The Lodging Industry - Rooms on the Run

Industry Overview

The lodging industry is comprised of commercial establishments known to the public as hotels, motor hotels and motels, providing services including lodging or lodging and meals, with the Standard Industry Classification of 7011.

In the 1920s, the hotel industry had its first major boom. Flourishing economic conditions and high occupancy rates encouraged hotel owners to expand properties and build many new larger ones. The depression brought an end to the expansion and sent many hotels into foreclosure or receivership. Hotel owners who survived the crash were able to add to their existing holdings and develop hotel chains.

The industry began a complete transformation in the 1950s when the need for affordable lodging increased. This need was satisfied by the invention of the motel. Motels competed effectively with hotels until the 1960s. By this time motels had begun to grow in size and offer more amenities. To compete, the hotel industry created motor hotels. Lodging at motor hotels was priced higher than the original motels creating, once again, a lack of low end lodging. This market was satisfied by the creation of budget motels. Budget motels were developed and operated on the same principals as the original motels. By the 1970s hotel chains were expanding through franchise agreements and the creation of high-leverage finance factors which caused the industry to become overextended. In the 1980s the hotel industry completed another cycle of growth and retrenchment. The Reagan administration began easing lending constraints and creating tax incentives for developers. In addition to growth, this period was characterized by an increase in new lodging concepts, such as the all suite hotel. Companies began to diversify which allowed them to do better planning and apply their resources more efficiently ^{8, 13}.

After several years of substantial losses the hotel and motel industry began to rebound in the early 1990s. In recent years the industry has been successful at minimizing salary cost, restructuring debt, and obtaining lower interest rates which led to higher pre-tax operation income.

Some of the major players in the lodging industry are Marriott International, Starwood Hotels & Resorts Worldwide, Hilton Hotels Corp., Trump Hotels & Casino Resort, Host Marriott Corp, Promus Hotel Corp, MGM Grand Inc., and Red Roof Inns, Inc. These hotels are the top performers based on revenue for the 1997 fiscal year. Revenue generated in the industry in 1997 was 23.810 billion dollars. The Appendix A displays the market share of the players within the industry⁹.

Driving Forces

With fewer properties being built and a strong economy, the industry has enjoyed steady increases in demand that have surpassed increases in supply for the last five years. The increase in demand has caused occupancy and average daily room rates to also increase

According to the American Hotel and Motel Association, 30 percent of the industry’ customers are business travelers and 25 percent are leisure travelers. Business conferences account for 25 percent of the industry’s customers while 20 percent of customers are staying for family or personal reasons¹⁰.

Dominant Economic Characteristics & Trends within the Industry

"The hotel industry has been enjoying strong conditions during most of the ‘90’s but now faces a slowdown due to industry over-capacity and a weakening in demand¹." Occupancy rates have slipped from around 65% in the last few years to 64.5% in 1997².

The hotel industry is going through a merger and acquisition boom. It’s much cheaper to buy than build. Management is now focusing more on value, brand development and management expertise rather than number of rooms, utilizing franchising and property management¹. They are renovating older hotels and adding upgraded features such as voice mail, laptop hookups and computer centers are being added to rooms.

The hottest category now is the "extended-stay" category which caters to people staying five or more nights. Room accommodations provide amenities like kitchens and laundries².

General Economic Conditions affecting the industry

Transportation and fuel costs play in large part in determining consumers’ ability to travel. Ticket and fuel prices as well as other industry complications like the recent pilot inhibit demand for lodging. The political climate and economic conditions both inside and outside the U.S. play a part in driving demand for lodging as well³.

Porter 5-Forces Model

Generally speaking, rivalry within the lodging industry itself represents the strongest controlling factor. Government regulations and suppliers represent moderate factors, and new entrants, buyers and substitute products make up the weakest controlling factors in the industry. The attached Porter 5-forces model provides further detail on the factors which influence strategic decisions of the companies involved in this industry.

