the family decision-maker is well aware of the risks - as well as the potential rewards. Generally projects must achieve a 20% unleveraged return. No one in the day to day management of Hyatt wants to promote a project unlikely to achieve the projected returns. 5 That said, a family business is never an entirely rational enterprise. At times, though not often, decisions are made with an emotional element - "because it's the right thing to do or, the numbers aren't compelling, but I really believe there's an up-side here." Always one is aware that the investment is the family's money, not that of some nebulous shareholders. Condition of Hyatt Regency Atlanta By 1993 the Hyatt Regency Atlanta, though wholly owned by the Pritzker family, was no longer the flagship of the Hyatt brand. Important as it was to the success of the Company, the hotel had been a "cash cow for many years, and was not consistently given the resources needed to maintain a building approaching its 30th birthday. Though, to the customer, the facility seemed clean and in reasonable repair, it nonetheless looked dated. The exposed concrete walls that had been so innovative in 1967 seemed crude and dirty. The Parasol Lounge, situated in an elevated concrete dish under a vast steel and glass umbrella hung from the atrium ceiling was no longer in use, in part because it was difficult to access. The remaining lobby bar was too small when the hotel was busy, and too large when it was not. The same problem handicapped the Lobby restaurant, Kaf Kobenhavn. Over the years signs, promotion banners, and marketing displays had been added but were seldom removed. New devices like an ATM machine and an automatic check-in machine had been placed wherever convenience suggested. The overall effect was chaotic and lacking in style. An update was needed. Not surprisingly, operating results were down, and had been for some time. In response most of the previous management team had been rotated out. While year-over-year 92/93 results were encouraging, it was clear to new management that significant capital improvements would be required to maintain the trend. With the new threat of an all-suite competitor next door, an aggressive plan was needed - and quickly! Although the state of negotiations between the local developer and the land owner was not known, the approach of the 1996 Olympic Games was creating pressure to start projects expected to be available for the Games. The Problem - What to Recommend? Despite the threatened competition, Hyatt was in a somewhat advantageous position. The IRS building had been for sale for nearly 3 years, and it was known that the owner was anxious to dispose of it. While the local developer was credible, his project would require at least 50% equity to qualify for financing. It was speculated that he would try to induce the building owner to stay in the project and contribute additional cash equity. Hyatt, on the other hand could make a cash offer for the property, and could close quickly. As the owner of the adjoining property, Hyatt was in a position to vacate an 18 foot perpetual access easement affecting the two parcels. The vacation of this easement would add substantial value to the eventual development of the property by making available additional developable floor space (FAR.) Finally anything that Hyatt elected to develop on the property could share the back of house and support facilities of the adjoining hotel. Buy and Hold Option In spite of the above, simply purchasing the building as a defensive move was not financially compelling. It was anticipated that the building and land could be purchased for $4,000,000 cash, plus $500,000 for asbestos abatement and demolition. The projected revenues from using the cleared site for parking did not support the above investment, even when attributing some value to blocking potentially competitive development of the site. . Two other options seemed more promising: Renovate the existing office building as an all-suites hotel managed by HRA. Demolish the office building, and construct additional meeting, exhibition, and parking facilities for HRA. All-Suite HRA managed Option Renovating the existing office building into an all-suites "tower" offered a number of benefits: It would give HRA a premium guestroom product, strengthening its appeal to high rate transient customers in Downtown Atlanta. It would be the ultimate "hotel within a hotel," a concept pioneered years before at HRA, but this time having its own registration, food service facilities (Club Lounge), elevators, etc. It would be well out of the hustle and bustle of the main hotel, but with this activity and fun available just down the corridor. It would play