History of Carnival
History of Royal Caribbean
Role of geographic expansion and diversification
Role of execution
Role of resources and capabilities
Portfolio of brands
Role of leadership and ownership
Role of innovation
LIST OF FIGURES
Total revenues (1988-2007)
Total revenues growth year on year (1996-2007)
Return on capital employed (1996-2007)
Carnival key events (1972-2007)
Royal Caribbean key events (1968-2007)
Non US revenues as percentage of total revenues (1998-2007)
Cruise demand worldwide (1990-2007)
Carnival-P&O Princess merger resulting fleet and geographical presence
Available passenger cruise day EBIT analysis (1996-2007)
Onboard & other revenues as percentage of total revenues (2001-2007)
Average voyage length (1996-2007)
Operating costs as percentage of total revenues (1996-2007)
Year-end global passenger capacity (1996-2007)
Average passenger capacity of existing fleet (1992-2007)
Commissions & transportation costs as percentage of total revenues (2001-2007)
Fuel as percentage of total revenues (2003-2007)
Onboard and other costs as percentage of total revenues (2001-2007)
Total debt to capital (1992-2007)
Net interest expense as percentage of total revenues (1996-2007)
Year-end global share of capacity (1996, 2000, 2007)
Weighted average age of fleet (1996-2007)
Royal Caribbean capacity breakdown by age (1996-2007)
Carnival capacity breakdown by age (1996-2007)
Cruiseship orderbook at September 2003
Cumulative excess cash flow (1992-2007)
Advertising expense as percentage of total revenues (1996-2007)
Consumer brand awareness (2007)
Carnival profitable growth engine
LIST OF BOXES
Industry consolidation (part I)
Carnival airlines venture
Industry consolidation (part II)
When to build
During the past 40 years the cruise industry has evolved dramatically from a form of mere transoceanic transportation to an alternative vacation at sea. The deregulation and expansion of the airline industry played a crucial role in the development of the modern cruise industry. As people could fly more frequently and cheaply than ever before, cruise operators were forced to rethink their business model, moving from an exclusive point-to-point transportation to a contemporary vacation product.
The Love Boat television series further contributed in popularising the industry in the 1970s and 1980s. Since its inception, the cruise industry has been—and continues to be—the fastest growing segment of the broader travel industry, even while it accounts for only a tiny percentage of overall proceeds. Despite growing at a compounded average growth rate of 7.7% since 1980, the penetration rate for the cruise industry is only 17%. In North America alone, the world’s largest cruise market, the cruise industry generated $20.6 billion in 2006.1 By comparison, the lodging industry in North America generated revenues of $133.4 billion during the same year.2
The cruise industry remains a relatively young industry. This is proven by the fact that, of the 168 million passengers that have cruised globally since 1990, 72% cruised in the past ten years and 43% in the past five years alone.
Many have debated whether new capacity creates more demand or whether demand forces operators to add more capacity. One camp argues that the new ships, which push the limit of ‘must see’ attractions, drive customers as the new ships receive vast publicity and consumer interest. The other camp argues that the value and appeal of a cruise ship is so compelling compared with land-based vacations that operators need more ships to keep up with the demand.
Although the question remains unanswered, it is clear that the cruise industry has in the past continually expanded to meet or boost demand: 40 new ships were built in the 1980s, 80 new ships were built in the 1990s, and 46 new ships are scheduled to enter the global market within the next four years.3
Even though there are more than 30 brands of cruise lines, only two companies dominate this industry: Carnival Corp & Plc (CCL) and Royal Caribbean Cruises Ltd (RCL).4 The cruise industry remains highly segmented by product—with a variety of brands targeting a wide array of price points, consumer needs, and itineraries— but by the end of 2007 Carnival and Royal Caribbean alone controlled about two- thirds of the global capacity, with shares of 45% and 21% respectively. Back in 1987, their estimated combined share of global capacity was only 11%.
Up until 2000, Carnival and Royal Caribbean followed a parallel revenue growth trajectory, though Carnival’s profitability has always exceeded Royal Caribbean’s. However, from 2001 onward Carnival consistently and visibly outperformed Royal Caribbean, virtually doubling in terms of global capacity share, and tripling in terms of revenues.
