Cruise Lines Set New Sails in Rough Financial Seas

The newest ship in the Royal Caribbean Cruises (RCL) fleet will power out from Ft. Lauderdale on its maiden voyage on Nov. 23. The $750 million Celebrity Solstice has onboard features to wow even jaded cruise hounds—a half-acre lawn with real grass for picnics or putting, a two-story spa, and a wine-tasting cellar. Want to gaze at the sea in your bathrobe? By stacking more decks above the hull, 85% of its 1,425 rooms have private balconies, one-third more than other ships.

Royal Caribbean couldn't have picked a rougher time to set sail, however. The travel industry is in its worst slump since the September 11 terrorist attacks seven years ago. To lure customers, cruise lines are slashing prices, eliminating fuel surcharges, and redirecting ships from exotic locations to ports that don't require expensive air travel. "Our bookings held up well until mid-September," says Richard D. Fain, Royal Caribbean's longtime chairman and chief executive officer. "Then mid-September came with a crash."

Slumping demand isn't the only problem. With customers galore a few years ago, the industry ordered an armada of bigger, fancier vessels. Because they take so long to construct, the new ships are now just hitting the water. Royal Caribbean will add six ships by 2012 at a cost of $6 billion. Rival Carnival Cruise Lines (CUK) estimates the industry will launch 38 ships in North America and Europe over the next three years, adding 28% to capacity.

The travel downturn is already taking a toll. Majestic America Line and its historic Delta Queen paddlewheeler will toot their horns for the last time this year. Norwegian Cruise Line—50% owned by private equity firm Apollo Global Management—is complaining about cost overruns on a giant ship being built for it in France. Many in the industry view this as a way for Norwegian to get out of its contract. Norwegian declined to comment. And after 40 years on the seas, the Queen Elizabeth 2, owned by Carnival's Cunard Line, is being retired to become a hotel in Dubai.

Royal Caribbean is being hit by the falloff, too, though huge vessels like the Solstice should help. After netting $603.4 million in 2007, the Miami company will earn $580 million this year on sales of $6.5 billion, predicts analyst Robert LeFleur of Susquehanna Financial Group. The cruise line has been using specials—book a cruise for one, and the second passenger is half-price—to fill many of its ships. But it hasn't discounted the Solstice. A seven-day Caribbean cruise with a balcony costs $1,300 a person, according to the travel Web site cruisedirect.com, about 30% more than comparable packages.

Megaships can be more profitable because they let cruise lines spread fixed costs across a larger base of customers and boast more ways to goose revenues from onboard restaurants and shops. "Even in today's climate, these ships are so economical they will produce a very healthy cash flow," CEO Fain insists. Still, Royal Caribbean's stock price has plunged by more than two-thirds in the past year, to under 12, its lowest level since late 2001.

Solstice is an attempt to reach out to the 80% of Americans who have never taken a cruise, particularly middle-aged women. Royal Caribbean hired a market research firm called Synectics, which in 2006 took five boomer women on a four-month tour of cruise ships, boutique hotels, and furniture stores. The focus group also visited the Solstice's shipyard in Germany. Among the design features they suggested: more storage space above and below the bed, double doors that opened up to the adjoining cabin, and footrests in the showers for shaving legs.

Royal Caribbean hopes to make a bigger splash in December 2009 with the launch of what will be the world's biggest ship, the 2,700-cabin Oasis of the Seas. Longer than an aircraft carrier, the $1.5 billion vessel will feature seven "neighborhoods" including a Central Park with outdoor cafés, as well as a boardwalk with a tattoo parlor and fortune teller. Says Peter Thomson, chief operating officer of travel agent Cruise Holidays: "That's a lot of excitement to sell."v