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Sea Of Green
Indeed, Carnival is so cash rich that over three years ending in 1998 it will build seven new cruise ships at a total cost of $2.1 billion without incurring much in the way of debt. This year, for example, Carnival will pay an estimated $674 million - in cash - for ship construction. Last year, it paid $432 million cash for construction. Five of the new ships will be delivered to Carnival's flagship Carnival Cruise Lines, and two will go to its more upscale Holland America line.
And still, there is money left over. Frank, Carnival's 54-year-old vice chairman and chief financial officer, is charged with figuring out what to do with it all. "I think my principal mission in life these days is to try to find ways to deploy our free cash flow in ways that will give us good returns," says Frank, who came to Carnival in 1989 after 14 years as a partner at the accounting firm Price Waterhouse and is now second-in-command to Carnival Chief Executive and Chairman Micky Arison. Consider the outlandish cash flow generated by Carnival's cruise ships: The new "Fantasy" class ships carry 2,040 passengers, cost $300 million to build, sail 100% occupied year-round and produce cash flow of $85 million annually. So, it would seem to make dollars and sense to build more of those floating leviathans after the current construction program ends in 1998, and Frank says that is a strong possibility.
Still, there are conflicting signs right now about the future of the U.S. cruise industry. In 1993, 4.5 million people took cruise vacations in the U.S., and trade groups predicted the number would rise to seven million by the end of the decade. In response, cruise lines ordered more than two dozen new ships, most of them capable of carrying 1,800 or more passengers.
After two decades of continuous growth, however, the number of people taking cruises actually declined from 1993 to 1995. The Cruise Line Industry Association expects 4.6 million people to take cruises this year, barely more than in 1993. Cruise industry analyst Paul Mackey of Dean Witter Reynolds in New York reports 15 to 20 cruise ships are up for sale, and many smaller cruise lines are struggling to survive. Jim Godsman, president of the Cruise Lines Industry Association, argues that the industry is healthier than passenger counts suggest. The U.S. economic recession early in the decade prevented cruise lines from ordering new ships. Since ships take about three years to build, there were virtually no new ones delivered the past two years. For example, Carnival received three ships from 1993 through 1995, compared with the seven it will receive between 1996 and 1998. In 1994, Carnival was the only U.S. cruise line to take delivery of a new ship.
Since the cruise industry operates at 86% of capacity, there wasn't much room to add new passengers on existing ships. "There are a whole lot of people writing about the industry and saying the industry is going to hell in a hand basket," Godsman complains. "It's not true."
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Industry malaise
Frank agrees that a lack of new ships caused passenger counts to stop growing. He says his company isn't worried about the health of the industry, which Carnival largely created in the 1970s by changing the image of cruising from a pastime for the idle rich to a middle-class holiday.
So far, the industry malaise hasn't hurt Carnival at all. In fact, the cruise line may be speeding up an industry consolidation process that Frank believes is inevitable. While the number of people taking cruises of at least three nights' duration fell slightly from 1993 to 1995 - from 4.5 million to 4.4 million - Carnival increased its passenger volume from 1.15 million to 1.54 million. Its market share rose from 26% to 35%, almost double the share of its largest rival, Royal Caribbean Cruise Lines. That 35% share looks especially good considering Carnival had just 26% of total ship berths at the end of 1995.
"We're adding five more ships (in addition to two delivered already this year) and the likelihood is that in 1999 and 2000 you may see additional ships from Holland America and Carnival," Frank says. "We have a great belief that this industry is going to continue to grow and prosper." For the six-month period ending May 31, Carnival carried 843,000 passengers, compared to 697,000 the year before. Earnings have grown in similar fashion. Last year, Carnival earned $451 million, or $1.59 per share, on revenues of $2 billion, for a 23% net margin. Cash flow from operations totaled $587 million. This year, most analysts expect Carnival to earn at least $525 million in net income, or about $1.85 per share. Frank expects cash flow to top $700 million.
Of course, it should be noted that Carnival's earnings are boosted by the fact the company pays virtually no U.S. income tax. Its ships are registered overseas and the company qualifies as a Panamanian corporation for tax purposes, even though it has 1,400 employees at its Miami headquarters. Carnival paid just $9.4 million in 1995 income taxes, as all of its shipping-related income was tax exempt. That put Carnival in the enviable 2% tax bracket.
New ships have been forcing the older ships - especially those carrying fewer than 1,000 passengers - into obsolescence. This has the effect of transferring more and more of the industry's total capacity to the major players.
