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Simon Says Merge

Already the largest mall owner in the country, Simon Property Group is poised to become even bigger if its acquisition of Chelsea Property Group meets shareholder approval in an upcoming proxy vote. The $3.5 billion cash and stock deal would give the Indianapolis, Ind.-based real estate investment trust (REIT) greater diversity by adding the lucrative factory outlet segment to its own portfolio of regional malls as well as big opportunities for growth in Asia.

Chelsea owns 18 of the top 30 outlet centers in the U.S. on a sales per sq. ft. basis, according to Les Morris, a spokesman for Simon. At the end of the first quarter, Chelsea's 31 U.S. centers generated $404 per sq. ft. with 98% occupancy.

Chelsea's 16.1 million sq. ft. portfolio also includes four centers in Japan, which generate $800 per sq. ft. in sales. The company also has five other Japanese centers in the pipeline, one of which was a joint venture with Simon prior to the merger.

Chelsea's strength in Japan complements Simon's strength in Europe, says Simon spokesman Les Morris. In November, Simon purchased a 49% stake in 38 shopping centers in France, Italy, Poland and Portugal, acting as a partner with the Rinascente Group, an Italian retailing giant.

In addition, Simon owns nine other centers in Canada, France and Poland. Chelsea and Simon have compatible international development philosophies, Morris says. Each prefers to work with local partners rather than going it alone in unfamiliar territory.

With rental costs for Chelsea tenants now 8% of sales on average, Morris says, Simon sees room to grow rents in the Chelsea portfolio. Simon also plans to introduce some of its own ancillary revenue programs, according to Morris, including programs that open the malls to vendors looking for short-term promotional space, such as MCI.

Analysts are high on the deal, which is expected to close in the fourth quarter. “Size has proven to be an effective strategy in increasing value for mall REITs as management teams have effectively cross-marketed tenant relationships, marketing activity and reduced operating costs,” wrote Prudential Securities analysts James Sullivan and Robert Belzer. “We expect similar synergies from the Chelsea transaction.”

Investors' reaction also has been favorable. Chelsea (NYSE: CPG) gained nearly $5 a share, rising from $58.34 to $63.35 when the announcement was made June 21. As of July 19, the stock was hovering around $65. Simon (NYSE: SPG) has held steady at $53 per share for most of July.

But are outlet centers a good long-term bet for Simon? Some observers aren't so sure. “When the outlet center business started, it was a unique concept in that it was done in mill towns, and the stores that were in there offered real value: real overruns, real mistakes in production,” says Howard Davidowitz, chairman of Davidowitz & Associates Inc., a New York-based retail consulting firm.

“As the business developed, what you have now are chain stores that have hundreds of outlet stores, like Dress Barn. The particular reason for an outlet is no longer valid,” adds Davidowitz.

Chelsea's management team will remain in Roseland, N.J., operating as a division of Simon. Barry Vinocur, publisher of Realty Stock Review, says although Chelsea's top executives have non-compete agreements, he wouldn't be surprised if the top officers begin to leave in 2006.

“Nobody's going to tell you on their honeymoon night, ‘Look, I don't think I'm going to be married to this person three years down the road,’” says Vinocur. “But I think the question that is obviously on everybody's mind is what will happen down the road.”

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