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A closer scrutiny of the two companies reveals that during the period 1996-2000 Royal Caribbean outgrew Carnival in terms of revenues 4 out of 5 years. Conversely, during the period 2001-2007, Carnival outgrew Royal Caribbean 5 out of 7 years.
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Most remarkable of all, Carnival achieved such astounding growth while sustaining superior profitability, as measured by its greater return on capital employed.
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This report explores the question of profitable growth in the modern cruise industry. It does so by directly comparing the financial and operating performance and the management practices of the two leading cruise operators, Carnival and Royal Caribbean, over the twelve-year period from 1996 to 2007.
History of Carnival
Carnival Cruise Lines was founded by Ted Arison, an Israeli immigrant with a penchant for boom-and-bust ventures. In 1968, 42-year-old Arison moved to Miami to operate a small, leased Israeli cruise ship between Florida and the Caribbean. He was left nearly broke when the Israeli government impounded it because the ship’s owners were in debt. After reading that Norwegian Caribbean Line’s Sunward was not in use, Arison called Oslo and said he could fill it with passengers already lined up for the Israeli ship. It was the beginning of a partnership between Arison and the Norwegian Caribbean Line, one that ultimately dissolved into bitter lawsuits in the early 1970s.
In 1972, Mr. Arison turned to a former schoolmate, Meshulam Riklis, owner of the American International Travel Service (AITS), a Boston-based travel conglomerate. Together they purchased a second-hand transatlantic liner, Empress of Canada for $6.5 million, converted it into a cruise ship and renamed it Mardi Gras . They formed the Carnival Cruise Line as a subsidiary of AITS, but Carnival had an inauspicious beginning. Mardi Gras , its very first ship, ran aground with 300 travel agents aboard during the maiden voyage.5
Mr. Arison bought out Mr. Riklis in 1974 for $1 and the assumption of $5 million in debt. The 906-passenger Mardi Gras was an aging fuel-inefficient ship that, during the fuel crisis of the early 1970s, cruised slowly among its ports of call in order to save fuel. To compensate for more time at sea, Mr. Arison filled his ships with time-wasting distractions that the crew dubbed the “Fun Ship”. Carnival offered entertainment at sea, with the industry’s first full casinos, live music, discos, and wild daytime activities—including belly-flop, beer-chugging, and hairy-chest contests—a complete change from the stuffy image of cruising featuring shuffleboard and afternoon tea. In contrast to the typical cruise customer, the Fun Ship theme attracted a relatively young, middle-class clientele. Soon Carnival would add new cruise ships built in the 1980s that were complete visual bonanzas, with bright colors and neon lighting unlike anything before seen in a cruise ship.6
The younger crowd Carnival succeeded in attracting were often first-time cruisers. It was part of a concerted market-development strategy comprising low prices, all-inclusive air-and-sea packages, one-class of service, an informal dress code and consistently offering four- and seven-day cruises. The latter especially was in stark contrast to the existing expensive, formal and relatively lengthy cruise vacation on offer—seven to fourteen days on average.
The new market segment, later called “contemporary”, was characterised by cruises of seven days or less with per diems of $200 or less, featuring a casual ambiance. It quickly became the fastest-growing segment of the cruise industry and Carnival seized the lion’s share by adding two more refitted, second-hand ocean liners—the Carnivale in 1976 and the Festivale in 1977.
In 1979 Ted Arison stepped down and his 30-year-old son Micky, a college dropout, became president and chief executive officer of Carnival Cruise Lines. His team embodied the party atmosphere advertised on its fun ships. A hundred or so employees—from the sales director to the pest-control guy—would crowd into his 900-square-foot apartment on Saturday nights to carouse.7
Meanwhile many competitors migrated toward Carnival’s winning formula, but no cruise liner did it as cheaply or as profitably. During the late 1970s and early 1980s, while few ships were being built and fuel prices were threatening to undermine the industry, the company took the bold move of contracting its first built-to-order ship, the Tropicale . By 1982, the country was already in a recession and shipyards offered rock-bottom prices. Carnival ordered three more ships: the Holiday, Jubilee and Celebration, superliners with capacities exceeding 1,450 passengers.
