By Wei Gu From Wall Street Journal

Sales at China’s outlet malls expected to outperform other retailers over next three years

China has a shopping mall glut, but investors believe there is still room to grow.

L Capital Asia, the Asian private equity business backed by LVMH Moët Hennessy Louis Vuitton S.A. , will on Friday announce its second largest investment ever in China, and its first investment in an outlet mall anywhere in the world.

The Singapore-based fund is investing more than $100 million in Sasseur Cayman Holding Ltd., which was founded as a coffee shop at China’s Southwest University by a photography teacher there in 1989. The coffee shop has gone—demolished by city planners—but Sasseur now has four outlet malls, where domestic and global brands sell leftover stock at bargain prices.

“The outlet concept will become much bigger in China,” says L Capital Asia Chairman Ravi Thakran. “As Chinese consumers become more sophisticated, they want better value.”

Sasseur plans to add another four outlet malls this year and bring its network in China to a total of 20 over the next five years. It says sales have increased at 30% a year since 2008, when its first mall opened in Chongqing. Government figures show standard shops stalled last year, with sales by China’s top 50 retailers down 0.7%, compared with 10.9% growth in 2013.

‘The outlet concept will become much bigger in China.’
—Ravi Thakran

“Outlet malls are countercyclical,” Sasseur’s founder and chairman Vito Xu says. “When retail sales fall, there is more excess inventory that needs to be cleared and more demand for bargain shopping.”
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Sales, including clothing, food and electronics, at China’s outlet malls are expected to grow 34% a year between 2013 and 2018, ahead of the 20% growth for shopping malls, 8% for department stores, and 29% for online, according to consultancy Roland Berger. The next three to five years will be a critical window for outlet mall growth, it says.

Full-price shopping malls suffer from slowing demand and increased competition, and there is more to come. Of the 10 cities in Asia that will have the most shopping mall space added this year and last quarter, nine are Chinese, CBRE Research says. The other is Bangkok.

But the number of discounted malls looks manageable. In 2014, China had 76 outlet malls, according to consultancy Zaihang, which says 51 new outlet malls should open over the next three years, bringing the total in China to 127. Despite this growth, China lags behind the U.S. and Europe, where there are 220 and 157 outlet malls, respectively, CBRE says.

Outlets, generally located out of town, are becoming destinations in their own right, helped by rising car ownership in China. Sasseur’s Chateau and Venetian-themed malls, complete with sculptures, ponds and ancient walls, are meant to stand out from the traditionally stodgy looking discounted shopping centers in China.

‘China is a challenging market because growth is slowing, but it is a huge market and still the story globally.’
—Mark Israel

Consumers are also looking more for value. Prices of luxury goods in China are on average 25% to 30% higher than in Europe because of duties and robust demand. And as China’s anticorruption campaign hits gifting demand, brands have been looking for ways to grow. Outlet malls provide a channel for clearing inventory without dedicating too many full-price stores to sales.

Outlet malls offer discounts of at least 30% to standard malls in China, pricing goods at or below the full price in Europe or Hong Kong. That is enough to entice price-conscious Chinese consumers to spend. Chinese customers at Value Retail’s Suzhou Village mall spend 50% to 100% more on average than customers at the company’s European villages, its China chief executive, Mark Israel, says. Value Retail is opening its Shanghai Village outlet mall in October.

“Local Chinese consumers are spending more than the local European consumer,” Mr. Israel says. “China is a challenging market because growth is slowing, but it is a huge market and still the story globally.”

One challenge for outlet malls that have mushroomed in China is finding enough leftover goods to sell, as brands get used to the new normal of slower growth in the country. E-commerce is another threat. Online discounters such as Vipshop.com, have been effective in helping brands, mostly lower to midprice ones, clear inventory through flash sales.

But there is still a largely untapped area—goods made just for outlets. In Western outlet malls, many products are only available at discounted stores, often using cheaper materials and made at lower quality factories. That should help satisfy the growing appetite for Chinese outlet malls.

Also, outlet malls in China will see some of the same trends as shopping centers, with a lot of supply overall, but only a small percentage being extremely successful. Globally, usually one big city has one or two outlet malls. Shanghai already has at least four and more are being built, including three near the soon to be open Shanghai Disney Resort alone. Well-known international companies are involved in each of them.

‘International investors are extremely interested in shopping malls, but they also see it as a high risk market. They are looking for strong operators that they believe in.’
—James Hawkey

U.S. private-equity fund Warburg Pincus, which invested in Sasseur’s first round of fundraising three years ago, also participated in this second round, which was led by L Capital Asia. Warburg Pincus hasn’t disclosed how much it invested.

“International investors are extremely interested in shopping malls, but they also see it as a high risk market,” says James Hawkey, head of retail at property research firm Cushman & Wakefield. “They are looking for strong operators that they believe in, who have projects that are sustainable in the long run.”

IMAGES: There is a glut of shopping malls in China, but one area still has plenty of room to grow. CBRE’s Sebastian Skiff talks to WSJ’s Wei Gu about investment in outlet malls in China. Photo: Getty
Panda sculptures outside a shopping mall in Xuancheng, Anhui province, China, on Nov. 3, 2014. Photo: Getty Images
The Gate of the Orient in Suzhou, eastern China, pictured on May 1, 2014. The building, which has been likened to a giant pair of pants, will house a luxury hotel, offices and a shopping mall. Photo: Agence France-Presse/Getty Images

For more on this story go to: http://www.wsj.com/articles/lvmh-backed-l-capital-asia-in-chinese-shopping-spree-with-investment-in-sasseur-1421913534