to Hyatt's strength in the transient market place, supported by Hyatt's Gold Passport frequent stay program, and strong airline affinity programs. It would allow HRA to enlarge its group room blocks and profit even more from the many citywide conventions. Planning studies had shown that it would be possible to build 280 suite rooms, including the necessary support facilities, and economic studies projected a room rate of $140 and an occupancy of 61% for the new suites upon opening, with an annual growth in room rate of 3% and a growth in occupancy to 67% over 3 years. The all-suites hotel could be supported by HRA's existing back of house, foodservice, and administrative facilities, which would result in significant operating efficiencies. Also, the hotel could make available services, such as a staffed business center and high end room service, not normally available in all-suites and limited service hotels. By retaining the building's foundations, incoming utilities, and structure (which was well suited to the conversion) Hyatt projected that it would be possible to develop a suites project at a relative bargain compared to a new build. The Suites project was projected to cost $20,000,000, including purchase of the building, and would include the needed renovations to the atrium lobby level of the hotel. A re-clad all-suites hotel would enhance the neighborhood as well as the existing front entrance of the hotel which the existing building faced. . An 8-year financial projection for the all-suites option is attached. (See Exhibit B). . Meeting & Exhibit Facilities Option Demolishing the existing office building and constructing group meeting and exhibition facilities on the site also offered a number of benefits: Planning studies had shown that it would be possible to develop a 30,000 SF ballroom (the largest in Atlanta), a 40,000 SF exhibition hall (modest compared to the other hotels), and approximately 120 additional parking spaces on the site. To tie the new and existing facilities together approximately 12,000 SF of existing meeting space would be lost. The project was projected to cost $35,000,000, including the purchase of the property and the necessary renovation of the existing public areas of the hotel. The facility would greatly improve the hotel's competitive position in the group marketplace in Atlanta, and would significantly improve the hotel's position nationally. Importantly, the hotel's ratio of meeting space per room would go from today's 55 SF/ Room to 100 SF/room, more in line with some of its national competitors. Hyatt had undertaken a similar addition at the Hyatt Regency O'Hare several years before and the market had responded reasonably well, though the financial results were only modestly ahead of the forecasts used to justify the expansion. Hyatt had been making a major push in the group meetings market nationally, and the results were encouraging, especially in the larger hotels. Studies had indicated that provision could be made in the design of the ballroom project for the eventual addition of either guestrooms or serviced apartments without affecting the new meeting space. The major concern was; can you afford to add so much (expensive) meeting and exhibit space without adding any rooms - traditionally the most profitable part of hotel operations? . . An 8-year financial projection for the meeting and exhibition space option is attached. (See Exhibit C) Note: Hyatt's design and construction personnel had evaluated both options and had concluded that both would require 6 months to design and document, between 12 and 14 months to construct, and at least 5 months to "shake down." If either option were to be available for the 1996 Olympics in Atlanta, a decision had to be made by May 1994 Study Questions 1. Given the options open to the owner, including doing nothing, which would you recommend, and why? It will be helpful if you summarize the merits and risks associated with each option. 2. What weight, if any, would you assign to any non-financial elements of the decision? For example, should the historic importance of HRA to Hyatt influence the owner's willingness to make a significant, though risky, investment in the property? Are their other issues? 