In 1987 Carnival Cruise Lines reportedly carried 552,774 passengers and generated $525.9 million in cruise revenues, giving it North American market shares of about 20% in number of passengers and more than 10% of total cruise revenues.8 Carnival became the world’s largest cruise line, operating seven cruise ships on three-, four- and seven-day voyages to the Bahamas, Caribbean and Mexican Riviera.9 About 70% of Carnival’s passengers in 1987 were on a cruise for the first time and typically paid less than $200 per day (sometimes as little as $125), while passengers in the “traditional” segment, which usually involves cruises of 10-14 days or more, paid over $250 a day. Cruises had become increasingly popular bookings for travel agents because commissions are based on total packages rather than on individual items such as airfare and hotels; not surprisingly, 98% of all cruise bookings were made through travel agents,10 who received an average 13% commission. Prices usually included roundtrip airfare to port cities, bus transportation to the ship, full use of ship facilities and activities, daily entertainment, and what Carnival daintily called “eight dining opportunities daily, including five full meals”. Passengers paid additional charges for shipboard beverages, gambling, shopping and for shore excursions. These on-board revenues accounted for about 14% of Carnival’s total cruise revenues in 1987.
In July of that same year, in a complex transaction that involved restructuring the relationship of several affiliated companies, Ted Arison relinquished approximately 20% of his equity ownership in an initial public offering of Carnival Cruise Lines stock. The company sold 27.1 million shares of Class A stock at $15.50 per share, netting nearly $400 million in proceeds that were used to reduce debt and help finance construction of Carnival’s Crystal Palace, the largest hotel and casino in the Caribbean.
Ted Arison was the sole owner of all the 27.5 million Class B shares, whose holders are entitled to elect eight directors, also with one vote per share. On other matters, however, holders of Class B shares are entitled to five votes per shares. Mr. Arison thus owns 79.7% of all common stock of the company, and his shares represent 88.8% of the aggregate voting power. His votes can elect all 11 directors.11 Because Carnival is incorporated outside the United States, its earnings are taxable only to Ted Arison as the sole holder of 10% or more of the voting stock. A 30% dividend payout ratio was maintained on all shares in order to assist Arison in paying the tax liabilities on his share of company earnings.
On September 15, 1987, Carnival signed a contract with Wartsila Marine Industries of Helsinki, Finland for construction of two new superliners. The two new vessels, each costing approximately $200 million, were sister ships to the Fantasy, which was under construction and scheduled for delivery in October 1989.12 From 1987 to 1992 Carnival ordered a new generation of 2,040-berth, 70,000 grt superliners to be delivered between 1990 and 1995. These ships, the Fantasy class, would became the largest and most successful series of vessels ever built in cruise history.
Carnival’s expansion came at a time of industry consolidation, due largely to overcapacity in the market’s pricier segment. In July 1988, P&O, the UK parent of Princess Cruise Lines, announced the acquisition of Sitmar Cruises for $210 million. Both Sitmar and Princess operated in the upscale segment of the market, primarily out of the West Coast, with Alaska/Mexican itineraries interspersed with Caribbean, Mediterranean and other cruises.13 In the same year Holland-American Lines bought Home Line. Over the last several years, Cunard Cruises has bought Sea Goddess Lines and Norwegian American Cruises. Norwegian Caribbean Line bought the Royal Viking Line. Most of these companies are privately held and owned by prominent shipping families.
