Luxury Hoteliers Magazine 3rd Quarter 2019 | Page 48

BUSINESS STRUCTURES (The Midnight Buffet) Disney, Virgin and Ritz-Carlton have each structured their entry into the cruise market differently. Disney took the traditional approach with a significant capital investment to own its ships and set up a separate cruise organization with marketing, sales, hotel operations and ship/technical operations distinct from Disney’s other operating businesses. This approach is operationally complex and involves a unique set of regulatory and legal rules and standards foreign to most hospitality organizations. Virgin Voyages has been funded by Bain Capital. Reportedly, Virgin has contributed its brand and management efforts in exchange for equity in the cruise company, which operates as a stand-alone entity, and a licensing fee. The capital for Ritz-Carlton Yacht Voyages was provided by the private equity firm Oak Tree Capital Management (as reported by Oak Tree). Ritz-Carlton will receive a licensing fee, oversee the hotel and spa operations of the ships and provide marketing and sales functions (which will take advantage of its past guest lists and rewards program). It is unclear whether the technical and navigational aspects of the ships will be managed by a third- party ship management company or whether the owner entity will operate the ships themselves. Regardless, Ritz-Carlton will not be involved in the technical and navigational management functions of the ships. The use of ship management companies and third- party ownership is very common in the shipping and cruise industry and is very similar to the structures used in the hotel industry. National Geographic has entered into a pure licensing agreement and sells cruises through its travel services group. The simplest structure for an existing brand to enter the market is very similar to the model used in the hotel industry. A third party will provide the capital for and own the ships and will most 48 ILHA likely hire the technical management company to operate the ships. The brand company will either: (1) time charter (i.e., lease the ship with the owner maintaining responsibility for the navigation, technical management and maintenance of the ship); or (2) simply license its name and contract to market and sell the passenger accommodations. The brand can either operate the onboard hotel, food, and beverage and entertainment itself or outsource the hotel management of the ships. Variations of these structures have been used in the creation of some of the industry’s most successful luxury and expedition cruise products. Additional ownership structures have been utilized on a limited basis. Luxury ships currently operate with condo-type ownership structures. Vacation ownership of cruise ships is recognized under the Florida Vacation and Timesharing Act. Cabin blocks on existing cruise lines and ship charters have been utilized as product offerings by vacation clubs. MINIMIZING RISK (Batten Down the Hatches) The simple structure adopted by Ritz- Carlton best minimizes the business risk involved in entering the cruise industry. The capital investment is obtained from private equity or other private investors. Private equity funds have been enamored with the industry, in no small part due to highly successful cruise industry private equity investments in recent years. Several of those investments have achieved very successful exits recently. In a number of jurisdictions, owning ships has considerable tax benefits, including accelerated depreciation, that also attract investors to this asset class. If structured correctly, current U.S. law (Section 883 of the Internal Revenue Code) exempts cruise lines that own and operate ships engaged in international commerce from tax on income “effectively connected” to the operation of those ships. This exemption includes income earned from itineraries that start and end in U.S. ports, provided the voyage includes international ports of call. Most U.S.-based cruise lines only pay taxes on the income derived from land tours occurring in the U.S. These tax benefits are achieved through a combination of incorporation in certain favorable jurisdictions and registration of the ships in favorable jurisdictions that have treaties with the U.S. or provide similar tax benefits to U.S.-registered ships. The tax structures are too complex to cover in this article but meeting the requirements is typically achievable. A number of businesses and investment funds have business models based on the ownership of ships that are leased or chartered to operating companies. SunStone Ships, located in Miami, currently owns 14 ships and has three expedition ships under construction in China. It owns the ships and provides technical and navigational management through an affiliate and offers hotel management through a separate affiliated ship management company. SunStone does not own or operate the ships under its own brands but exclusively for third parties that market and sell the accommodations under various brands. V-Ships Group, based in Monaco, has managed technical and navigational operations for some of the world’s top luxury cruise brands and hundreds of ships, including passenger and cargo under such management. The use of ship management companies to operate ships for third parties that sell transportation on the ship is extremely common in both the cargo and passenger shipping industries. The operation of a cruise ship is very complex from an engineering and marine perspective. In addition to the navigation and propulsion of a massive ship, the operation involves electrical generation and distribution equivalent to that of a small city, sewage and waste treatment, water treatment, HVAC and the hotel, catering and entertainment operations of a large resort at sea. The difficulty of operating an economically scaled