3. What are the potential impacts on the options of the approach of the 1996 Olympic Summer Games in Atlanta? Exhibit A Summary of Downtown Atlanta Hotel Meeting Facilities MEETING SPACE/GUEST ROOM RATIO HYATT MARRIOTT HILTON WESTIN 1279 Rooms 1068 1674 1224 65,000 Meeting Space 70,358 81,000 (120,000)* 28,884 16,000 57,000 (156,000)*** 22,100 6,724 18,576 16,244 17,000 9,100 Ballroom/ Jr. Ballroom Dedicated Exhibit Hall # of Breakouts 39,000 40 41,000 50 99,000** 39 0 32 Ratio 71.68 57.48 53.37 50.82 As the above clearly indicates, HRA currently lacks the physical meeting space to effectively continue to grow revenues within this marketplace. While HRA's Association market and Corporate market continue to slip, the hotel has only been able to maintain occupancy by pursuing more primary business. As a result, the rate has continued to suffer. This situation will in all likelihood continue and will contribute to a relatively flat rate in the future. In 1993, HRA was able to grow revenues due primarily to the success of the public facilities (Georgia World Congress Center and Inforum). However, in 1993, HRA still did not have more than eight in-house meetings that were 700 rooms or more. *The Marriott dedicated exhibit hall is carpeted, has ceiling and wall treatment, and is therefore convertible to high quality banquet space, effectively providing 120,000 sq.ft. of meeting/banquet space. It also has portable walls and is used as meeting space. ** This square footage is located within the Atlanta Market Center but is sold by Westin as its in house space because the two facilities are connected by pedestrian bridge. *** 99,000 square feet is located within the Atlanta Market Center. HYATT REGENCY ATLANTA BALLROOM ADDITION ECONOMIC SUMMARY -- INCREMENTAL CASH FLOWS ($000) 1994 1995 2000 2001 1996 1997 1998 1999 Capital Expenditure (14,000) (21,000) Net Operating Income (359) 3,027 6,892 4,701 4,910 6,793 7,391 Reversion at 10% 73,910 (14,000) (21,359) 3,027 6,892 4,701 4,910 6,793 81,301 Hyatt's Problem Just what I don't need groaned Valerie Ferguson as she hung up the phone late one cold afternoon in December of 1993. Bad enough the weather stinks, and it gets dark by 4:30P, now this!" A friend in the real estate business had just called to ask if she was aware that a rumor affecting her hotel was circulating in the Atlanta real estate community. It seemed that a potential buyer had recently surfaced for the long-vacant a former federal office building, known locally as the IRS building," just north of the Hyatt Regency Atlanta (HRA). The scuttlebutt was that the developer intended to re- develop the former office building into an all-suites hotel with a national chain affiliation. Valerie was a Hyatt veteran. Since joining the company as a reservations agent at HRA, she had progressed swiftly through a series of assignments around the Hyatt system culminating with her recent promotion to General Manager of the Hyatt Regency Atlanta (HRA), one of Hyatt's largest and most important hotels. Since arriving in Atlanta, Valerie had been under enormous pressure to arrest the declining profitability of the hotel and improve its occupancy. The construction of a 280-room all-suites hotel next door was likely to further erode her corporate transient customer base and make the turn-around more difficult. "I've got to go see Tim." Tim Lindgren, Hyatt's Divisional Vice-President -Southeast Division, whose offices were in the hotel, was an intense, competitive, and pragmatic individual. His response, on hearing the news was "We can't let this happen! We've got to come up with some options we can present to the Pritzker family" (the owners of Hyatt and of HRA) Background As many in the hotel industry know, the Hyatt Regency Atlanta was the first modern atrium hotel in the United States. The vision of a local Atlanta architect, John Portman (who had also invested in the development) the project had foundered. Over budget and short of capital, construction had stopped in 1966, and new investors were earnestly sought. Those from within the hotel industry - Sheraton, Marriott, Hilton, and others - came to look, but the reaction of all was summed up by Conrad Hilton: "That concrete monster will never fly!" It should be noted here that in those days it was the norm for hotel companies to own, or at minimum hold a very significant ownership interest in the facilities they operated. The Management Contract of today, in which management companies operate facilities owned by others, was relatively rare. Through real estate circles, the Atlanta project came to the attention of A. N. Pritzker, scion of the Pritzker family of Chicago. The Pritzkers, among their many other holdings were the owners of Hyatt House Hotels, a regional operator of airport motels, mostly on the West Coast. a Then, as now, the Pritzker family members were opportunistic investors. In 1957 they stumbled into the hotel business. Jay Pritzker, son of A. N., found himself stuck, because of flight delays, in a motel near the Los Angeles airport (LAX). It was called the Hyatt House, and was owned and operated by the gregarious and hands-on Hyatt Von Dehn. Jay and Von Dehn struck