On a rapid course for expansion: The unorthodox strategy adopted by Royal Caribbean Cruises

Financial Times

December 27, 2004

Richard Fain, chief executive of Royal Caribbean Cruises, rises from a chair in his office overlooking the Miami coast to explain how one of the company’s ships will be “stretched” next spring.

He points to a computer model that illustrates this novel form of ship surgery. The 74,000-tonne Enchantment of the Seas will be cut in half and a new 73ft section inserted. The logistics are complex: the midsection will be floated from Finland and then wedged into place at a dry dock in Rotterdam using hydraulic jacks and 18-wheel lorries.

Why such an elaborate operation? It is simply the quickest way for Royal to increase capacity to meet a growing demand for cruises, says Mr Fain. “We can add a relatively small number of berths but at a profitable rate,” he explains. “This way we can maximise the existing hardware.”

The stretching initiative will add 151 rooms at a price of about Dollars 60m (Pounds 31.3m), compared to the Dollars 800m or so that it would cost to build a similar ship. Royal plans to have Enchantment of the Seas back in service by July 2005, whereas new ships take years to build.

The dry-dock method reduces costs by about Dollars 7m – an important saving given the declining US dollar and the fact that the majority of cruise liner construction takes place in Europe.

With the launch of nine ships since 1999, Royal has expanded its fleet by about one-third yet still cannot meet demand. The company did not expect high growth in passenger numbers just a few years ago. Indeed, it made a bid for P&O Princess, a UK rival, in November 2001 to strengthen its financial position following the terrorist attacks of September 11 2001.

“In the dark days after September 11, we thought, ‘How will things change?’ We were more highly leveraged than our competitors, so if times were bad, we would be punished disproportionately,” says Mr Fain.

Royal’s move caught the jealous eye of Carnival, the world’s largest cruise company, which made a counterbid for P&O in December 2001. A fierce, drawn-out tussle followed, concluding with P&O’s wedding to Carnival in April 2003 after a Dollars 8.2bn hostile takeover.

Mr Fain is calm and introspective when recalling the drama. “There was a lot of excitement in being involved with something like that,” he says. “Obviously, I was disappointed, but the deal was initially struck at a time when our bargaining power was not at its highest.”

Without a trace of irony, Mr Fain recounts his telephone call to Micky Arison, chief executive of Carnival, to offer congratulations the day after the rival’s bid was accepted – a magnanimous gesture on Mr Fain’s part, considering he once described the battle for P&O as “rancorous”.

As it turns out, Royal overestimated the downturn. Like its competitors in the cruise industry, it rebounded surprisingly well from a “perfect storm” created by terrorism, the war in Iraq and the Asian outbreak of the Sars disease – mainly because travellers more willingly took to the seas than the skies.

Cruise companies also expanded their operations to regional ports to accommodate a growing number of “drive-to” passengers – those who preferred driving to their embarkation point rather than flying.

In 2003, the worldwide number of cruise passengers increased by 6.6 per cent to 9.83m, according to the International Council of Cruise Lines, an industry body. Total expenditure by passengers and companies’ operational costs rose to Dollars 12.9bn last year, against Dollars 10.3bn in 2000. “After 9/11, we did better than we could have imagined,” said Mr Fain.

Royal may be benefitting from the sector-wide upturn, but it has also created some momentum of its own. With just two brands and 29 ships, Royal is much smaller than Carnival, which has 12 brands and 75 ships. But it has carved a niche for itself with some attention-grabbing marketing initiatives such as adding rock-clim bing walls to all its ships and bringing Cirque du Soleil, the Canadian circus troupe, to its Celebrity cruise line. When Enchantment of the Seas is stretched next year, Royal plans to add bungee trampolines and suspension bridges.

Royal is also trying to change the perception that cruising is an activity reserved for retirement couples and the elderly. This year it launched Xpeditions – branded cruises to Antarctica and the Galapagos Islands – adventure destinations not normally associated with large operators.

It is also trying to appeal to families by offering childcare facilities and clubs for teenagers. The company has formed a partnership with Fisher-Price, the toymaker, to develop programmes for children and parents, noting a sharp increase in children under three cruising with their parents in the past few years.

Further, the cruise industry remained relatively unscathed even after a record four hurricanes this summer. Operators retained bookings and continued to run cruises by changing itineraries and moving their ships out of a storm’s path.

Although the impact of the hurricanes dented Royal’s earnings by 10 cents a share in the third quarter, net yield – an important industry gauge – rose by 12.8 per cent to pre-9/11 levels. This was due to increased capacity, ticket revenues and on-board spending by guests.

Advanced bookings and pricing are strong and the company expects fourth quarter net yields to rise by 4 to 5per cent from previous forecasts of 1 to 3 per cent. As demand for berths outpaces supply, Royal has seen a 7 to 9 per cent increase in prices this year.

Still, Carnival remains solid in the number one position. Last year it generated Dollars 6.7bn in revenue, not including results from P&O Princess. Royal, by contrast, had sales of Dollars 3.8bn.

Analysts say that its heavy load of Dollars 5.8bn in debt, Dollars 955m of which is short-term, remains a drag on the company, though Royal has said it plans to refinance.

Soaring oil prices are also a concern for Royal, though it is about 45 per cent hedged for fuel costs for fourth quarter.Against this, cruise companies are enjoying the effects of the weak dollar, as more travellers are booking cruises in advance to lock in rates for spring and summer.

The future may be difficult to predict, but for the time being Royal Caribbean appears to be on course for further growth.

A CAREFULLY PLOTTED ROUTE TO MEET DEMAND Royal Caribbean Cruises has adopted a number of tactics to meet the demand for cruise berths and expand its market share.

* Increased capacity: Royal will splice a new 73ft midsection into Enchantment of the Seas in spring 2005 to add short-term capacity. The ship is expected to be back in service in July 2005 with an additional 151 cabins.

* Departure points: Royal opened a new port in Bayonne, New Jersey, in May 2004 as an alternative to Manhattan’s cruise port, where facilities have been criticised as overburdened and outdated. Across the industry, companies are expanding from traditional departure points into cities such as Boston and Galveston, Texas.

* New markets: Royal launched adventure cruises to Antarctica and the Arctic in March 2004 in an effort to attract a younger market. Trips to Galapagos Islands are planned for summer 2005.

* Fixtures and fittings: Royal has installed rock-climbing walls, first introduced in 1999, to every ship in its fleet.

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