Q#1 Marriotts CFO proposed this project because: (1) Marriott wanted to separate its management

operations from property ownership. In this way, Marriott could get rid of its real estate investment
business in trouble and related debt; meanwhile the hotel management business could be unburdened and
have the ability to raise additional capital to finance growth. With 10.4x interest coverage after spin-off,
MII could easily get A or even AA credit rating for additional debt. This is the main reason for the spin-
off. (2) The two separate businesses could have more clear business models and get higher valuation
respectively. (3) More career opportunities would be offered to Marriotts management team. This spin-
off is necessary for survival. With 1.5x interest coverage and 59% debt-to-capital ratio, Marriott would
easily be downgraded to BB or even B level. This would make Marriott even more difficult to raise
additional capital and become a vicious circle. Moreover, Marriott had unconsolidated affiliates, which
had $3.1 bn long-term debt but negative equity on their balance sheet. If we consolidate proportionately
these balance sheets into Marriotts, its balance sheet would be even worse. The crucial issue here is
whether this spin-off is fraudulent conveyance and whether the board of directors has fiduciary duties
to bondholders when Marriott is approaching insolvency. Value generated in this spin-off came mainly at
the expense of bondholders; a small fraction might come from better analyst coverage and higher
valuation.
Q#2 Managements responsibilities should be enhancing firm value and maximizing shareholders
returns. With the spin-off, management is clearly doing their job to maximize the shareholders value.
There is no conflict of interest between management and shareholders in this case, given that Marriott
family still owns 25.75% stake in Marriott and the Marriott brothers are still managing Marriott.
However, there is conflict of interest between management/shareholders and bondholders. The spin-off is
done at the expense of bondholders. Most of bondholders are put in HMC, which has significant lower
interest coverage and higher debt-to-equity ratio.
Q#3 There are several reasons for Marriott to disregard other forms of restructuring and focus on a spin-
off. A carve-out would imply that the parent would sell part of the shares to outside investors. This poses
two issues: first, the ownership structure of the carved-out unit would most likely change, which could
challenge how the Marriott family has been running the business; second, HMC doesnt look anywhere
close to having a high sell price or being attractive to outside investors. Again, a split-off would imply a
clear ownership break-up between MII and HMC, shareholders having to decide in which corporation
they would have ownership (not likely to have any of them eager to own HMC alone). Finally, other
forms of pure divestiture would be appropriate if the businesses were somehow unrelated; on the contrary,
Mr. Marriott wants to avoid the distress sale of its overgrown hotel real estate. The spin-off fits like a
glove the purpose of financial engineering without changing control. The fact that more than 80% of the
new corporations would have the same ownership structure also qualifies for tax free reorganization while
giving MII a clean balance sheet ready to raise some debt. Since MC wasnt performing so well, the
spin-off also detracts potential acquirers from considering an offer, since a change of control would
trigger a taxable event. This ties in to the requirements for Section 368(a): First, the new corporation
needs to qualify for continuity of business purpose and continuity of interest, keeping current owners
from cashing out of the business for free; second, there has to be a clear business purpose beyond
financial engineering. While the purpose for MII is pretty clear, the objectives become grey when
focusing on HMC. In other words, Section 368(a) is very important as means to make it more difficult for
a company to get rid of a portion of its business that will eventually go bankrupt and getting away with it
for free. Hence, Marriott will have to prepare a comprehensive explanation on how the spin-off is better
for both services and real estate businesses.
Q#4 The Spin-off makes sense when: PV(MC Consolidated) < PV(MCs service) + PV(MCs properties
holding). Before looking into the actual numbers we can argue that the capitalization of the services
business will definitely increase as result of the reorganization, i.e. the market will price in the
managements access to financing to expand operations and focus on a better performing business. On the
other hand, the real estate business will most probably get hurt in terms of market price and the market
value of debt will likely decrease with the higher bankruptcy probability of the underperforming/over-
levered company. Overall, this means shareholders are benefitted (wouldnt be the case in a split-off,

