Past retail failures in China don't scare Simon away: Developer's partnership with Wal-Mart could be key

August 15, 2005

Executives of Simon Property Group Inc. are confident the shopping mall owner's foray into China will prove successful, even though they acknowledge others have failed there.

In a conference call with analysts late last month, the locally based real estate investment trust announced its plan to be the first American company to develop retailing projects in the communist country.

Its first project will be a 500,000-squarefoot mall at Hangzhou, a city of 6 million people about two hours from Shanghai. Construction is set to begin in October with completion expected in the spring 2007.

Despite acknowledging the failure of others who have attempted similar projects, Simon Chief Financial Officer Stephen Sterrett said the company's model is sound.

"Our strategy to investing in China is wholly consistent with our successful approach to investing in Europe," he said during the July 28 call. "There's been a fair bit of press about some of the world's largest malls that have been developed in China over the last three or four years. I think the track record of those is relatively checkered."

Simon declined to further discuss its plans beyond what was said during the conference call and mentioned in a press release.

Past failures

Scott Harris, spokesman for the New York-based International Council of Shopping Centers, of which Simon is a member, said the failures involve Chinese-based ventures.

"Five or six years ago, when the concept of shopping centers took root there, almost everything was built on the basic premise to outdo each other in terms of size and extravagance," Harris said. "It's inevitable some would make it and some wouldn't."

Following its European strategy, Simon is partnering with another entity to develop properties instead of building a presence through acquisitions, said Richard Sokolov, company president and chief operating officer. In Europe, Simon owns interests in 51 shopping centers in France, Italy, Poland and Portugal.

"We have found the way to get much better returns and create more value for our shareholders is through the development process [rather] than buying something in the acquisition field where our dollars are just a commodity along with a lot of other bidders," he said.

Sterrett told analysts during the call that Simon should realize annual returns of roughly 10 percent, which is consistent with its U.S. operations.

Simon's China project is a joint venture involving Morgan Stanley Real Estate Funds and investment firm Shenzen International Trust and Investment Co., established by the Chinese government to develop shopping centers there.

Why Wal-Mart?

More than a dozen potential projects have been identified, Sterrett said, comprising a total area of about 8 million square feet. Each project will range in cost from about $45 million to $70 million and be multi-level, ranging in size from about 430,000 square feet to 750,000 square feet.

What is different about the projects is that Arkansas-based retailing giant Wal-Mart Stores Inc., the largest importer of goods made in China to the United States, will anchor the mall projects. Simon is better known for developing upscale properties.

While the country's economy is growing, a large chunk of its population-900 million of 1.3 billion-is made up of those considered peasants. Beside its affordability, Wal-Mart already is a known brand in China that appeals to the middle and lower classes, Harris said.

The discount retailer has opened 48 stores in China since venturing there in 1996 and hopes to expand to 90 during the next two years. Most of the existing Wal-Mart stores are free standing, Harris said, making the relationship with Simon even more interesting.

Besides Wal-Mart, Warner Theaters may be an anchor tenant on some projects.

One of Simon's partners in the project, the Chinese government-owned SZITIC, is an owner of Wal-Mart China. SZITIC also has a joint venture with a Hong Kong company called Capital Lands that is developing Wal-Mart-anchored centers in other provinces of China.

China's entry into the World Trade Organization in late 2001 has helped to open its borders to foreign development. Firms from many U.S. industries now invest and sell in the formerly closed country, including Indiana corporations such as Eli Lilly and Co. and Cummins Inc., and law firm Baker & Daniels.

According to a 2002 report by the International Investment Bank, China's economy is forecast to grow at an average of 6 percent annually during the next two decades. If it does, it will become the second-largest economy in the world next to the United States by 2030.

China, currently the world's sixthbiggest economy, recorded a higher-thanexpected 9.5 percent growth rate in the first half of 2005, making it even more attractive to developers such as Simon.

"Macquarie [Bank] is launching [a listed property trust] focusing on China and they have bought a portfolio to seed that investment," said Jeffrey Donnelly, an analyst with Wachovia Securities, during the call. "China is often hailed ... as a big source of growth."

The Australian-based bank announced the same day as Simon's conference call that it indeed will launch the trust within the next year with a focus on retail assets, after paying $93 million for nine shopping centers in China.

In Asia, Simon also holds interests in five Premium Outlet centers in Japan, through subsidiary Chelsea Property Group. Sterrett said the company is developing the outlet centers in South Korea, with the first project serving the Seoul market.

Harris at the ICSC said India could be the next attractive market for developers.
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