According to Micky Arison, Carnival had considered buying both Home Lines and Sitmar, but passed when it felt the price had climbed too high.14 In 1988 Carnival also advanced a proposal to acquire a stake in Royal Caribbean. After reviewing Carnival’s offer, one of the three investment partners in Royal Caribbean, Gotaas- Larsen, agreed to sell its stake for $260 million. Soon afterward another investment partner, Skaugen, agreed to sell its share for $232 million. Contractual agreements provided a very narrow window for any partner to convert the right of first refusal into an alternative purchase, thirty days to arrange the deal and forty days to complete the financing. The Wilhelmsens were able to raise the needed capital and exercise their right to match Carnival’s offer to purchase the Gotaas- Larsen and Skaugen interests, leaving Royal Caribbean an independent company as it remains today.15
Carnival was more successful the following year. In January 1989 Carnival purchased Holland America Line, Westours and Windstar for $635 million in cash (of which Carnival borrowed about $325 million) plus the assumption of approximately $350 million of existing Holland America Line debt. Prior to the acquisition Carnival’s fleet comprised seven ships, with a total passenger capacity of 8,448, all but one based in the Caribbean for year-round operation. The purchase provided Carnival with a big step up in size—$475 million of estimated annualized revenues; geographic diversification in a move beyond the Caribbean into Alaska and western Canada; and broadened passenger demographics with more upscale customers in the “traditional” sector to complement its existing dominance of the “contemporary” market.16
The deal added four large ships, with a total capacity of 4,503 berths, in the seven- and ten-day premium segment of the cruise market from Holland America Lines, and three smaller Windstar ships, with a total capacity of 444 berths, in the luxury segment. Whereas Carnival cruises cost as little as $125 per day, including airfare, Holland America cruises started at $150 per day excluding airfare and could reach nearly $400 per day for the most luxurious accommodations and itineraries. The ships cruised along the Alaskan coast during the spring and summer and moved to warmer regions, including the Caribbean, in the fall and winter. Holland America also brought three luxurious sailing vessels that operated in the Caribbean, South Pacific, and Mediterranean on seven-day itineraries. In addition to its cruise operations, Holland America operated land tours in western Canada and Alaska through its Westours operations and related Westmark Hotels, and was the largest operator of tourist hotels (2,300 rooms) and shore excursions (via small boat, domed rail car and tourist bus) to Alaska and the Canadian Northwest.17
Carnival carried 783,485 passengers in 1989, earning profits of $193 million on revenues surpassing $1 billion. The same year Carnival completed its Crystal Palace Resort & Casino, a lavish 150-acre resort in the Bahamas, which cost $250 million to develop. The 1,550-room hotel had many extravagant features, including a $25,000-per-night suite that included a robot that brought bath towels, and an aquarium with a stingray. With its 13 restaurants, golf course, tennis courts, and other recreational facilities, the Crystal Palace was the biggest resort in the region.
In 1990 Ted Arison, now 66 years old, stepped down as Chairman of Carnival and was succeeded by his son Micky. Shortly thereafter, the industry’s boom of the previous decade began to taper off. The effects were reflected in Carnival’s stock price, which slid from 25 points in June 1990 to 13 points late in the year. It also became apparent that the Crystal Palace would be highly unprofitable. At the end of fiscal year 1990, Carnival incurred a $25.5 million loss from the resort and casino operation. Not long after it attempted to sell the Crystal Palace, but with no prospective buyers in 1991 Carnival agreed to turn over a large portion of the resort to the Bahamian government in exchange for cancellation of some of the debt incurred during construction. Carnival took a $135 million write-down on the Crystal Palace for that year.
On April 15, 1991 Carnival announced what would become an aborted attempt to acquire Premier Cruise Lines.18 The company declared that it would pay $372 million for Premier Cruise Lines, which operated three ships, assume certain ship lease liabilities and issue $220 million in Class A common stock.19 It also announced that it would begin construction on a third 2,040-berth superliner ship. At the time Premier was in the second year of a ten-year marketing agreement with Walt Disney Co. whereby Premier was the official cruise line of Walt Disney World. Premier was scheduled to locate a ship on the West Coast and market cruises in conjunction with Disneyland. Moreover the marketing agreement with Disney might have eventually been expanded to parks in Japan and Europe. The company had no debt on its balance sheet and, in turn, Carnival’s debt would not have increased as a result of the acquisition.20 However, though completion of the sale was scheduled for early June of the following year, Carnival eventually decided not to buy Premier Cruise Lines, dismissing the deal as “dilutive of Carnival’s earnings”.21
Next, the war in the Persian Gulf brought higher fuel and airline costs and deterred tourists. Advance bookings dropped immediately. Since vacation travel is a discretionary expenditure, the economic backdrop plays a significant role in the health of the leisure travel industry. During 1992, consumers, hoping for an early end to the recession, were instead battered by headlines of continued downsizing and the elimination of jobs.22 Carnival responded with special price promotions and advance bookings rebounded sharply as the Gulf War drew to a close. The August quarter is typically Carnival’s strongest, representing one-third of total annual revenues and almost half of annual profits.23 The company also benefited Americans who became reluctant to travel internationally, boosting demand for domestic holidays, particularly in the more upscale Alaska market.