1 Corporate Restructuring: Jos Liberti

carve-out or other restructuring form resulting in separate ownership) and debt holders get hurt but we
will deal with this issue later on. For now, assuming MII keeps the same P/E ratio as MC, the market
value of debt equals book and the market capitalization of HMC is not higher than its BV we obtain the
results in Exhibit A. As expected, unlocking the services business from a sick real estate will be the
source of value to the entire firm. As a robustness check, the MVD would have to drop more than 60% for
the spin-off to break even with the consolidated company in terms of EV. This scenario is somehow
unlikely even in a fire sale of HMC assets.
Q#5 According to the case, the one we prefer is the corporate conception. This is because the company is
essentially responsible for all the stakeholders which include both debt and equity holders, among others.
This is important because shareholder conception and corporate conception could have led the company
to pursue different actions and to represent the interest of different group of people. Had the company
favored shareholder conception, the company would do everything in the best interest of shareholders and
maybe even at the expense of other stakeholders in the firm. On the contrary, had the company favored
corporate conception, the company would be more holistically consider all actions based on interest of all
stakeholders. These conflicts of interests often lead to agency costs and the discrepancies between
ownership and control, as well as between debt and equity holders. The role of fraudulent conveyance in
this case is to protect all stakeholders in the company. This is because fraudulent conveyance protected
creditors from debtors who tried to shelter their wealth or avoid their debts by conveying their property to
others. Similar to the case, MC is looking to spin-off the company and let one entity with troubled
business/assets to assume majority of the debt. This action may be in the best interest of equity holders
but not debt holders. Debt holders would be put in an inferior position than before since they would have
fewer assets to claim to when things go wrong with MCs businesses. In addition, there is less room for
errors in HMCs property holding business especially when the real estate market crash. Therefore, debt
holders might try to block this spin-off by requesting the Federal Bankruptcy Code, the Uniform
Fraudulent Conveyance Act, or the Uniform Fraudulent Transfer Act to test if the spin-off would trigger
the constructive fraud.
Q#6 For the purpose of this analysis lets consider that we have a fair estimate of the market value of
assets for each of the corporations MC, MII and HMC. Additionally, we can consider that equity holders
have a call option on these assets for which the exercise price is the total value to debt. To get the total
value of debt we need to make the proportionate consolidation of unconsolidated investment affiliates to
uncover true long-term liabilities. We can do this by adding $349 m total commitments to debt holders of
the unconsolidated affiliates to the total long-term debt. Using a set of simplifying assumptions, we can
now compare the total market value of debt before and after the spin-off to measure how much
bondholders get hurt (Exhibit B) using the Black-Scholes pricing model. The results come with no
surprise as all the debt is transferred to HMC while all the ability to pay it down stays on MII. Marriott
basically engineers to skip returning bondholders $1.3bn. An even easier way to look at this would be to
compare the present value of debt for MC at the current interest rates and compare that to the PV debt of
HCM after an inevitable downgrade (from Appendix A) and of MII after a possible upgrade. Note that the
values obtained for MVD post spin-off still make previous assertions about value creation hold true.
Q#7 Mr. Marriott, who has two hats to play (as the top management and as a shareholder), would have to
weigh the side he would like to base his actions on. As a top management, he has a responsibility to
protect all the stakeholders, therefore pursuing a spin-off might only benefit shareholders but would
potentially hurt the debt holders. As a shareholder, Mr. Marriott clearly has a hidden incentive to push for
the spin-off proposal and protect his and other shareholders interest. Therefore, it depends on the sides he
is more inclined to. However, had he played the shareholders role and pursued spin-off strategy, debt
holders would be put in a disadvantage position as they would only have HMC and its property-holding
businesses/assets to rely on. Since the real estate market crash, HMCs ability to pay back debt is doubtful
and the company has less room for errors. Mr. Marriott should be worried about the debt holders and
HMCs capacity to service debt. If HMC cannot do so, it might potentially lead to the bankruptcy of this
entity, thereby affecting Marriotts credibility and reputation ultimately. Besides, spin-off strategy clearly
demonstrates agency costs between debt and equity holders as the two parties have conflict of interests. In

