From Travel Weekly:
Mergers on the horizon in small luxury-cruise sector?
By Dan Luzadder
When top executives in the small luxury-cruise sector talk these days about their struggle to keep business afloat during three years of travel recession, war and shifting economic winds, the change in tone is as clear as a bosun’s whistle. They say they are upbeat and optimistic about the next two years. They are pleased that competitive pricing for high-end luxury cruises is finally stabilizing. Their wealthy and travel-savvy clients are filling ships, reflecting a rising demand from a broader segment of the affluent.
Bookings are coming in earlier, sellouts are happening more quickly and volume is up by 20% to 40% over the first quarter of last year. All are signs of a healthy recovery and are particularly welcome in a sector that has been slower to recover from travel’s economic woes than other segments of the luxury travel economy. But this small band of elite cruise operators also appears to be on the cusp of a major shakeup, one that could change the look, if not the art, of the sector.
CEOs and presidents of luxury-cruise providers, along with industry experts and other observers, said they expect consolidation to surface in the “near future” and suggest that signs are already visible in the wake of better economic conditions. How soon consolidation will occur remains a subject of debate, and exactly what shape consolidation might take -- absorbing of small brands by large companies or combinations between small, independent operators -- remains difficult to discern.
An urge to merge
Several of the sector’s leaders acknowledge that they are considering merger strategies as part of their long-term thinking on the future of the sector as a way to improve profits and meet head-on what could be a rapidly growing market in luxury travel that may soon outstrip capacity. The potential sea change is made more likely by profitability concerns. Though business is up and the “have-money, will-travel” market of affluent consumers is growing, operators are still overburdened with costs that are keeping profitability below the levels that some owners, shareholders and lenders want to see. And because quality of service is a nonnegotiable item, cost-cutting is seen as difficult to do without undermining the product.
“Historically the sector has provided awesome product, wonderful onboard cuisine, superb service, and it’s generally loved by the travel agent community,” said Larry Pimentel, co-owner and CEO of Florida-based SeaDream Yacht Club. “The trouble is, it isn’t making a lot of money.” Pimentel and others within the sector say that what makes luxury cruising attractive to wealthy customers is the same thing that makes it difficult to be profitable.
While small, intimate ships are popular with travelers, owners must spread considerable costs among far fewer passengers than larger cruise lines, which often carry thousands of passengers at a time.
“You have one captain with a 200-guest ship, and one captain with the Queen Mary 2, and your cost ends up being the same,” Pimentel said. “Small ships going to the most exotic and unique destinations require a lot of development work. There are many things like that which make the cost of delivery too high.”
The answer could lie in the deeper pockets of larger companies that can bargain for better rates on commodities, port fees and a host of other costs of doing businesses, without compromising world-class service.
Economies of scale
Some players in the marketplace already have accomplished those economies of scale, most notably Yachts of Seabourn, Radisson Seven Seas and Crystal Cruises, all of which are operated as divisions of major shipping or contemporary cruise companies. Deborah Natansohn, president of Seabourn, said partnering with Carnival has made Seabourn better able to compete against the independents. “Whenever you get economies of scale, that is an advantage to the bottom line,” she said. “Being part of Carnival, we already realize those economies, and we benefit from their purchasing power, whether it is fuel or champagne.” When it comes to shared costs, Seabourn is the exception, however, not the rule.
On the other hand, she said, that doesn’t necessarily mean that Carnival is willing to build small ships to serve a growing luxury market, unless it is clear that it would be the best use of resources.
“Carnival is always looking for growth opportunities,” she said, “but also to get the best return for shareholders.” That might explain why Carnival and other major players are not building small ships in anticipation of market growth in luxury cruising. Large ships invariably give better return on the dollar.
Does that mean that Carnival has incentive to put Seabourn into play if the sector should begin to consolidate? “I’ll never say never,” Natansohn said. “In every industry, you see people looking toward how consolidation or partnerships can lead to a better return. I don’t think the luxury-cruise industry is any different.”
Silversea: A ‘first mover’
Albert Peter, CEO of Silversea, one of the most respected of the small lines and one of the first to take the plunge into the ultra-luxury market, is among those who see business combinations as having a growing appeal within the sector. “Consolidation makes sense,” Peter said. “It would certainly be useful from the economies-of-scale perspective, and it would be something we would welcome.” He describes Silversea as a potential “first mover” in any consolidation plays, in part because he expects the market to grow as a result of more affluent baby boomers who are using their wealth to see the world and because of new wealth in places like China and Southeast Asia, which are still largely undeveloped markets for luxury cruising.
“I believe that ultra-luxury cruises can be a lot bigger,” Peter said. “There are certainly bankers who agree with that.” He said his company will revive a plan later this year to launch an initial public offering on one of the European stock exchanges. The IPO has been in mothballs for at least two years during the economic downturn. But Peter said it has been moved again to the forefront in the wake of improved results in the luxury sector.
Silversea’s plans to go public may leave company owners, the Lefebvre family of Rome, with a controlling interest. But taking the luxury line public could sends ripples through the sector, especially if access to new capital enables the company to pursue acquisition or to fund faster organic growth. It could also put more information in the hands of institutional investors that have the ability to influence corporate decisions on how best to promote profitability.
That could mean changes in business models -- particularly the all-inclusive models used by a number of the luxury operators -- and in cruise destinations. It also might influence how quickly other companies move to expand capacity with newbuilds, if Silversea is able to grow more quickly than competitors. Peter, meanwhile, says that while consolidation would be helpful, “you have to look at the situation involving these companies. You have [shipping conglomerate] NYK involved with Crystal Cruises and Radisson owned by [Carlson Cos.], one of the largest family holdings in the U.S. You have to look at each respective shareholder to know its needs and desires.”