Industry Prospects & Overall Attractiveness

The Hotel Industry will be going into the next century over-capacity causing a weakening in demand. This will result in fierce competition within the industry. Look for slow to moderate growth in this industry.

Company Analysis - Major companies (4) within the industry

Hilton Hotels Corp.

Hilton Hotels Corp. is currently one of the industry leaders with Starwood and Marriott. Revenues for 1998 came in at $1.769 Billion, registering a 67% decline in revenue from 1997⁴. This decline is due in part because of the spin off of the gaming operations to a separate company, "Park Place Entertainment Corp.", and because Hilton lost their bid for ITT to Starwood. Hilton also took a risky 7% increase in room rates in 1998³. Net Income for 1998 was $297 million. It’s share of market dropped from 23% in 1997 to only 11% of the total industry in 1998. Hilton’s P/E ratio of 12.5 falls below the industry P/E ratio of 18.8 for 1998.

Hilton’s mission is to make "Hilton" synonymous with excellence in the hospitality industry as well as maximize shareholder value. Specifically, the goal is 20% annual growth EBITDA & EPS (Earnings before interest, taxes, depreciation, amortization and non-cash items).

The strategies involved in pursuit of this objective are: 1) to buy and own full-service hotels in major market locations; 2) to leverage the Hilton brand name worldwide; and 3) to maximize operating efficiencies⁵.

Hilton’s President and CEO since 1996 is Steve Bollenbach and their home office is located at 9336 Civic Center Drive, Beverly Hills, California 90210; telephone (310) 278-4321⁶.

Hilton’s portfolio includes approximately 250 hotels totaling 86,940 rooms as of 1/1/99. Some of Hilton’s flagship properties include The Waldorf Astoria, Hilton Hawaiian Village, Hilton Chicago & Towers, Conrad International, as well as Hilton Garden Inn Hotels and Hilton Residential Suites⁷.

Marriott International

Marriott International is focusing on maximizing the value of their lodging, senior living and distribution services businesses. Marriott International’s style of management is one that focuses on its customers and its employees. Emphasis on quality and attention to detail are hallmarks of the company. Creativity is encouraged and rewarded. In addition to TQM, Marriott uses the Collaborative Approach to management.

Marriott International’s CEO and chairman of the board is J.W. "Bill" Marriott Jr. He joined the Marriott Corporation in 1956 and was named President in 1964, CEO in 1972, and Chairman of the Board in 1985. Marriott International’s home office is currently located at 10400 Fernwood Road, Bethesda, MD 20817 (11).

Marriott International had sales of 7.968 Billion in 1998, down 12% from 1997. Reported revenues were down due only to a change in accounting practices. Net income for 1998 was 390 Million and increase from 324 Million (1). Furthermore, the financial information of the company prior to the spinoff on March 27, 1998, from the former Marriott International (now Sodexho Marriott Services, Inc.) is a combination of both Marriott International (New) and Sodexho Marriott Services, Inc.

Marriott operates in two business segments, Lodging and Contract Services. Lodging consists of rooms, food, and beverage. Lodging accounts for 58% of sales and 72% of profit. Currently, Marriott’s lodging group encompasses 1,588 properties totaling 310,000 rooms. Marriott Contract Services consist of management, Senior living, and distribution services. Contract services account for 42% of sales and 28% of operating profit.

Marriott has the broadest portfolio of brands of any lodging company in the world. Some of its brands include the following, Marriott, Courtyard, Towne Place Suites, Fairfield Inns and Suites, Residence Inn, and Ritz Carlton¹¹.

Promus Hotel Corporation

"Our vision is to be the "Premier Hospitality Company" in the world offering high quality lodging brands in well defined market segments, and by recruiting and retaining the best people, trained and empowered to deliver excellent service to every customer, every time…Guaranteed."

