S-F-249

Graduate School of Business STANFORD UNIVERSITY

MARRIOTT CORPORATION BONDHOLDERS VERSUS EQUITY HOLDERS

On October 5, 1992, Marriott Corporation announced a plan to restructure the company by splitting itself into two parts. The announcement caused immediate and opposite price movements for its stock and its bonds. Stockholders were happy and bondholders were in a furor, particularly those that bought a new issue of bonds in April. The Restructuring Plan The two separate companies were to be Marriott International and Host Marriott. The former company would manage/franchise over 700 hotels and motels. In addition it would manage food and facilities for several thousand businesses, schools, and health-care providers. Finally, it would manage 14 retirement homes under contract. For these businesses, 1991 sales amounted to $7.4 billion. J. Willard Marriott, Jr., Chairman of Marriott Corporation, was to become Chairman of Marriott International. Host Marriott was to own most of the hard assets. More specifically, it would own 139 hotels or motels, 14 retirement communities, and nearly 100 restaurants/shops at airports and along toll roads. For these businesses, 1991 sales were $1.7 billion. Operating cash flows for these businesses approximated 40 percent of total Marriott Corporation operating cash flows, pre-restructuring. Richard Marriott, Vice Chairman of Marriott Corporation, was to become Chairman of this company. The key element in the restructuring plan was that Host Marriott was to keep the debt associated with these assets, approximately $2.9 billion. In contrast, Marriott

International would have only modest debt after the restructuring. The bond indenture was felt not to preclude such a transfer of assets and debt. Known as event risk to bondholders, there were numerous cases of this in the 1980s with the leveraged buyout movement. Bondholder wealth was expropriated in favor of equityholders, and the Marriott restructuring was felt to be a variation off the same
1992 by the Board of Trustees of the Leland Stanford Junior University. All Rights Reserved. This case was written by Professor James C. Van Home of Stanford University on the basis of publicly available data and information.

S-F-249

theme. While Marriott International was to provide a $630 million line of credit to
Host Marriott, the expiration date of the line was sooner than the maturities of many of the bond issues outstanding. Merrill Lynch was advisor to Marriott on the restructuring plan, and Marriotts new chief financial officer, Stephen Bollenbach, was instrumental in the development of the restructuring plan. It called for stockholders of Marriott Corporation receiving one share of stock in each of the new companies for each share of stock previously held. Technically, the transaction represents a spin-off. The Marriott family owned approximately 25 percent of the shares before, and would initially own the same percent in each of the two companies afterwards. The Companys Debt Structure Year-end balance sheets for 1991 and 1990 are shown in Exhibit 1, and longterm debt at January 3, 1992 is seen to be $3.2 billion. This debt included some dozen bond issues with a total face value of $2-i /4 billion. Maturities ranged from one to 15 years, and all issues were rated BBB by Standard & Poors. This rating was later lowered to single B, which remained the bond rating for the new Host Marriott. In contrast, Marriott International received a rating of a single A, an increase over the rating for the pre-restructured company. The companys legacy of debt came from aggressive expansion of hotels and motels in the i980s. With depressed real estate conditions in the early 1990s, the company was unable/unwilling to sell off certain assets and reduce its debt. The companys strategy was to manage properties, not necessarily to own them. For the most part, ownership was viewed as only a temporary phenomenon during initial

development. Security Price Reactions and Going Forward Exhibit 3 shows the prices of Marriott Corporations common stock and two of its bond issues around the time of the restructuring announcement. The stock increased sharply in price, while the bonds dropped. These reactions are consistent with a wealth transfer, recognizing that other things were not held constant. Still the bond and the stock markets voted with their feet. The initial reaction of bondholders was to call foul. Those that bought the April, 1992 bond issue were even more vocal, citing the legal words fraudulent conveyance. The good company/bad company syndrome was invoked. Marriott management tried to assure bondholders that it was their intent to service all debt on time and that the interest and principal payments promised would be delivered. Therefore, bondholders should not worry. Stockholders, in the meantime, were elated with the restructuring plan. All three parties to the transaction bondholders, stockholders and management needed to plot their next steps.
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Exhibit 1

Marriott Corporation Consolidated Balance Sheets 1991 and 1990 Year Ends
(in millions) January 3 1992 Cash & cash equivalents
Accounts receivable

December 28
1990

Inventories Prepayments Current assets Investment in affiliates Net property, plant & equipment Assets held for sale Goodwill Other assets Total assets Current maturities, LTD Accounts payable Accruals Current liabilities Long-term debt Deferred taxes Deferred income Other liabilities Preferred stock Common shareholders equity Total liabilities & equity

$36 524 243 220 $1,023 455 2,485 1,524 476 437 $6,400 $52 579 704
$1,335

$283 654 261 230 $1,428 462 2,774 1,274 494 494 $6,926 $75 675 887 $1,637 3,598 584 312 388 407 $6,926

3,189

614 232 351

200

479 $6,400

S-F-249 Exhibit 2 Marriott Corporation Statements of Income 1991 and 1990 Fiscal Years (in millions) January 2 1992 $8,331 December 28 1990 $7,646

Net Sales Costs and expenses Depreciation & amortization

Miscellaneous income

Interest expense Restructuring costs

Other income

7,692 272 43 320 55 $145 63 $27 $0.80

0.28

7,069 208 47 324 153

141

Income before taxes Income taxes Income after taxes Dividends

Earnings per share (in dollars) Dividends per share (in dollars)

$80 33 $27 $0.46 0.28

Exhibit 3 Marriott Corporation Security Prices Around Time of Restructuring Announcement

9-3/8% of
6-15-1997

9-1/2% of
5-1-2002

Common Shares
$17-i /8

October 1, 1992 October 2, 1992 October 5 (announcement) October 6, 1992 October 7, 1992 October 8, 1992 October 9, 1992 October 30, 1992 November 30, 1992 December 31, 1992

$111.0
111.2

$108.0 108.2
83.6 83.1

17-1/8 19-1/4 19-1/8 19-1/8 18-1/2

89.3
83.9 79.4

80.3 83.1 $88.9 89.2 94.7 4

82.7 82.7 83.2 $87.4 91.3

93.6

18-5/8
$20

20-3/8 20-3/4