Most mergers are bad ideas: just ask Carly Fiorina, whose disastrous decision to buy Compaq, when she was the CEO of Hewlett-Packard, more or less ensured that she would be remembered, in Jeffrey Sonnenfeld’s words, as a “colossal business failure” and “one of the worst technology CEOs in history”. So when Jeff Goldfarb proclaims that Marriott’s $12.2 billion acquisition of Starwood, creating a hotels behemoth with over 1 million rooms, is bad for Marriott and bad for Starwood, it’s easy to believe him.
Certainly there’s a lot of nervousness about the merger from Starwood’s most loyal guests. Hugo Espinoza has spent 203 of this year’s 320 days (so far) in Starwood hotels, for instance, and tells Josh Barro that he’s “livid,” and fears for his platinum-for-life status.
And yet, this is one of the few mergers I’m optimistic about. Any multi-billion-dollar deal like this one is going to run into fraught management and implementation issues, of course. But there’s a logic here which could mean that creating such a behemoth makes sense for all concerned – not only the two companies and their hotels, but even the loyal Starwood customers who are rending their clothes and gnashing their teeth worrying about what will become of their precious Starwood Preferred Guest (SPG) program.
For the hotel companies themselves, this is basically a case of bigger is better.
The deal is good for Marriott, in particular, because it’s paying almost entirely in newly-issued stock: just $2 of the $72 bid price is being paid in cash. Marriott’s shares are trading at 24 times earnings even after the big announcement, which is a premium to the price of 22 times earnings that Marriott is paying for Starwood. In other words, a dollar of Starwood earnings is going to be worth $24 when Starwood is part of Marriott, even though Marriott paid only $22 for it. Not a bad deal, on its face.
The deal is also good for Starwood, because it means the company gets to be owned by a large and efficient hotelier, rather than by some random Chinese conglomerate.
More generally, the deal is good for both groups, because while the hotel industry has always been a place where bigger is better, nowadays size matters more than ever. These days, most hotel rooms are booked over the internet, and the power of the big hotel-booking websites has never been greater. Expedia, for instance, isn’t just Expedia: it’s also Travelocity and Orbitz. Which means that it can charge as much as 25% in commissions to small hotels. The bigger that Marriott is, the more Expedia needs it, and the more equal the tough negotiations between the two.
What goes for Expedia, of course, also goes for Priceline and TripAdvisor and Alibaba and Google: wherever a giant website controls billions of dollars in potential bookings, only a giant hotel chain has the might to stand up to them and prevent them from skimming off an unconscionable amount for their intermediation. The megacorps you should be worried about, in the hotel industry, aren’t the hotel groups themselves, but rather the big travel-booking websites, who take in far more money than they add in value.
And then there’s the even bigger threat to the hotel industry. Marriott CEO Arne Sorenson says that Airbnb and other home-sharing websites “look a bit like a combination of an intermediary and a traditional competitor” – in other words, they’re not only big websites people go to in order to book a room, they’re also a rival source of rooms.
Size helps Marriott here, too. A lot of Airbnb customers don’t necessarily realize this yet, but hotels are already substantially cheaper than Airbnb: according to Merrill Lynch, the average hotel charges $122.32 per night, while the average Airbnb apartment charges $196, a premium of 60%. If Marriott can maintain its price advantage, while building up a suite of 30 different brands which appeal to a wide range of demographics, it has a much higher chance of being able to fend off the Airbnb menace.
And then, crucially, there’s the legendary Starwood loyalty plan. It’s smaller than Marriott’s, with 21 million members to Marriott’s 54 million, but it punches well above its weight: while people will join Marriott Rewards just because they stay in Marriott hotels, they join Starwood Preferred Guest because they get real value out of it, and especially out of the SPG credit card.
The fear, with the SPG program, is that Marriott will look askance at how generous it is, and see an easy way to make extra profits: just make it harder to get valuable rewards. After all, Starwood has to be generous, because in terms of sheer convenience, Marriott, with its 4,300 properties, easily beats Starwood, with its 1,270.
But as we’ve seen, Marriott is facing more competition than ever: it’s not about to get complacent. And Sorenson has said that SPG was itself “a significant factor behind the decision to merge.” SPG members are younger than Marriott Rewards customers, and it’s clear that Marriott can learn a lot about how to build real loyalty – as opposed to simple program membership – from Starwood.
Sorenson told Fortune that “the DNA of Marriott is being an operating company, and in many respects Starwood is a brand and marketing company.” Translated from the corporatespeak, what he’s saying is that while Marriott knows how to run hotels, Starwood knows how to sell them – especially to people under the age of 45. And one great way to sell hotels is to give away a lot of free nights, while making a profit at the same time.
How does Starwood manage that? By selling hundreds of millions of dollars’ worth of points to American Express each year. American Express then uses those points to persuade high spenders to use its highly-rated SPG credit card as much as possible. And then it makes even more money from the interchange fees on that card, as well as from charging interest on the purchases, and, of course, the $95 annual fee. It’s a classic win-win – and once again, now that Starwood has merged with Marriott, the combined group will have a huge increase in negotiating leverage with Amex.
American Express has recently lost similar card deals with Costco and JetBlue; it’s going to want to fight hard to retain Starwood. That means Marriott will be able to extract a lot of money out of Amex – just so long as Amex can continue to count on its SPG customers staying as loyal as they currently are. If Marriott devalues SPG points so that the card becomes less attractive, then people will use it much less, it will be worth less to Amex, and that lovely steady cashflow from Amex will quickly disappear.
Hotel points are a fantastic business for Starwood. It costs Starwood nothing to issue the points, it gets paid hundreds of millions of dollars for them by Amex, and then when the points are redeemed, there’s a very good chance that the hotel in question is not full, and that therefore the guest spending a free night is not displacing someone who would otherwise be bringing in revenue. What’s more, Starwood has a lot of “treat” brands, which make you feel special, and which keep customers loyal to the program: Westin, St Regis, W Hotels, the Luxury Collection. Even Sheraton, the main brand, has some great hotels once you leave the U.S.
Marriott, by contrast, with the exception of Ritz-Carlton (whose loyalty credit card costs a whopping $395 per year), is better at plain business hotels, or at giving people functional places to stay: Courtyard, Residence Inn, Springhill Suites, Fairfield Inn.
Put the two together, and you have a formidable range of hotel brands, without noticeably more overlap than there was before. (Yes, St Regis competes directly with Ritz-Carlton, but then again Marriott’s many lower-end brands competed with each other already.) If Marriott can treat its customers to Starwood’s long list of premier international hotels, while also offering a vast range of domestic options to Starwood’s die-hard loyalists, everybody should be able to come out a winner.
Except, perhaps, the big travel websites.