He said he remains optimistic about such opportunities. “If you look at the Carnival low-cost model and the ultra-luxury model, it is clear that Carnival’s model works better than ours,” he said. “But I truly believe there is a very good market for us, and once we find the right size and get rid of overcapacity, hopefully, one day, two companies can meet and find the right solution.”
Cost hinders growth
Rob Kwortnik, an assistant professor at the Cornell School of Hotel Administration, specializes in the cruise industry, a decision stemming in part from his early exposure to the business through his father, a former cruise line executive and consultant to the Cruise Line Industry Association. Kwortnik recently prepared a case study on Carnival, and said the luxury cruise industry is poised for change.
“It is really an exciting time to watch the sector,” he said, with growth on the horizon. But he said it is widely noted that luxury-cruise operators have not rebounded as quickly since 9/11 as their counterparts in land-based luxury accommodations. He attributes that to cost issues. “It wouldn’t surprise me to see some consolidation at this point, but more along lines of a company with deeper pockets and marketing power purchasing one of the independent luxury brands,” Kwortnik said. “You have to ask yourself, ‘Would the luxury segment benefit from that kind of partnership, rather than seeing, say, Silversea and Crystal combining?’ It might make more sense.”
Crystal Cruises President Gregg Michel said he sees opportunity for consolidation in the industry, without referring to any specific company, but said that “given the recent restructuring of fleets and organizations, companies are better structured to compete on their own.” Crystal, which deploys the largest ships in the luxury sector, operates under the umbrella of companies owned by NYK (Nippon Yusen Kabushiki Kaisha). Like Seabourn, Crystal uses NYK’s purchasing clout to its advantage.
The idea of major-minor player combinations seems more logical, Kwortnik says, when considering the “astonishing” difference in the numbers of passengers that the contemporary and premium segments carry, compared with the luxury sector. The major companies account for 95% of cruise sales, while the small luxury brands serve just 5% of the cruising public, he said.
“The difference is so dramatic,” he said. “Carnival will embark in less than a week the same number of passengers as Seabourn can embark in a year. That gives you some indication of the scope, distribution and brand power that some line like Royal Caribbean or Star Cruises could bring to one of these smaller luxury companies.” Interest in smaller luxury cruise lines could be stimulated by market forces if the size of the market for luxury cruising grows as some in the industry predict, said Kwortnik. “The front end of the baby boom is about to retire and move squarely into the crosshairs of the luxury sector,” he said. “What you read these days about the wealth and buying power of the baby boomers suggests that you may see this sector just explode.”
At the same time, competition for the market is likely to grow as well. What was once called the mass market (now labeled as the contemporary segment) has narrowed the gap between the low-cost and the premium cruise market, capturing customers by improving service, Kwortnik said. The premium market has done the same thing to attract customers who want luxury but at a somewhat lower price, squeezing market share out of the luxury providers.
“Carnival, for instance, delivers an excellent product at a pretty amazing price,” Kwortnik said. “No one would dispute that the level of service on the luxury brands is superior and no one would dispute the quality and amenities of luxury cruising. But some of the premium brands are able to deliver on product for far less money. If you have a per diem at Carnival of $100 a day and it is $700 at Silversea, that is a sizeable difference. “
Natansohn said the trend is an issue that luxury operators have learned to deal with. “I think in the last 10 years, as new ships have come on line for the contemporary sector, it has put pressure on premium, and the premium has, in turn, put pressure on the luxury sector,” she said. “With new ships come new amenities.”
But the premium brands can’t match the luxury sector’s personalized service, which is possible with only 200 passengers onboard. “The experience is different,” Natansohn said. “We can go to intimate ports and more pristine destinations. We have a one-to-one crew ratio. The food is going to be of higher quality, like the difference between going to an intimate restaurant or to a catering hall.”
Challenged by profitability
While some see the financial pressures brought by banks and other lenders as a primary catalyst for change in the industry, Mark Conroy, president and CEO of Radisson Seven Seas, has a slightly different view. “Obviously, we are all privately owned, so the banks don’t decide our fate, our owners do,” Conroy said. “But our shareholders certainly want us to maximize profitability.”
The sector, Conroy notes, was on track to be very profitable in 2001, up to the point of the U.S. terrorist attacks. “After that, the trajectory was different,” said Conroy. “We have returned to the trajectory we had in 2001. But I think my owners would like to know that we are not one-trick ponies.” As a result, business management is coming under closer scrutiny, with cost containment a focal point in discussions about sustainable service. “You have to provide service efficiently, and you have to provide the service that people are willing to pay for,” Conroy said. “It may be OK if you don’t have costs in line when business is booming. But when it is not, then you are going to get hurt.”
As pressure mounts from owners and lenders for better bottom-line performance, market share is being fragmented between traditional luxury competitors and the luxury options from the premium sector.
To make it more complicated for small luxury lines, Cunard’s two large, transatlantic ships, the Queen Elizabeth 2 and the Queen Mary 2, are drawing thousands of passengers at luxury prices, siphoning business from the small-ship lines.
It has led to speculation over where the luxury cruise business might end up. “This is definitely a sector in transition, and it is a necessary transition,” said one upper-level executive as he chatted with competitors and industry officials between sessions at the Seatrade Cruise Shipping Convention last month in Miami Beach. “There is no choice, as I see it, but consolidation.” Conroy sees some common ground among providers in that perspective. “If consolidation makes sense for the premium guys, then it makes sense for us too,” said Conroy. “We all have substantial owners and our owners all have their own vision about what they want to do as a company. But, any time you have a merger discussion, you raise a lot of questions.”