Promus’ primary focus is to develop, grow and support its franchise and management business. Primary sources of revenue are from the operations of owned and leased hotels, franchise royalty fees and management fees.

Promus Hotel Corporation is the parent company and owner/operator of Doubletree Hotels, Guest Suites and Resorts, Embassy Suites, Hampton Inn, Hampton Inn & Suites, Homewood Suites, and is entering the vacation interval industry. Promus Hotel Corporation completed a "merger of equals" with Doubletree Corporation in December of 1997. By combining the franchising and brand management expertise of Promus with the hotel management and entrepreneurial acquisition style of Doubletree, the new company has more than 1,325 hotels and 192,000 rooms.

Each of the brands owned and operated by Promus targets a specific segment of the hotel industry. Each is well positioned for further growth as the hotel industry continues to grow. Promus owns a limited amount of hotel real estate because its focus is on franchising and managing hotels. Both of these business lines are very profitable for the company and allow for aggressive unit growth and margin improvement with limited capital investment. Approximately 70% of Promus’ earnings come from its franchising, management and other service-related businesses.

From meager beginnings, the first Holiday Inn motor hotel was opened in Memphis, Tennessee, in 1952. As the company grew and incorporated, it acquired businesses to support and supply the hotel business (i.e. furniture manufacturing). By 1974, the emphasis was to re-engineer and re-focus the company back to its core business, and 16 non-core businesses, including a meat processing company and Trailways Bus Lines, were sold during the following decade. In the early ‘80’s, the upscale all-suite hotels were developed and many were sold in the late ‘80’s to recapitalize the company. In 1990, the Promus Companies was spun off from Holiday Inn, and by 1995 Promus Hotel Corporation was spun off from the Promus Companies. In 1996 and 1997, Promus formed strategic alliances with Equity Inns, and joint ventures with Vistana to build Embassy Vacations Resorts. In December 1997, Promus merged with Doubletree Hotel Corporation.

Promus Hotel Corporation is located at 755 Crossover Lane, Memphis, Tennessee. In December 1998, Norman P. Blake Jr. was named C.E.O., replacing Raymond E. Schultz.

Red Roof Inns Inc.

4355 Davidson Road, Hilliard, Ohio 43026-2491 Telephone: (614) 876-3200

Web Page: www.redroof.com. CEO: Francis W. Cash

Red Roof Inns is currently one of the largest owners and operators of economy hotels in the United States and the District of Columbia. Their basic business strategy is a no frills establishment. They are able to keep their prices down by skipping many of the features that their competitors offer, such as cocktail lounges, restaurants, conference rooms, and other facilities. The company currently has more than 290 inns, with approximately 34,000 rooms in 37 states and the District of Columbia⁴. Most hotels are located near major traffic areas, interstate highways, airports, or convention centers. Because of their no frills policy and prime locations, they can offer a quality room to both business and leisure travelers for less than $50 per night.

The company was originally started by businessman James Trueman in 1972. He opened the first Red Roof Inn in Grove City, Ohio, and ran the successful business until he passed away in 1986. At the time of his death, the company was the largest privately owned and operated chain of economy hotels in the United States.

In 1993, the Morgan Stanley Real Estate Fund bought the company for 600 million. Under this new ownership, they abandoned some of their previous business characteristics. They added swimming pools to two of their Florida locations, and they built an upscale, full service Trueman Club in Columbus, Ohio. The company continued to grow rapidly by acquiring property and franchising their Red Roof Inns. Francis W. Cash, Chairman and CEO, says of their recent growth "We significantly exceeded our 1998 goal of franchising………Our goal for 1999 is to add 50 franchised inns and we hope that we can again exceed our goal." He later adds " The shift in strategy we made over a year ago to move from being a developer and owner-operator to a company focused on franchising and other fee based revenues has, we believe, put us in a position of solid financial flexibility¹⁴."

