Corporation Finance - Marriot Case

Corporation Finance

Homework #4:

1. Does Project Chariot add value? How does each party fare – equity, debt, and management?

In an economic sense, there is no value added. The management, and equity holders benefit at the expense of the bond holders.

From a firm standpoint, yes this project adds value, it allows a complete restructuring of the firm, allows the management side to ditch the interest payments of the underperforming real estate holdings. It allows the real estate holding side to continue making their debt service payment while not puking real estate holding on the lows.

Equity holders now have a larger stake in a company that shed a huge amount of its debt risk, without this risk the new firm can reissue debt at better levels, Re Leverage and grow the equity value. Also, the equity holders will be getting a tax benefit by getting a tax free share of the new more profitable company.

Debt holders get left holding the bag. Without the service business the company will have problems making its debt service payments. Also there will be a downgrade of the firm’s debt, forcing higher rates to be paid. Its debt to equity ratio skyrockets to 76% and its default risk goes with it. It is possible that ratings agencies can move the debt rating to junk, and a mass purge due to many funds inability to hold this kind of debt.

Management benefits from the increase in roles, higher management positions between the two companies.  Also, employees can be narrower in scope, and focus on the service side of the business, which was the core of JW Marriott’s company philosophy.  

2. Why is management considering the plan? Should they have any concerns?

Management is considering the plan due to recent collapse in real estate pricing. The decrease in holding prices have taxed the firm to the extent it can no longer grow its service/management business. This is putting the 2 sides of the business at odds. It also is causing the firm to have convexity risk, as they sell assets to service the debt, they continue to lower the value of existing assets. If the firm can separate the debt from the rest of the firm, it may be able to keep its holdings until prices recover.