In February 1992, Carnival agreed to invest $25 million in loans for a 25% interest in Seabourn Cruise Lines with an option on 25% more. Seabourn operated two ultra-luxury ships sailing with mostly 14-day worldwide itineraries and catered to a very affluent customer base. With this move, Carnival further broadened the range of cruise options, with the middle market served by the Carnival brand, the upper-middle group by Holland America and the highest tier by Seabourn and Windstar Cruises.24 Carnival continued to pursue new cruise ventures, including preliminary talks with Club Mediterrane S.A. to form a joint venture that ultimately could establish its presence in Europe.25 The company also committed $2 billion to increase its berth capacity 57% by the end of 199626 and expand its leadership position by having one of the youngest fleets in the industry.
INDUSTRY CONSOLIDATION (Part I)
With price discounting and increased ship capacity, competition has been intense in the North American market, especially in the Caribbean. In conjunction with this competitive environment, the financial condition of many cruise lines has deteriorated leading to a gradual trend of industry consolidation. In 1980, the 7 largest cruise lines commanded 54% of the capacity in the industry. In 1992, the 7 largest cruise lines command approximately 71% of the industry.27 By the end of 1992 Carnival accounted for 18.5% of the North American cruise industry’s total capacity and 6.9% of global industry capacity.
Much of the 1990s were spent on acquisitions and sell offs. In September 1993 Carnival contributed the Mardi Gras to Epirotiki, a Greek cruise firm, for a 16% interest. The next month it renamed the Carnivale the FiestaMarina offering cruises that focused on the Latin America and US Hispanic market. In March 1994 the FiestaMarina was traded to Epirotiki, boosting Carnival’s stake in the company to 43%. Epirotiki leased the ship back to FiestaMarina Cruises, but by July Carnival discontinued the concept and returned the ship to Epirotiki. In September 1994 Ted Arison sold 3.4 million shares in secondary offering at $41 7/8. Carnival had been involved with Epirotiki for a year-and-a-half but separated because of different strategic directions and cultural differences.28
During 1994 Carnival Corporation, which owns 50% of Carnival Hotels and Casinos, (CHC) acquired a majority stake in Registry Hotels with the worldwide rights to use the brand name. Carnival subsequently spun off 90% of its interest in CHC to its shareholders through a special dividend. In August 1994 Carnival sold the Bahamas casino resort to the Ruffin Group of Texas for $80 million. It was plagued by low occupancy and lost hundreds of millions of dollars.
In 1994 Carnival’s parent company renamed Carnival Corporation to distinguish between it and its flagship brand, Carnival Cruise Lines.
CARNIVAL AIRLINES VENTURE
Carnival Airlines lasted a bit longer than the Crystal Palace. It started in November 1988 by flying tourists on one Boeing 727 between Fort Lauderdale and Carnival’s Crystal Palace in Nassau. It eventually expanded and began scheduled service in 1990, including feeder service to its cruise ships. Initially, it flew from New York and Puerto Rico to Fort Lauderdale. In time, flights were added to include Miami, Chicago, Orlando, Tampa and White Plains.
By 1997 the airline served 16 cities with 50 daily departures between the northeast, Florida, California and the Caribbean. It was the largest Florida-based airline. But intense pressure from other low-fare carriers and a crash in the Everglades by ValuJet in May 1996 took its toll on passenger loads and revenue. Previously profitable Carnival Airlines reported a $75 million loss for fiscal year 1997. On top of that, its pilots had just voted 73 percent in favour of collective bargaining.