up a conversation in the motel's coffee shop, Fat Eddie's. The topic- the potential of airport motels in that era of rapidly growing air travel, especially on the West Coast. The conversation led, within several hours, to an agreement between Jay and Hyatt for the Pritzkers to purchase the Hyatt House at LAX and the Hyatt name. Jay's charismatic brother Don, just out of the military, would volunteer to run the operation. The LAX deal led to others, mostly in airport locations up and down the West Coast, such that by 1965 Hyatt had 6 hotels with 1856 rooms and an expanded reach that included properties in Chicago, Des Moines, and Albany NY. As the company grew it focused on the individual business traveler - even then, a prized customer. In addition to targeted brand advertising, recognition programs such as "HERS [Hyatt Executive Reservations Service] - a reward program for secretaries who referred business to Hyatt - were enormously successful. On seeing the incomplete Regency Hotel (as it was then called) both A. N. and Jay were taken by its audacity - and its scale. Though Jay later held that the numbers looked promising, he admitted that they had bought Portman's vision - it could be great, and the down side didn't look too bad. When looking at deals - both inside and outside the hotel business - Jay used to say "You have to assume that the project will cost more than anyone believes, and that the returns won't be as good. That way you won't be disappointed. The art, of course, is in being able to judge the potential extent of both ranges. Jay was extremely good at this both because of an innate knack, but also because he took care to surround himself with the best talent he could find. The 800 room hotel, with extensive meeting and convention space, two restaurants and a bar at the atrium level, and the first rooftop revolving restaurant and bar since the Seattle Space Needle, opened for business on May 1, 1967 at 8:00 AM. No one showed up! Jay, Don, Ed Sullivan (General Manager), and others were scared to death - Where was everybody???? The next day allayed their fears. The place was mobbed - and stayed that way for several years as people flocked to see for themselves an entirely new type of urban hotel. HRA was extensively covered in feature articles in national newspapers and magazines, was featured in major films, and was carefully studied by academics in city planning and urban design. The impact on the company was enormous. Never before, nor since, has a major U.S. hotel company been able to move up-market so rapidly. Hyatt House, a small chain of airport motor hotels suddenly became the urban luxury hotel operator of choice. The huge success of HRA, and the publicity that it generated for Atlanta as a whole, led to deals to develop similar Portman-designed Atrium hotels; in Chicago at O'Hare International Airport, and in San Francisco at the Embarcadero. Soon other city mayors and managers clamored to create the incentives needed to attract a Hyatt Regency Hotel to their communities. The impact of the Hyatt Regency Atlanta on Hyatt, and the industry as a whole, cannot be overstated. For the Pritzkers, Hyatt became the family's public image. HRA also quickly 2 became the "cash cow" that made possible still more deals. In addition to the many new projects in various cities around the United States, within a year design was started for a 200-room addition to HRA, to be constructed on an adjoining parcel on Ivy Street. Completed in 1971, this addition connected HRA to Peachtree Center, Portman's mixed- use office and retail center just south of the hotel. The addition's unique round tower featured pie shaped rooms which, though tight, helped satisfy the continued strong transient and group demand. Because HRA was so busy, so profitable, and the company's and the city's flagship, many of the best and brightest in the industry were attracted there. In this environment it is not surprising that many industry innovations were created - some as solutions to operational problems. A good example is Regency Club, Hyatt's Concierge Level. The concept of a hotel within a hotel was created at HRA as a way of giving special attention to frequent corporate travelers who enjoyed the style and flair of the Hyatt experience, but didn't want to deal with the inconveniences inherent in a large and busy convention hotel. Many of these services are taken for granted today, but back then, the idea of a separate registration area, keyed access to special floors, a private lounge with food and beverage service, and concierge services was a major innovation, and very popular with Hyatt's most profitable guests. Competitors enter the market In business, success is