Performance Analysis

The Lodging Industry as a whole is on the rise. Industry sales for 1998 were $15.750 billion, with a sales growth of 51%. The net income for the industry was $1.292 billion. Return on equity was at 11.2%, the current ratio was 1.2 and the debt to equity ratio was a very leveraged 109%. The total asset turnover ratio was 52%, and the price earnings ratio was at 18.8.

Key Ratios, Benchmarking, Trends

The four key ratios we looked at for each company were the ROE, the current ratio, the debt to equity ratio, and the total asset turnover ratio. For Hilton Hotels Inc., the ROE for 1998 was a skewed 158.8%. The current ratio was .9, which is slightly below the industry average. They look to be a dangerously leveraged company. The debt/equity ratio is extremely high at 1624%, and the TAT was 45%. With a growth rate of -67%, the company is desperately trying to turn things around. For Promus Hotel Corporation, their ROE was below the industry at 9%, and their current ratio was .5, which is relatively low. Their debt/equity ratio was 61, which is comparatively good, and the TAT was 40%. Their growth rate was 269%, due to the acquisition and merger previously mentioned. Marriott International had a good ROE, at 15.20%. Their current ratio was .9, which is slightly below the average. They have a very good debt/equity ratio of 49%, and their TAT is a high128%. They had a 20% growth rate for 1998, and it looks like this company is in good shape with their ratios. For Red Roof Inns the ROE for 1998 was 9.3%, which falls slightly below the average. Their current ratio was .6, which looks to be slightly low. The debt/equity ratio was a relatively high 139%, and the TAT was 40%. Their growth rate was 31%, which was 20 % below the industry average.

Conclusion & Future Outlook

The trend for the lodging industry is currently franchising. The larger hotel chains such as the Marriott, Hilton, and Promus Corp. are continuing to invest in franchising of their hotels rather than the purchasing or construction of the actual buildings. I would look for this trend to continue, causing the companies sales and net income to increase, without having to take on more debt.

According to Value Line, the Hotel Industry will have a sales growth of approximately 6% a year through the year 2003. Operating margin is expected to decrease to 16% from 16.5% over the five years, and net profit is expected to increase 3.9% per year over the five years. Long term debt is expected to grow by 4% per year, but this percentage may decrease if companies continue to franchise rather than buy or build. The return on shareholders equity will increase from 11.2% to 11.5% over the five years, and the P/E ratio is expected to grow to 1.30 from .97 ¹.

Revenues from Moody’s Industry Review, January 22, 1999

Notes regarding Hilton financials:

67% decline in revenues in 1998 due to spin off of gaming operations to Park Place Entertainment Corp. Now shows only its own management fees, rather than full revenue – reduces top line but swells its operating margin.

7% increase in room rates in 1998

1624% Debt/Equity Ratio:

High because of purchases and/or ownership interest in 10 Hotels and 2 Casinos

1996 Extraordinary Loss - $74 million - extinguishment of debt including tender and defeasance premiums (acquisition of Bally)

BIBLIOGRAPHY

¹Value Line, Hotel/Gaming Industry, February 26, 1999

²Hoover’s Online: Travel Services & Lodging

http://www.hoovers.com/features/industry/travel.html

³Lexis®-Nexis® 1998 ARS

⁴Dow Jones Interactive (Company to Primary Industry Comparison Report, 4/1/99)

⁵Lexis®-Nexis® 1997 ARS

⁶Yahoo!Finance HLT Form 10-K

⁷Hilton Web Page: http://www.hilton.com/corporate/overview/index.html

⁸http://hotel.online.com

⁹Moody’s Industry Review, Jan 22, 1999, Volume 17, No.34.

¹⁰Smith Travel Research, http://www.str.com

¹¹Marriott International Homepage, http://www.marriott.com

¹²Form 10-K, Marriott International, http://www.edgar-online.com

¹³"50^th Annual Report on American Industry,1998"

¹⁴PR Newswire, 3/2/99-Dow Jones Newsbank