Capital Markets

Leadership in Finance: Starwood’s Vasant Prabhu

For the hotel company's CFO, it's much more important now to have a stash of cash than to rake in the revenues.
David KatzMay 21, 2009

These days, a good night’s sleep can be hard to come by for a CFO in a precarious industry like the hotel and time-share business. Banks and investors are well aware of the fragility of travel-and-vacation revenues in the current downturn, and capital doesn’t come cheap. Some finance chiefs might feel that the expense of stashing away enough cash to ensure their companies’ survival if their worst-case scenarios come true is too high right now. Not Vasant Prabhu, CFO for Starwood Hotels & Resorts Worldwide, however.     

Lately, Prabhu has been busy negotiating a looser leverage covenant on Starwood’s revolving credit line and leading the way as his company pounced on a big bond offering just before issuing its quarterly earnings call. Both moves came at a high cost. But the finance chief believes it was worth it, because, as matters stand now, things would have to get pretty disastrous for the company to run out of cash.

On April 27, Starwood announced that it had increased the maximum debt-to-EBITDA ratio in its revolving loan covenant from 4.5 times to 5.5 times without having to cut the size of the loan. In return, it will pay the banks’ fees and higher interest rates and make other changes to the covenants. At the same time, the hotel company pre-paid a $500 million bank term loan due June 29 by drawing down on the revolver, thus reducing the funds available under it to $1.2 billion.  

Just three days after announcing the changes to its revolving loan facility — on the day it issued a first-quarter 10-Q revealing a devastating drop to $6 million in net income compared to $32 million in the same quarter of 2008 — the hotelier announced that it would sell $500 million worth of senior notes due in 2014 at an interest rate of 7.875%.

The offering, finished on May 7, netted the company $474 million. Starwood says it intends to use part of that sum to cut its bank borrowing. Prabhu says he and his colleagues are in talks about securitizing some of the company’s receivables, also in the hopes of paying down debt.

Prabhu Starwood“Our view has been: let’s assume the worst and prepare for it. We want to have no problems whatsoever with liquidity, and we want to have no problems whatsoever with leverage.” Starwood CFO Visant Prabhu

Indeed, having enough cash and the ability to borrow it is of paramount importance in a time of falling revenues. That’s especially true at Starwood, which has been changing its business model over the last six years from a hotelier heavily enmeshed in real estate to one that stresses leasing and managing its properties and burnishing its brand. Up until the downturn, Prabhu was heavily involved in helping his company shed real estate assets.

While that has left it less vulnerable to the current unraveling of property values, it has also meant that the company is picking up less revenue than its peers. For example, revenue for the company fell by 4% in 2008 , according to figures supplied by Capital IQ. In contrast, the average revenue decrease for a group including Starwood and four other comparable companies — Choice Hotels, InterContinental, Wyndham Worldwide, and Marriott — was just 1%.

On the other hand, Starwood’s cash as a percentage of revenue rose by 168% versus the average,which dropped by 5%.And the company cutits selling, general, and administrative expenses as percentage of revenue by 2.2% in 2008, while the average of the group rose by 3.9%.

Like the decreased revenue, the rise in the cash percentage and the cost cuts seem to have stemmed in large part from the company’s change in business strategy.

Since 2006, Starwood has been looking to slash its investment in owned real estate and home in on the management and franchise sides of business. In that period, it has sold 56 hotels for about $5 billion.

The turnabout has caused the kind of decreases in revenues that hotel companies always suffer when they sell off properties. It’s a trend that doesn’t bother Prabhu all that much, however, because it’s been matched by a simultaneous surge of cash on the company’s balance sheet. Having loads of cash on hand seems to fit in well with the mindset of a finance chief who enjoys being prepared for the worst. An edited version of CFO’s recent interview with Prabhu follows.

What are the biggest leadership challenges you face as Starwood’s CFO?
I’ll focus first on the challenges the crisis of the last 18 months has caused. Being in this business puts you at the epicenter of the crisis, in two dimensions. To a significant degree, the crisis has been driven by the real estate segment of the economy. Many of the issues relating to the financing of real estate are relevant to our sector. But we are not an issuer of commercial mortgage-backed securities and the like because we are not in that business.  That is done by mostly pure real estate owners.  