quickly followed by competition. So it was that within a few years plans were being drawn by John Portman's office for the 1068 room 70 story Westin Peachtree Plaza two blocks south of HRA on Peachtree Street. Importantly, this property contained 57,000 SF of meeting space including a 22,100 SF ballroom, then the city's largest. Opened in 1974, it was for a time the tallest hotel in the world. Two years later the Atlanta Hilton & Towers opened. Though undistinguished architecturally, the 1224 room hotel featured more than 70,000 SF of meeting space. Hyatt responded to competitive pressures -in particular the growth in size of many groups loyal to the hotel - with a second addition to HRA in 1982 of 247 rooms and 16,000 SF of meeting space. The addition remedied a number of functional shortcomings in the original building, and provided substantial additional meeting space. For various reasons the 1982 expansion never achieved the financial performance originally forecast to justify the project. Because the site only permitted the construction of a 12,000 SF ballroom, the hotel's major meeting room remained its original 17,000 SF ballroom. Overall, it's meeting facilities remained third best in a highly competitive market. The situation really deteriorated with the 1986 opening of the 1674 Room Marriott Marquis just behind the Hyatt. Also designed by John Portman, the Marriott contains the world's tallest hotel atrium and the largest ballroom in Atlanta - 28,884 SF in one column-free space. Even more problematic, from Hyatt's perspective, was the hotel's total of 120,000 SF of meeting space, or 71.86 SF/Room - high by industry standards. Exhibit A contains a summary of meeting facilities by hotel. Downtown Atlanta Though Atlanta's downtown district has not experienced the explosive growth of the surrounding suburbs such as Buckhead and the Perimeter, it has largely avoided the "hollowing out" that has devastated so many urban centers as the impact of the automobile has taken hold. Growth in commercial real estate has been substantial. Since 1967 several major corporations have made downtown Atlanta home. These corporations include Georgia Pacific, Bank South, First Atlanta Corporation, Sun Trust and The Southern Company. In addition, a substantial number of new office buildings have been constructed, both inside and outside Portman's Peachtree Center complex, to accommodate the growth of companies already headquartered in downtown Atlanta. Supporting this growth have been significant improvements in Atlanta's infrastructure. The freeways serving downtown and the surrounding region have been substantially expanded, and a from-scratch regional heavy rail/subway system, MARTA, was opened in 1979. a Atlanta Convention Facilities Atlanta has always been a meeting place. Founded as a rail juncture in the 19th century, Atlanta is now one of the nation's largest airline hubs, home to Delta Airlines. The 1981 completion of the new mid-field terminal complex at Hartsfield International helped to accommodate the traffic of an airline hub that consistently vies with Chicago's O'Hare for the honor of the World's Busiest Airport. Supporting Atlanta's roll as a meeting place, has been the frequent expansion and renovation of the World Congress Center, Atlanta's convention center. Comprising some 2,000,000 square feet of meeting and exhibit space, adjoined by both the 15,000 seat Omni Center Arena (recently replaced by the 20,000 seat Philips Arena) and the 72,000 seat Georgia Dome, Atlanta is able to offer one of the most extensive and complete convention facilities in the United States. The availability of this space, coupled with an extremely favorable exhibition cost environment, and attractive hotel rates, makes downtown Atlanta one of the best Convention values in the Country. Brand Segmentation & Hyatt's Position In the mid-1980's the hotel industry was looking for ways to grow, in what many then considered an almost-saturated market. This desire was fueled by a convergence of needs: the need of publicly traded hotel companies to show earnings growth, the need of financial institutions to lend money at high rates with attractive up front fees, and the need of developers to develop. The mutually attractive solution was to declare that customers were really looking for different products -limited service facilities for a better price, all-suites for a better business working environment on the road, and a larger suite (almost an apartment) for extended stays. In order for these differing concepts to be viable financially, tradeoffs would have to be made. To afford the additional space required for all-suites, some of the amenities customers had come to expect in full