Is This a Dream Cruise for Investors?

The path to the altar is strewn with crushed hearts, some of them corporate. But no broken engagement between companies has proved quite so stunning as the one that befell Royal Caribbean International. It stood ready to seal a merger with P&O Princess Cruises (POC ) before a congregation of investors. But then, rival suitor Carnival Cruise Lines (CCL ) swung in and grabbed enough shareholder votes at the meeting to halt what P&O Princess hailed as an investor "dream cruise." That was last Feb. 14, Valentine's Day.

Now, nine months, a few regulatory approvals, and much courting later, P&O Princess has kissed off Royal Caribbean and is betrothed to Carnival. If they tie the knot, Carnival will take P&O Princess in a stock deal valuing the combined company at $23 billion. Despite the usual caveats attending any merger--not least those paid for in stock--the Carnival-P&O marriage looks sweet for investors. To see the deal this way, one must peer past some definite dangers on the horizon: war, higher oil prices, a second and deeper dip into recession. Yet when you look back at where the cruise industry has been and out toward where it's headed, it seems a safe bet that consolidation will shore up business at sea.

Not that the cruise biz is hurting for customers. Through its first three fiscal quarters, ended Aug. 31, industry leader Carnival boarded 2.6 million passengers on 44 ships, which sail under the banners of six different brands besides Carnival, including Holland America and Cunard Line. That was nearly as many passengers as sailed with Miami-based Carnival in all of fiscal 2000. Unlike other travel businesses, Carnival actually saw its profit grow, by 2%, to $825 million on $3.3 billion in revenue through the nine months. Likewise, London-based P&O Princess' pretax profit climbed 9% through September this year, to $310 million, on $2 billion in revenue.

The shadow over all this nice growth is "net revenue yield." That's cruise lingo for the amount of revenue, after such costs of sales as travel agent commissions, per each available passenger berth. While industry revenues have risen, yields keep slipping--by 4% in Carnival's first nine months of this fiscal year and by 6% in P&O Princess' comparable period.

The culprit? Vast expansion of cruise fleets. On Nov. 15, for example, Carnival's biggest ship, the 2,974-passenger Conquest, is set for its maiden voyage from New Orleans to Cozumel, Mexico. All told, in five years Carnival has more than doubled its berths and expects capacity to climb another 18% next year. Similarly, P&O Princess' capacity is up 12% this year. This is why you can sail from, say, Port Canaveral, Fla., on a four-day Royal Caribbean cruise to the Bahamas for $179. With so many new berths, the battle for market share is fought with discounts, sinking yields.

That won't change overnight. But Royal Caribbean already sees capacity growth slowing to 11% next year, from twice that rate in 2001. If P&O Princess' 31,130 berths are added to Carnival's 65,830 and brought under Carnival's control, prices figure to firm, buoying profits. Carnival is best set to exploit those berths: Measured by operating income per berth, its profitability tops P&O Princess' and is much higher than more leveraged Royal Caribbean's (chart). Yet at $29 a share, Carnival trades at less than 17 times Standard & Poor's (MHP ) estimate for profit this year, well below its average past multiple of 22. One risk: While P&O Princess already paid $63 million to get out of its deal with Royal Caribbean, Royal Caribbean could try to win back Princess with a higher bid. Time isn't short. With legal technicalities, P&O shareholders won't vote on the Carnival deal until early next year. Tentative date? Feb. 14.

By Robert Barker

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