In April 1997 Carnival Airlines merged with Pan Am, and the merged company did not acknowledge the collective bargaining rights of Carnival’s pilots. The merger allowed Arison to cut his losses and absolve himself of any personal exposure connected to investments in Carnival Airlines. He made a $30 million capital investment in new Pan Am equity and guaranteed bank loans totalling $25 million, which Pan Am could not have obtained on its own. At the time of the merger, Arison was a 43% shareholder in Pan Am. His share decreased to 20% by the time Pan Am filed for bankruptcy in February 1998. Carnival Airlines terminated operations April 3, 1998.29
In October 1995 at an analyst/investor meeting in New York, Carnival’s management disclosed it was pursuing potential acquisition opportunities made attractive by the competitive environment. During the same month, the company announced it had retained an investment bank to propose a restructuring of debt- laden Kloster Cruise Ltd., the industry’s third largest operator. Kloster Cruise Limited was owned by VARD AS, a Norwegian concern listed on the Oslo stock exchange. Its fleet included the Royal Cruise Line (premium segment) and Norwegian Cruise Line (contemporary segment), but had posted losses for the previous four years. Kloster had already dissolved its upscale cruise line, Royal Viking in 1994 by selling the Royal Viking Sun to Cunard for $170 million and transferring the Royal Viking Queen to Royal Cruise Line.30 Kloster still had approximately $300 million of bonds outstanding and total debt approaching $825 million.
The investment seemed to present an opportunity to acquire a company on the verge of failing, but which upon restructuring could develop into a viable operation. Carnival purchased $101.5 million of Kloster’s publicly-held junk bonds as a means of gaining voice in any restructuring proposal. Carnival though paid as little as $81 million for the bonds. Though Kloster’s parent company, VARD, said it was in talks with Carnival, which could lead to joint ownership of NCL with Carnival taking a majority stake, but nothing materialized. Carnival kept NCL afloat by purchasing the remainder of its debt and offering close to 85% of par trading value, but it never entered into a shareholder agreement.
In February 1996 Carnival sold NCL an option to buy back $101 million worth of its bonds, and made a small profit on the sale. Analysts at the time suggested Carnival was not really interested in owning NCL, operator of eight mostly modern cruise ships, given NCL’s large debt. Instead, by preventing the bankruptcy of NCL, Carnival avoided a major blow to the cruise industry, which relies largely on public confidence to promote demand. The cruise industry was still struggling to rebound from the Gulf War and Carnival’s bailout of NCL came just a week before Regency Cruises announced bankruptcy. A year later, NCL was in vastly better financial condition and had announced plans for a public offering. It was soon talking of expansion through new ship construction.31
INDUSTRY CONSOLIDATION (PART II)
Regency Cruises announced it had cancelled operation of all of its vessels for all future scheduled sailings effective October 29, 1995. Regency operated six ships in the budget segment (characterised by smaller, older vessels) with a total of 4,375 berths. Passengers on current cruises were provided with return air flights home from the point of disembarkation. Financial difficulties were the culprit, as Regency failed to complete the planned purchase of the Fair Princess from Princess Cruises federal marshals were seizing a Regency ship by on behalf of creditors. The failure of Regency underscored the fact that secondary and tertiary operators were finding it increasingly difficult to compete with the larger, well- capitalised top-tier operators. Though the shutdown was said to be temporary, Regency never restarted operations.
Around this time, travel agents became more selective about which lines they booked as result of the tendency of operator deletions. Interestingly, the negative sentiments caused by the cancellation of several cruises seemed to have no negative impact on the overall demand for the cruise product. Both consumer demand and channel support were gravitating toward the larger, well-capitalised operators that were bringing on new vessels. This event served only to further strengthen the momentum of a trend that clearly benefited Carnival.
On February 22, 1996, Carnival announced it had reached an agreement to acquire a 29.6% interest in British tour company Airtours PLC for approximately $307 million. The deal closed in April, entering the company into an unsecured five-year, multi-currency revolving credit facility that funded approximately $163 million of the acquisition cost. To fund the remaining purchase price, Carnival issued 5.3 million shares of Class A common stock valued at approximately $144 million. Airtours was expected to use the capital infusion to fund further expansion of its operations in Europe and North America.