service hotels would have to be sacrificed - room service, restaurants, indoor parking and, importantly, meeting facilities. At this time Hyatt had commissioned a serious survey of the market to determine whether it too should consider diversifying it's offerings. The research suggested - one is never fully confident of these results - that neither a limited service nor an extended stay a concept was consistent with Hyatt's sophisticated brand image, but that an all-suite concept should be considered. This result may have been influenced by the fact that the industry-leading all-suite brand at the time was Embassy Suites. Their shotgun suite" (from outside in: bedroom, bath, living room) required the incorporation of a sky-lit atrium to provide natural light to the living room that adjoined the public corridor/balcony. Jay Pritzker was skeptical. Limited service and all suite hotels with few supporting facilities are great when demand is strong and competition limited. In fact, they can be extremely profitable - because they are inexpensive to build and, with limited facilities, can operate with low overhead and generate high operating profits. The problem is that demand can quickly change. With barriers to entry low, a strongly performing hotel is likely to be flanked by competitors before long. Then what do you do? Jay's view: We should stick to our knitting - full service hotels & resorts." The research did confirm that Hyatt's core competency, serving the large corporate and association group market, was extremely viable. Importantly, it had the advantage of providing underlying strength during periods of downturn in the economy, since groups tend to need to meet, regardless of cutbacks in individual travel. "Economic cycles obviously have an impact on our meeting schedules. When times are tough we might forgo a training meeting or a benefits workshop, but we still have to incent our sales people - after all they are driving our success. For them we want the best, and that usually means a Hyatt venue" said Lila Friday, Prudential's corporate meeting planner. These and other comments were welcome news, given Hyatt's commitment to this market. Hyatt and the Pritzker Family For most of its history, the Pritzker family of Chicago has privately owned Hyatt Hotels Corporation. One of a number of large enterprises owned by the family, Hyatt has for many years been the best known and most public of the family's holdings. Led by the scion of the family A. N. Pritzker, ably supported by his son Jay, the growth of Hyatt has been opportunistic, "deal" oriented, and relatively conservative. Whenever possible, growth came through the negotiation of long term management agreements - wherein Hyatt agreed to manage, for a fee, an asset constructed and owned by a third party - frequently a large investment pool such as an insurance company or pension fund. In certain cases the family invested its own funds in a project and took a substantial ownership in the real estate. Whenever Pritzker investment decisions are made, the evaluation used is quite conservative. Everyone involved is well aware of the "down-side" risk and takes care to make certain that the family decision-maker is well aware of the risks - as well as the potential rewards. Generally projects must achieve a 20% unleveraged return. No one in the day to day management of Hyatt wants to promote a project unlikely to achieve the projected returns. 5 That said, a family business is never an entirely rational enterprise. At times, though not often, decisions are made with an emotional element - "because it's the right thing to do or, the numbers aren't compelling, but I really believe there's an up-side here." Always one is aware that the investment is the family's money, not that of some nebulous shareholders. Condition of Hyatt Regency Atlanta By 1993 the Hyatt Regency Atlanta, though wholly owned by the Pritzker family, was no longer the flagship of the Hyatt brand. Important as it was to the success of the Company, the hotel had been a "cash cow for many years, and was not consistently given the resources needed to maintain a building approaching its 30th birthday. Though, to the customer, the facility seemed clean and in reasonable repair, it nonetheless looked dated. The exposed concrete walls that had been so innovative in 1967 seemed crude and dirty. The Parasol Lounge, situated in an elevated concrete dish under a vast steel and glass umbrella hung from the atrium ceiling was no longer in use, in part because it was difficult to access. The remaining lobby bar was too small when the hotel was busy, and too large when it was not. The same problem handicapped the Lobby restaurant, Kaf Kobenhavn. Over