On the one hand, we’ve been impacted by what’s going on in real estate; on the other, hotels are an economically sensitive business impacted by the economy. So the twin crises — a crisis in real estate and a significant shrinkage in the economy — are directly impacting us. 

Being an economically sensitive business, that is probably job one. So the first thing we did as we saw things beginning to turn down was move very, very fast to deal with two aspects that we knew we would have to deal with: a) our costs, and b) our capital spending. The first thing we did was launch, in the middle of ’08, a variety of cost-reduction initiatives. We took out between 25% and 30% of what we call “above hotel costs,” or SG&A, well before things really turned down badly.

We went through process by process, function by function, across the globe. And instead of telling everybody, “Cut 20 %,” we looked at structure, looked at value, looked at where there was opportunity to control a bit. Where we could broaden people’s jobs. Where there were things that we might have done in good times that are not as valuable now. 

How many layoffs did you make?
There are no specific numbers we’ve thrown out. But what we’ve been saying publicly, which is evident in our numbers, is that our SG&A costs have come down between 25% and 30%.  In fact, in the first quarter they were down 28% from what they were in the same quarter the previous year. 

Where did the bulk of that cutting occur?
The vacation-ownership [time-share] business took a very big hit, because the consumer has been hard hit. We worked with that business to take their infrastructure down almost 50% because of how much their business was being hit by this. We’ve taken the infrastructure back to where it was three or four years ago because that’s where the sales base has been.

We scaled back sales centers and development activities and the SG&A stuff that oversaw all that. The bottom line was to say, When our sales space was roughly half what it was today, three or four years ago, our SG&A was x % of those revenues. What does it take for us to get our G&A back to the same percentage?

Have you outsourced any finance functions?
We haven’t done a lot of outsourcing. We’ve done more centralization. For example, we’re in the process of centralizing some payables and payroll functions from all over the company, including the hotels we own. We are going to be evaluating further centralization and outsourcing portions of it. 

On a much bigger scale, we have outsourced a significant portion of our entire company’s [information technology] organization offshore. Our IT function in the hotel company is a big enterprise because we run large proprietary reservations systems. So that’s where we’ve been looking at outsourcing and offshoring in a big way. And we look at doing similar things in other functions. We are looking at it in finance, and we will probably look at it in other functions too.

Beyond cost cutting, what are the biggest challenges you’ve been facing as CFO?
The second thing we did was to really scale back our capital spending. This is a capital-intensive business in both our hotels and our vacation ownership. We went through a very rigorous process of prioritizing capital and concluded that we were going into a credit crunch. Therefore, cash was going to be king. Capital spending had to be scaled back, and couldn’t be done on a pruning basis. It had to be radical surgery. And we had to assume that cost of capital was going up. 

We had to cut back on projects other than the ones that had truly the very best returns and the most essential capital. In the hotel business, you have to spend capital in good times and bad because if something fails you have to replace it. In our vacation-ownership business, we became very selective about which projects we would pursue. We decided we were not going to start anything new because we have stuff we can sell and the cost of capital is very high. So we dramatically scaled back our capital spend by 60% or 70% for 2009. 

In the last two or three months, the focus has been on maximizing liquidity and continuing to reduce our leverage. Our view has been: let’s assume the worst and prepare for it.  We want to have no problems whatsoever with liquidity, and we want to have no problems whatsoever with leverage. 

What do you regard as your greatest achievement as finance chief?
If there’s one thing that I think I’ve been happy about, it’s that we haven’t been surprised in terms of our results, even though the industry has taken a very big hit. We have reacted fast on the cost-and-capital front.  And we haven’t bee caught flat-footed either on a liquidity or a leverage basis.   

If I looked at us today I’d say, “I feel phenomenal. We’ve got access to extraordinary liquidity. Our leverage is very comfortable. We’ve been beating our numbers consistently relative to expectations even though they’re down year over year.” But you know, that’s just today. Today doesn’t matter as much as being prepared for tomorrow.

What is your biggest nightmare as CFO of Starwood? What keeps you up at night, if anything?
I try not to let things get to the point where anything keeps me up at night. I like to look at worst-case outcomes and know what I’m going to do in those situations. If I’ve already dealt with a nightmare while I’m awake I don’t have to dream about it at night. 