Airtours, based in Manchester, England, was the UK’s second largest integrated leisure travel group. The group, which comprises UK, Scandinavian and Canadian tour operators, a charter airline, retail outlets in the UK and Scandinavia, 16 hotels and two cruise ships, has grown rapidly over the last several years. In 1991, Airtours launched Airtours International, which operates 18 jets, and in 1992 the group acquired the Aspro and Tradewinds tour operations; in June 1994 it acquired Scandinavian Leisure Group from SAS Airlines including the Sunwing Hotel Group and 50% of charter airline Premair. Also in 1994, Airtours launched its cruise operations with the introduction of the 727-passenger Seawing (formerly the Souythward of Norwegian Cruise Line) and later added the 1018-passenger Carousel (formerly the Nordic Prince of Royal Caribbean Cruises). In August 1996, Airtours announced its acquisition of another Royal Caribbean ship, the 1004- berth Song of Norway for $40 million. The ship set sail in May 1997, and its purchase clearly indicated solid demand for Airtours’ cruise products in Europe. The ships operated out of Majorca and sail to the Canary Islands, Cyprus and Spain.32
Carnival entered into a new growth phase and made a huge leap in size of construction with the 101,353 ton, 2,640-passenger Carnival Destiny which entered service in 1996. The Destiny was some 40% larger than any existing ship and is the first too wide to pass through the Panama Canal. However, the Destiny has also proven the most successful, to date, of any CCL ship, giving credence to the theory that as offerings—activities, entertainment, dining—increase with the size of the ship, they will attract more passengers and decrease the risk of having to fill so many more berths. Also it burned less fuel than older ships with less than one-half its capacity, and needed less time in drydock to upgrade to new industry safety standards. Each incremental week in drydock for a ship reduces its potential revenue by 2% and profits to an even greater extent.
Carnival expansion plans included Asia as well. In September 1996, the company signed an agreement with Hyundai Merchant Marine to form a 50-50 joint venture targeting the Asian cruise vacation market. At the time, Hyundai Group was one of South Korea’s largest corporations, with nearly $70 billion in revenue and 200,000 worldwide employees. Carnival and Hyundai each contributed $4.8 million and in November 1996 the joint venture bought Carnival Cruise Lines’ Tropicale for $95.5 million cash. The vessel was chartered back to Carnival until it would be needed for cruise operations in the Asian market. But things quickly turned sour; Carnival claimed irreconcilable differences and dissolved the joint venture a year later. According to Carnival, the two companies had very different views as to how the joint venture should be managed and the strategic direction it should take. Carnival repurchased the Tropicale for $93 million and turned its focus to Europe.33
In June 1997, Carnival and Airtours jointly purchased Costa Crociere, an Italian- based cruise company listed on the Milan stock exchange. The cost of the transaction totalled $705 million including $430 million in existing debt. Of the remaining $275 million, 50% was financed by Carnival with $6 million in cash, a $34 million loan to the entity, and a guarantee of $95 million of off-balance sheet debt. Costa’s fleet consisted of seven ships with an aggregate 7,710 berths (excluding one ship that was to be retired), generating approximately $725 million in revenue in 1996 operating in the Mediterranean, Baltic, Caribbean, and South America.34
Historically, demand for Costa’s cruises had been seasonal, strong during the summer months in the Mediterranean and Northern European markets, and lower in the winter months when it sailed in more competitive markets. Virtually all its earnings occurred in the fourth quarter.35 Because Carnival was headquartered in the US, where laws prohibit companies from doing business in Cuba, Costa had to divest its holding in the island nation. It had operated two cruise ships, Costa Playa and Mermoz, under the Pacquet brand. It also owned 50% of Silares Terminales Caribe, a joint-venture with the Cuban government that operated three cruise ship terminals.