the years signs, promotion banners, and marketing displays had been added but were seldom removed. New devices like an ATM machine and an automatic check-in machine had been placed wherever convenience suggested. The overall effect was chaotic and lacking in style. An update was needed. Not surprisingly, operating results were down, and had been for some time. In response most of the previous management team had been rotated out. While year-over-year 92/93 results were encouraging, it was clear to new management that significant capital improvements would be required to maintain the trend. With the new threat of an all-suite competitor next door, an aggressive plan was needed - and quickly! Although the state of negotiations between the local developer and the land owner was not known, the approach of the 1996 Olympic Games was creating pressure to start projects expected to be available for the Games. The Problem - What to Recommend? Despite the threatened competition, Hyatt was in a somewhat advantageous position. The IRS building had been for sale for nearly 3 years, and it was known that the owner was anxious to dispose of it. While the local developer was credible, his project would require at least 50% equity to qualify for financing. It was speculated that he would try to induce the building owner to stay in the project and contribute additional cash equity. Hyatt, on the other hand could make a cash offer for the property, and could close quickly. As the owner of the adjoining property, Hyatt was in a position to vacate an 18 foot perpetual access easement affecting the two parcels. The vacation of this easement would add substantial value to the eventual development of the property by making available additional developable floor space (FAR.) Finally anything that Hyatt elected to develop on the property could share the back of house and support facilities of the adjoining hotel. Buy and Hold Option In spite of the above, simply purchasing the building as a defensive move was not financially compelling. It was anticipated that the building and land could be purchased for $4,000,000 cash, plus $500,000 for asbestos abatement and demolition. The projected revenues from using the cleared site for parking did not support the above investment, even when attributing some value to blocking potentially competitive development of the site. . Two other options seemed more promising: Renovate the existing office building as an all-suites hotel managed by HRA. Demolish the office building, and construct additional meeting, exhibition, and parking facilities for HRA. All-Suite HRA managed Option Renovating the existing office building into an all-suites "tower" offered a number of benefits: It would give HRA a premium guestroom product, strengthening its appeal to high rate transient customers in Downtown Atlanta. It would be the ultimate "hotel within a hotel," a concept pioneered years before at HRA, but this time having its own registration, food service facilities (Club Lounge), elevators, etc. It would be well out of the hustle and bustle of the main hotel, but with this activity and fun available just down the corridor. It would play to Hyatt's strength in the transient market place, supported by Hyatt's Gold Passport frequent stay program, and strong airline affinity programs. It would allow HRA to enlarge its group room blocks and profit even more from the many citywide conventions. Planning studies had shown that it would be possible to build 280 suite rooms, including the necessary support facilities, and economic studies projected a room rate of $140 and an occupancy of 61% for the new suites upon opening, with an annual growth in room rate of 3% and a growth in occupancy to 67% over 3 years. The all-suites hotel could be supported by HRA's existing back of house, foodservice, and administrative facilities, which would result in significant operating efficiencies. Also, the hotel could make available services, such as a staffed business center and high end room service, not normally available in all-suites and limited service hotels. By retaining the building's foundations, incoming utilities, and structure (which was well suited to the conversion) Hyatt projected that it would be possible to develop a suites project at a relative bargain compared to a new build. The Suites project was projected to cost $20,000,000, including purchase of the building, and would include the needed renovations to the atrium lobby level of the hotel. A re-clad all-suites hotel would enhance the neighborhood as well as the existing front entrance of the hotel which the existing building faced. . An 8-year financial projection for the all-suites option is