Another thing: we are absolutely intolerant here about people surprising us. We have a culture in which there are absolutely no penalties to delivering bad news and an extraordinary amount of support and encouragement if people are willing to deliver bad news fast, when you can do something about it. 

The worst situations are where people sit on things and don’t tell you and then they tell you at a point where you can’t do anything about it. That we don’t tolerate. 

So you are very well acquainted with the black swan?
Absolutely. I’ve always been of the view that the world in the end is fundamentally unpredictable, and you just need to know how you’re going to react. And you need to have sufficient facts and sufficient time to deal with things. So our people are very, very attuned to the idea that bad news has to travel fast. 

Was the company’s change from a real-estate-heavy strategy turning to a lease-and-management model the main driver of the 158% rise in cash on the balance sheet in 2008?
Yes. That strategy is one of the reasons I came here. We have reduced the capital intensity of the business. We dramatically increased our ROAs and ROEs, dramatically improved our cash-flow profile, and significantly reduced our cyclicality. Today, our management and franchise business, in which we get paid fees for the use of our brands, for managing hotels, and for all the other services we provide, is only down 15% in the first quarter, whereas our owned hotel business, like all other owned-hotel businesses, is down 50%. So the fact that we own half as much as we did five years ago has allowed us to be far more resilient in this crisis. 

Our capital needs are lower, which means that even in a terrible downturn we will be cash-flow positive. The job is not done, however, and we will continue to lighten up on our ownership of real estate. The other thing we did is to substantially enhance our focus on development, which is the process by which we bring new hotels into our system. We have almost 400 hotels that are likely to open in the next three or four years, which, relative to our current size, is a huge amount of growth. 

Does the fact that your revenues have been down relative to your peers have anything to do with the change in strategy?
Oh, absolutely, because what happens when you sell hotels is that you can no longer book the revenue. All you do is book the fee. It is a deliberate strategy of reducing your revenues but increasing your margins and increasing your capital intensity. 

Yes, we’ve sold hotels. We lost some of those profits and kept the fees. But we took a large amount of assets off our balance sheet, generated cash, increased our margins ,and made this business a much higher-margin, higher-growth, less-cyclical, cash-rich business with much higher ROE.

What was your role as CFO in shaping this policy?
The finance function and the CFO play a very big role in the selling of the real estate and the focus on development,. Clearly, the sale of the real estate was a central aspect of what I had to do.  The brand side was more of a support role for the finance function.    

What’s been the upside and the downside of this strategy since the economic crisis hit?
There’s been no downside as such in the sense that we’re quite happy that we own less real estate. It insulates us this during a crisis like this hits. Now would we have been a little better off if we had owned less real estate? Yes, we would have been better off if we owned even less.  

This is not a great time to be selling hotels, so we’ll be very careful not to sell too much.  We’ll probably slow down and wait until things get better. But otherwise, we feel pretty good about everything we did. We’re not regretting any of it. 

What was your thinking behind the $500 million notes offering? It seems to have come at a pretty high cost.
We’ve been very quick at turning on a dime to do bond issues. We’ve been watching our spreads widen to yields-to-maturity as high as 18%. For a very sound company, that was quite ridiculous.  here was no way we were going to issue bonds at those rates. 

Then we started seeing things tighten up in the second half of March. And then I decided: let’s run like hell to be ready to issue bonds if there’s a window the day we issue our earnings, because I sensed that the momentum was on our side. So we called a couple of banks, got everything lined up, and raced to get our 10-Qs ready. 

On Wednesday evening [April 22], we got all the internal approvals. On Monday morning [April 27] we looked at the market. It looked like it was opening well, and our goal was that if we can do a deal in the single digits we would do it. Until Thursday morning [April 30], it didn’t look like it would get there. But the stars aligned, and we were ready and able to push through to an 8.75% yield to maturity, which was astonishingly better than anything we could have looked at even a few weeks ago. It substantially enhanced our liquidity to do that. 

Why was it that you particularly wanted to time your senior note offering with your earnings release?
Well, we didn’t necessarily want to time it with our earnings release. It’s good if your 10-Q is ready because the bond underwriters like to have that. Your first window when you’re this close to earnings is on the day of your earnings release. And it was a Thursday, and Friday is not a great day to do a bond issue. So it was either you go on Thursday or you wait until the following week. And this is in a market where windows have been opening and shutting very fast. So we jumped in.