• Starwood faces up to profit decline

Starwood Hotels suffered a 46% drop in its post-tax profits in the final quarter which was "well below expectations", according to the company.

And the momentum continues to be negative regarding the deteriorating operating conditions, it added.

The company has responded by implementing "aggressive" cost cuts to counteract the profit drop.

For the current year, it was "nearly impossible to have a clear view" of the future trading conditions given the "turbulent economy", according to CEO Frits van Paasschen during a conference call with analysts last week.

In its results statement Starwood gave some "broad parameters" to be used for planning purposes. These foresaw a revpar drop over the year of 15% which equates to EBITDA tumbling by 35%.

Vasant Prabhu, CFO, said on the call: "The hotel recession is now global in scope and much deeper than might have been expected in October".

Territories which had previously been holding up have recently begun weakening. Latin America dropped sharply in December and the Middle East declined during January.

There was significant hesitation among travel bookers which had created a lot of pent up demand, said Prabhu. "It is hard to predict when this will come back," he added.

The 15% revpar decline for Starwood's owned hotels worldwide was a baseline case, said Prabhu. This could manifest itself as a 25% drop in Q1, followed by 20% down in Q2, 15% down in Q3 and flat in Q4 as the comparatives become easier due to the poor final quarter of last year.

"This has taken us well beyond the traditional contingency plans to fundamentally rethink hotel operating practices," said Prabhu. "We will be running hotels leaner than we ever have."

The devastating profit tumble in Q4 was caused by Starwood's exposure to its 69 owned or leased hotels. In comparison, revenue from managed and franchised hotels had dropped just 5%, thanks in part to a 4% net growth in rooms during 2008 but also because it is much less operationally leveraged than owned hotels.

Van Paasschen said that the "core strength" of owned luxury properties had turned against the company.

The precipitous drop in revpar had caused the company to look at what it can control by looking at the performance after 9-11 where there had been a 15% drop in revpar over four quarters.

The process had started last April, said van Paasschen, in three areas: corporate overhead; property operations; and procurement.

In terms of corporate overhead bout 100 jobs have gone in North American hotel operations alone. Starwood had come together from a patchwork of smaller hotel companies and now overlaps were being eliminated by having a single centre for human resources, by consolidating payroll and so on. "We want to better meet the needs of owners," said van Paasschen. About $85m has been trimmed from 2007 overheads during 2008.

Capital expenditure has also been cut. Maintenance capex and IT spending has been halved. "We are spending only what we have to," said Prabhu.

At the timeshare operation, Starwood Vacation Ownership, 35% of the sales force has gone and several projects have been cancelled.

Van Paaschen said that there had been bottom up efforts at cost-cutting called lean operation that has seen work matched with demand plus the outsourcing of areas such as butchery and baking.

A top-down approach, dubbed normative modelling, has seen hotels across the system benchmarked and best practice shared. This has led to fewer housekeepers and simpler menus among other things.

Fees for owners had also been reduced by cutting back in areas like training, a cost that is passed on to owners.

In terms of procurement there had been vendor consolidation and a reduction in the range of food items.

Despite these cuts, van Paasschen said guest satisfaction scores had risen across the board which was an "amazing achievement" by Starwood's workforce (called associates).

Starwood's move into a primarily fee income model would continue, said van Paasschen. "The branded management hotel business is one of the most attractive in the capitalist world," he said.

Today, 53% of EBITDA is derived from fees which compares to 18% five years ago. The long-term aim is to achieve 80% from fees.

A key to this is assets sales. In the final quarter, $305m was banked as a result of selling three hotels in Venice ($206m), and the Westin Turnberry (for $99m). Only Turnberry was sold subject to a long-term management agreement.

Concluding his opening remarks, van Paasschen said: "The press says that this crisis is unique and unprecedented, which it is, but the same could have been said for many previous crises. Fundamentally, the global economy will rebound. Today's reduced travel budgets are tomorrow's pent-up demand."

Starwood's net income was $79m in the final quarter compared to $146m in the same period a year earlier. Revpar was down 12.1% worldwide, system-wide.

 

HA Perspective: Starwood's figures make a strong case for the switch into the asset light model. Of the big five operators (Hilton, Marriott, InterContinental and Accor are the others), Starwood has arguably the most constrained balance sheet.

Marriott and IHG are mostly asset light and Accor last week tucked away a Eu600m bond. Hilton is more opaque but its private status ought to give it a little more wriggle room.

Starwood's gross debt at the end of last year stood at $4bn. Management plans to bring this down to $3.6bn at the year end.

While interest cover is fine, the company could sail close to the wind with leverage cover (EBITDA divided by gross debt). Bank covenants restrict this to 4.5 times.

If EBITDA does decline further than expected, the company is likely to be forced to make even more draconian cost cuts to keep within these covenants.

Other options will be tough to implement. Asset sales are difficult at present and selling-on loan notes for timeshare looks even harder.

There is a real risk that further cost cuts will alienate guests and owners. Already, it could be argued, Starwood is putting future growth at risk due to the severity of its cuts to its development teams.

Marriott is so far the only company to rival Starwood in the savagery of its cuts in this area. Marriott slashed its domestic development team and M&A department in September, followed by a further cull in November this time of the international, particularly European, development teams.

The key difference, however, is that Marriott has historically proved careful not to impact on its brand and operating standards. Its management team is longer in the tooth with the experience to know how far it can go when compared to Starwood's. And Marriott has less pressure than Starwood to compromise here.

Starwood said it is anticipating the rate of signings to go down (self-fulfilling given the cuts to its development teams). And the pipeline of existing signings has also been cut from 470 properties to 425 as credit conditions have caused some deals to collapse.

Its balance sheet situation means it is unlikely to intervene to prop up any of these troubled projects. Rivals, including Marriott, IHG and Accor, have said that it is possible they may step in with cash for schemes that look able to meet hurdle rates.

Hilton, via Blackstone, looks less likely to put in cash, particularly as the $20bn of debt in the Blackstone takeover has still to be syndicated. But Hilton does seem determined to grow itself out of its problems and has been building its development team to take advantage of the withdrawal of rivals such as Starwood and Marriott.

Starwood is still on course to open its 1,000th hotel this year but its ambition to expand its portfolio by 40% over the next five years looks a stretch.

"We have to respond to the current environment but not compromise our ability to grow," said van Paasschen on the conference call. In this regard, he has probably the biggest challenge of any CEO among the big players.

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