LOOKING UNDER THE HOOD OF THE MARRIOTT MARGIN CAR

Only a 560 bps margin decline on a 26% decline in RevPAR? Are these guys great mechanics or is something else going on?

When MAR reported only a 560 bps margin decline on a 26% drop in RevPAR this past Thursday, it seemed almost heroic.  This masterful cost cutting spurred several analyst questions of whether this kind of massive property level cost cutting can continue. 

If you look under the hood there’s a lot of “other stuff” in Owned, Leased, Corporate Housing & Other.  The “Other” bucket skews the margins and doesn’t exactly paint a true picture of what’s really going on from a cost cutting standpoint. “Other” includes branding fees and termination fees, which have zero associated expenses.  “Other” also includes some application fees which franchisees pay to procure a contract, and re-licensing fees which get paid on properties when ownership changes but the MAR flag is retained.  Marriot doesn’t disclose application or re-licensing fees, so for the purpose of this note we will just ignore them.

Branding fees come from two primary sources: affinity fees on Marriott rewards credit cards and licensing fees on branded Ritz Carlton residences developed in conjunction with Ritz hotels.  As can be seen below, branding fees have become a larger portion of profits from Owned, Leased, Corporate Housing & Other each year since 2006, accounting for 47% in 2008 and 90.5% in 2Q09. 

LOOKING UNDER THE HOOD OF THE MARRIOTT MARGIN CAR - mar exposure to brand fees

Termination fees on managed and franchised hotels are typically collected when MAR branded hotels trade hands and the new owners want to reflag or simply terminate the existing management or franchise contract.  Termination fees have been declining as the transaction environment for hotels has cooled.  MAR recognized $26MM, $19MM, and $15MM of termination fees respectively in 2006, 2007, and 2008.  MAR does not disclose termination fees on a quarterly basis but they did disclose that they were down y-o-y for the first two quarters of 2009. 

On a combined basis, branding and termination fees accounted for 58% of Owned, Leased, Corporate Housing & Other profit in 2008, up from 47% in 2007.  In 1Q09, MAR reported branding fees of $14MM and some small amount of termination fees.  When you strip those out, it implies that Owned, Leased, & Corporate Housing profits were actually negative and declined around 500bps vs the reported 370 bps decline.  This past quarter MAR reported $19MM of branding fees out of $21MM of total profit for Owned, Leased, Corporate Housing & Other.  Even if there were no termination fees, margin excluding branding fees was less than 1%, implying around an 800-900 bps decline in margins (net of fees). 

Affinity fees are pretty stable and most likely growing.  However, we would wager that branding fees on Ritz condos are at best likely to slow along with the entire condo market.  Termination and re-licensing fees are also likely to be down for 2009 and 2010 unless you believe transactions will accelerate.  Finally, application fees should also be on the decline as new builds come to a grinding halt.  As the cost cuts comps become more difficult we expect some negative margins for this business net of fees. 

LOOKING UNDER THE HOOD OF THE MARRIOTT MARGIN CAR - mar margin chart