On May 28, 1998, Carnival and a group of investors purchased Cunard Line, the world’s eighth largest cruise line with five luxury cruise ships and about 3,100 berths. The acquisition price was $500 million, adjusted for working capital and debt assumed. After these adjustments, Carnival’s cash investment in the acquisition, which was accounted for as a purchase, was approximately $257 million. Simultaneous with the acquisition, Seabourn Cruise Line was merged with Cunard. Carnival owns approximately 68% of the merged company, which is named Cunard Line Limited. Carnival has the option to purchase the remaining 32% of Cunard at any time for approximately five million shares of Carnival common stock. Cunard would enable Carnival to enter the trans-ocean cruise sector as it operates the famed Queen Elizabeth II , which was scheduled to make 17 trans-Atlantic crossings in 1999.
Besides providing a dominant position in the luxury market, CCL acquired two strong luxury cruise brands-Cunard and Queen Elizabeth II. In order to leverage the Cunard brand, Carnival developed a new class of ship designed specifically for the brand. Cunard has been mismanaged in the past and a new shipbuilding program should help re-invigorate the brand. Revenues also benefited from CCL marketing initiatives as well as improved yield management techniques. On the cost side, CCL’s purchasing power and the consolidation of some of Cunard’s operations enabled CCL to substantially improve margins.
During the 1990s, the cruise industry as a whole broadened its ports of embarkation to include several new cities. At the start of the decade, 69% of the cruise industry’s itineraries began in either Miami, Fort Lauderdale, Vancouver (for Alaskan cruises), or San Juan, Puerto Rico. By 1998, that percentage was reduced to 57%, reflecting the growing diversity of cruise vacations. There were dramatic increases in embarkations from regional cities, including New Orleans, Boston, San Diego, and Seward, Alaska.
Carnival also began diversifying its ports of call. Cruises began departing from Newport News, Virginia, and Galveston, Texas. It was also accomplished with little or no cannibalization of core itineraries because, as has been the case in the past, consumers still ventured to Miami or San Juan for the more traditional Caribbean cruises, while using the local itineraries for shorter, more spontaneous holidays. The geographic broadening of the industry resulted in lower overall costs for passengers by reducing, and in some cases eliminating, the need for airfare. Airfare generally has no effect on bottom line earnings, as it is not a profit center and is not a component that cruise lines spend much effort managing.
In the rapidly consolidating cruise industry, Carnival tried to clinch one of the two remaining large players. After NCL, P&O was the only independent cruise company of size that would be a viable takeover candidate. On several occasions Princess [P&O], the third-largest cruise company, had rebuffed Carnival’s efforts to acquire it. Meanwhile Norwegian Cruise Line had a brush with bankruptcy earlier in the 1990s, and Carnival attempted to take over the company by becoming a large bondholder. The effort failed, but Carnival kept NCL in its sights. NCL had since taken some positive steps, including stretching two vessels and taking delivery of a brand new ship, Norwegian Sky . Acquiring NCL and its fleet of nine vessels would add 13,134 new berths, or an additional 25%, to Carnival’s projected 2000 berth base.
1 “The Contribution of the North American Cruise Industry to the U.S. Economy,” Business Research & Economic Advisors and Cruise Lines International Association, August 2007
2 “Lodging Industry Profile,” Smith Travel Research and American Hotel and Lodging Association, November 2007
3 S. Kent et al, “The essentials of cruise investing,” Goldman Sachs, May 5, 2008, p.14
4 In the rest of the document we refer to Carnival and Royal Caribbean by using their ticker symbols CCL and RCL
5 L. Wayne, “Carnival Cruises’s Spending Spree,” The New York Times, August 28, 1988
6 R.J. Kwortnik, “Carnival Cruise Lines, Burnishing the Brand,” Cornell Hospitality Quarterly 2006; 47; 286
7 J. Boorstin, “Cruising for a bruising?,” Fortune, June 9, 2003
8 B.E. Thorp, “CCL Equity Report,” PNC Institutional Investment Sevice, November 14, 1988
10 “Informal presentation of Carnival Cruise Lines by Micky Arison,” E.F. Hutton & Co. December 9, 1987
11 B.E. Thorp, “CCL Equity Report,” PNC Institutional Investment Sevice, November 14, 1988
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33 R.A. Klein, “Cruise ship squeeze: the new pirates of the seven seas,” New Society Publishing , 2005
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35 B. Dalton, D. Wolfe, “CCL Equity Report,” CIBC Oppenheimer, November 20, 1997