2 Corporate Restructuring: Jos Liberti

good times where the debt holders can easily get paid and equity holders enjoy the upside returns, the
conflict seemed to be unseen. In bad times where the future of the company is uncertain, equity holders
would find ways to stop the bleed even if it comes at an expense of debt holders. Hence, the conflict of
interests and ability of equity holders to effect the change and act in their best interest are the primary
reasons for these costs to exist. To make matter worse, by doing spin-off, Mr. Marriott might have
expected HMC to be fallen into the zone of insolvency or even bankruptcy, so that he could lead the
negotiation with creditors to ask for discount debt payments or even get away without paying back debt.
As a result, spin-off the businesses now would lead the way for him to get away with his desirable
businesses/assets, segregating from the troubled businesses that have large amount of debt. However,
should we operate in an M&M world, where the assumptions are no bankruptcy cost, everything is
correctly priced, and capital structure is irrelevant, among others, we would not be facing this type of
problem. Debt and equity holders would have no conflict as the enterprise value of the two entities (from
the spin-off) and enterprise value of MC would be the same. Additionally, the debt holders would have
gotten paid back, given no bankruptcy and perfect information in the market. Therefore, whether or not
MC decided to spin-off or operate under one entity, it does not matter in an M&M world.
Q#8 We conducted a series of event studies by using three event windows: 1) one day before and after
announcement (Window 1), 2) 3 days before and after announcement (Window 2), 3) 20 days before and
after announcement (Window 3) (Exhibit C). We found that CARs during WINDW 1 and WINDOW 2
are significantly positive, 8.42% and 15.61% respectively. As a result $133 million $215 million value
was created during this period. However, if we look at WINDOW 3, the CAR is only 1.03% and not
significant, which means the announcement did not make a significant impact on the stock price of
Marriott (Exhibit D). The bond price moves to opposite direction. The price went down by around 25% 4
days after announcement. Assuming the price of all $3billion debt of Marriot declined 25%, the impact is
worth -750 million. However, if in the long term, the bond price also was going back to the original price
range. What is behind the movements of the stock price and bond price? We assume that the market first
believed that the deal might be done and the value would be transferring from bond holder to
Q#9 As we described in Q8, the market was more inclined to the expectation that the deal would NOT
happen, which means the stock price would go down to the intrinsic price. Risk arbitrageurs with that
expectation would short the stock and buyback and return when the price goes down (Sell high and Buy
low).
Q#10 Both Penzoil and Texaco management have a fiduciary duty to their respective shareholders.
Having already been awarded $10.3B in appeals court, Hugh Liedtke, believed he would be able to obtain
significantly more than the $2B settlement being offered by Texaco, and would be violating his duty if he
does accept less than that amount. Penzoil may believe that they will have been able to recover more than
the $2B even if Texaco follows through on its threat of bankruptcy. Texaco on the other hand, feels that if
they were to pay the amount demanded by Penzoil they too would be violating fiduciary duty. A big part
of what is preventing a mutually beneficial agreement is ego on behalf of the CEOs. Penzoil feels
wronged by Texaco stealing Getty away from them and Texaco feels that the judgment is tremendously
outsized. Both are willing to go to extremes to defend their position, Penzoil by filing liens on Texacoss
assets and Texaco by filing bankruptcy. In a Modigliani-Miller world there are no bankruptcy costs. If
Texaco suffered no bankruptcy costs, its strategy would have been much more effective in reducing the
final settlement amount, as could have remained in bankruptcy indefinitely without incurring any negative
effects on its operations or share value. As bankruptcy law blocks Pennzoil from grabbing Texaco's
assets, Penzoil cant force Texaco into quickly settling on Pennzoil's terms. This would have worked in
Texacos favor and would have provided them an opportunity to negotiate the settlement down
significantly.

3 Corporate Restructuring: Jos Liberti