Industrywide, there were 126 cruise ships in service with 105,000 berths at the end of 1995. The Cruise Line Industry Association estimated then that those figures would grow to 133 vessels with 116,000 berths by the end of 1996.
But Frank says the trade group's estimate of growth is inflated. He expects total capacity will increase by only about 3,000 berths this year, as older, smaller ships rapidly come out of service. These ships lack the amenities and economies of scale to compete with the megaships. They're also subject to new federal safety regulations that require expensive retrofitting.
"What's been happening is the number of ships coming out [of service] has exceeded our expectations," Frank says. So while Carnival's capacity could grow from 26,000 berths to perhaps 40,000 berths from 1995 to 1998, industry capacity may grow at a much slower pace than the 5% to 6% envisioned by the trade group.
Thus, Carnival should grow at a much faster pace than the industry as a whole. "If you look at our numbers for the first half of the year, we continue to show fairly dynamic growth," he says. "At a time when the industry will grow anywhere from 2% to 5%, we are probably going to grow another 9% to 10%. Based on that, if you extrapolate out, we could get close to 40% [market share] by 1998 or 1999. Clearly we are taking market share right now."
Mackey says Carnival will continue to draw passengers away from other cruise lines. They are newer, nicer and no more expensive for travelers. "For the majors, it really is a field of dreams," he says. "They tell me the [Carnival ship] Destiny, which won't even go into service until late November, is already booked well into 1997." The 101,000-ton Destiny will be Carnival's largest ship yet, with 2,600 berths.
Nevertheless, there is that nagging little question about future growth. Frank acknowledges Carnival can't grow forever by siphoning passengers from weaker cruise lines. Robert Jenkins, travel writer for the St. Petersburg Times, notes there is some feeling that the cruise lines are running out of virgin marketing territory. Carnival's TV ads featuring Kathie Lee Gifford are ubiquitous, and all cruise lines nowadays offer special packages for wedding parties, business conferences, wine tasting groups, family reunions and myriad other groups. "I don't think there's much they've missed" in the way of marketing, Jenkins says.
Earlier this year, Carnival managed to find a place to invest some of its cash while at the same time developing a new market. Carnival paid $300 million for a 29.5% interest in the United Kingdom's largest tour operator, Airtours Plc., which provided vacations for 4.4 million people in 1995. Airtours operates two cruise ships in the Canary Islands and the Mediterranean and owns 32 airplanes.
Frank believes Carnival's ties to Airtours will provide an excellent marketing opportunity. The European cruise market is approaching one million passengers annually but Carnival carried just 3,000 Europeans on cruises last year. Mackey believes Carnival could triple that number this year with minimal effort.
Another analyst, Peter McMullin of Southeast Research Partners in Boca Raton, also likes the Airtours deal for its marketing possibilities. "I think there are more strategic implications than the immediate returns on that," he says. Both Mackey and McMullin have buy recommendations on Carnival stock, which traded for about $28 per share in late June.
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European potential
Frank suggests Carnival may join with Airtours to build a European-based cruise line. "There is a huge potential market there and none of the European cruise operators, in our view, has exploited it very well. I think there is an opportunity for a stronger operator to go into Europe and do more with it," Frank says.
Another investment possibility is buying up smaller competitors. Carnival made a move in that direction last year when it paid $81 million for bonds in ailing Kloster Cruise Ltd., the parent of Norwegian Cruise Line. Carnival hoped to use the bonds to strike a deal to buy Kloster, but ended up selling them earlier this year when negotiations went nowhere. Frank predicts there will be just three major cruise companies in the future - Carnival, Miami-based Royal Caribbean and Los Angeles' Princess are the big three now - with a few smaller niche operators at the high-end of the market. "The companies in the middle group, they may be consolidated. The smaller companies with older ships are of no interest to anyone," he says bluntly.
Carnival is also involved in a joint venture with the Continental Cos. of Miami, called Carnival Hotels, that has signed a letter of intent to build a resort in Panama. Frank says Carnival Hotels is not a major investment.
Longer term, there is a possibility of expanding into the cruise business in Asia. One Singapore-based company, Star Cruises, is doing well and is building two new ships. "They certainly would seem to be the forerunners of cruising in the Far East," Frank says.
"As we get bigger, I think we're looking for ways to explore opportunities in other parts of the world both in the tour and travel business as well as in the cruise business," Frank says. "That doesn't mean we don't have confidence in the cruise business. We are building ships as fast as we can. It's not so much that we don't think we can grow the market, but we are going to have a lot of free cash flow beyond that. We are looking for ways to deploy that cash flow."