attached. (See Exhibit B). . Meeting & Exhibit Facilities Option Demolishing the existing office building and constructing group meeting and exhibition facilities on the site also offered a number of benefits: Planning studies had shown that it would be possible to develop a 30,000 SF ballroom (the largest in Atlanta), a 40,000 SF exhibition hall (modest compared to the other hotels), and approximately 120 additional parking spaces on the site. To tie the new and existing facilities together approximately 12,000 SF of existing meeting space would be lost. The project was projected to cost $35,000,000, including the purchase of the property and the necessary renovation of the existing public areas of the hotel. The facility would greatly improve the hotel's competitive position in the group marketplace in Atlanta, and would significantly improve the hotel's position nationally. Importantly, the hotel's ratio of meeting space per room would go from today's 55 SF/ Room to 100 SF/room, more in line with some of its national competitors. Hyatt had undertaken a similar addition at the Hyatt Regency O'Hare several years before and the market had responded reasonably well, though the financial results were only modestly ahead of the forecasts used to justify the expansion. Hyatt had been making a major push in the group meetings market nationally, and the results were encouraging, especially in the larger hotels. Studies had indicated that provision could be made in the design of the ballroom project for the eventual addition of either guestrooms or serviced apartments without affecting the new meeting space. The major concern was; can you afford to add so much (expensive) meeting and exhibit space without adding any rooms - traditionally the most profitable part of hotel operations? . . An 8-year financial projection for the meeting and exhibition space option is attached. (See Exhibit C) Note: Hyatt's design and construction personnel had evaluated both options and had concluded that both would require 6 months to design and document, between 12 and 14 months to construct, and at least 5 months to "shake down." If either option were to be available for the 1996 Olympics in Atlanta, a decision had to be made by May 1994 Study Questions 1. Given the options open to the owner, including doing nothing, which would you recommend, and why? It will be helpful if you summarize the merits and risks associated with each option. 2. What weight, if any, would you assign to any non-financial elements of the decision? For example, should the historic importance of HRA to Hyatt influence the owner's willingness to make a significant, though risky, investment in the property? Are their other issues? 3. What are the potential impacts on the options of the approach of the 1996 Olympic Summer Games in Atlanta? Exhibit A Summary of Downtown Atlanta Hotel Meeting Facilities MEETING SPACE/GUEST ROOM RATIO HYATT MARRIOTT HILTON WESTIN 1279 Rooms 1068 1674 1224 65,000 Meeting Space 70,358 81,000 (120,000)* 28,884 16,000 57,000 (156,000)*** 22,100 6,724 18,576 16,244 17,000 9,100 Ballroom/ Jr. Ballroom Dedicated Exhibit Hall # of Breakouts 39,000 40 41,000 50 99,000** 39 0 32 Ratio 71.68 57.48 53.37 50.82 As the above clearly indicates, HRA currently lacks the physical meeting space to effectively continue to grow revenues within this marketplace. While HRA's Association market and Corporate market continue to slip, the hotel has only been able to maintain occupancy by pursuing more primary business. As a result, the rate has continued to suffer. This situation will in all likelihood continue and will contribute to a relatively flat rate in the future. In 1993, HRA was able to grow revenues due primarily to the success of the public facilities (Georgia World Congress Center and Inforum). However, in 1993, HRA still did not have more than eight in-house meetings that were 700 rooms or more. *The Marriott dedicated exhibit hall is carpeted, has ceiling and wall treatment, and is therefore convertible to high quality banquet space, effectively providing 120,000 sq.ft. of meeting/banquet space. It also has portable walls and is used as meeting space. ** This square footage is located within the Atlanta Market Center but is sold by Westin as its in house space because the two facilities are connected by pedestrian bridge. *** 99,000 square feet is located within the Atlanta Market Center. HYATT REGENCY ATLANTA BALLROOM ADDITION ECONOMIC SUMMARY -- INCREMENTAL CASH FLOWS ($000) 1994 1995 2000 2001 1996 1997 1998 1999 Capital Expenditure (14,000) (21,000) Net Operating Income (359) 3,027 6,892 4,701 4,910 6,793 7,391 Reversion at 10% 73,910 (14,000) (21,359) 3,027 6,892 4,701 4,910 6,793 81,301