The proposed merger between Royal Caribbean Cruises (RCC) and P&O Princess Cruises (POC) will create the world's largest cruise company with 47 ships and 86,887 berths capable of carrying approximately 3.3 million cruise passengers a year in 2002, compared to Carnival Corporation's fleet of 46 ships, 66,807 berths, also capable of carrying approximately 3.3 million passengers a year in 2002.

The merger talks were underway before the September terrorist attacks, prompted by the softening of the economy, according to the two cruise companies.

The combination has an aggregate market capitalization of approximately $6 billion, with POC holding a 50.7 percent interest and RCC 49.3 percent.

Carnival's market capitalization totals about $15 billion.

While the new group does not have a name yet, the corporate entities of RCC and POC will each take the new group name, with dual stock market listings.

The new combined entity will have a single, unified business headquarters in Miami and a significant corporate office in London, according to POC. The group will also maintain what it called a "substantial presence" in Los Angeles and Seattle, as well as other offices in the U.S., U.K., Germany and Australia.

Richard Fain, currently chairman and CEO of RCC, will be chairman and CEO of the group. Peter Ratcliffe, currently CEO of POC, will be managing director and COO OF the group.

Rationale

The two cruise companies are combining mainly to cut costs. But the merger is also expected to help RCC and POC maximize the potential of their ships through what they called strategic deployment; to accelerate the geographic penetration of cruising into new global vacation markets; and to enhance their product offering in existing vacation markets, according to a prepared statement.

The cost savings are expected to be at least $100 million per year, after the merger is completed.

The savings are expected to come primarily from marketing efficiencies, improved purchasing, rationalization of offices in various locations, reduced information system costs and combining Alaska tour operations. The one-time cash costs of integration are expected to be less than half the level of the annualized savings.

Nick Luff, CFO of POC, will become CFO of the new company. Richard Glasier, currently CFO of RCC, will assume a new position within the group.

The new company expects to retain the majority of the debt facilities currently in place for RCC and POC. It also intends to put in place additional debt for the funding of new ships that do not already have financing in place.

The merger is expected to be completed in the second quarter of 2002. The new company will operate the Royal Caribbean International (RCI), Celebrity Cruises and Princess Cruises brands separately.

Joint Venture

RCC and POC also plan to launch a new joint venture in Europe with four new ships, two contributed by RCC and two by POC. The four new ships - two Radiance-class and two Grand Princess-class - are currently on order and are scheduled for delivery in 2003 and 2004. The joint venture will have an asset base, including the ships, in excess of $2 billion.

The new company will offer a product targeted to Southern European customers, primarily from Italy, France and Spain, thus competing head on with Carnival's Costa Crociere.

If the joint venture comes to fruition, however, it also signals that RCC and POC are less confident in the domestic growth potential by removing four new ships that were originally destined for the North American market. The upside is that the move will reduce domestic capacity, thus lessen the downward pressure on pricing. But price increases here could be offset by a lower price level in the European market.

Poison Pill

However, the structure of the joint venture has led some analysts to describe it as a poison pill to keep Carnival from spoiling the merger. At press time there were rumors that Carnival would bid for POC shares although Carnival has given no such signals. But the company has previously expressed an interest in POC.

Analysts also speculate that Carnival could block the merger by acquiring a large enough shareholding of POC to veto the high shareholder approval required.

According to reports, RCC and POC have also discussed a merger as long ago as 1991.

Market Shares

The new combined RCC and POC company will have a market share of approximately 38.2 percent in North America in 2002, compared to 38 percent for Carnival. The third largest operator will be Norwegian Cruise Line (NCL) with an estimated market share of 11 percent.

With two companies controlling 80 percent of the industry, more stable pricing may result, although NCL would still be there as a potential spoiler.

Thus, it makes more sense that Carnival's next move will be to bid for NCL, which it almost acquired jointly with Star Cruises before being outmaneuvered in 2000. Such a move would enable two companies to control nearly 90 percent of the cruise market - practically all of the mass market.

However, cruising is discretionary spending and vacationers have many alternative vacation choices, so the cruise companies will have little choice but to follow the market. If they raise prices too high, vacationers will simply go elsewhere.

Perspective

From investors' point of view, the ultimate question is whether the merger of the second and third largest and most profitable companies, which notably also have the largest debt loads, will create a new more profitable unit or just a larger company which will still be the second (and third) most profitable and will still have the largest debt load.

At the end of September, RCC and POC had a total debt load of $5 billion, compared to $2 billion for Carnival, which also has $3.3 billion in liquidity.

The two companies may also benefit differently from the merger. For instance, RCC's debt/cap ratio is 62 percent, POC's is 47 percent. The combined company will have debt/cap ratio of 56 percent. So in the new unit, POC will have to help pay off RCC's debt.

The merger is also being termed a "merger of equals," but in recent corporate history there is no such phenomenon. When RCC acquired Celebrity, it was also called a merger of equals. Today, Jack Williams, president of RCI, is also president of Celebrity.

That begs a second question: How well will POC operate under the leadership of RCC - or vice versa? How well will the two corporate cultures integrate?

Right now there must be plenty of concern in Los Angeles where Princess is headquartered based on the statement that the new company would maintain a "substantial" presence in Los Angeles.

The two companies also said the merger will allow them to maximize the potential of their ships through strategic deployment. RCC and POC operate in many of the same markets so it remains to be seen how the new company will best deploy its ships so as not to cannibalize each other. The three brands of RCI, Celebrity and Princess may be strong in different markets and have different passenger followings, but overlap in many areas in terms of product quality and delivery and itineraries.

RCC and POC also said they would accelerate the geographic penetration of cruising into new global markets. That is at best a high-cost and low-profit proposition based on RCI's recent cutbacks of programs in the Southern Caribbean, changes in the Royal Journeys program, and its withdrawal from the Far East a few years ago.

The bottom line is whether the new combined entity can operate significantly more efficiently and attract more business than RCC and POC could on their own.