Westfield: history, characteristics, and significance

Westfield Group is one of the world's largest developers and managers of retail property. They operate 119 malls in Australia, the United States, New Zealand and the United Kingdom. The group is solid financially and has a strong, experienced management team. They have been able to leverage these strengths in part by sticking to their core business.

This has resulted in a finely-tuned organization, but also one that lacks in diversification.

Westfield is liquid, but has seen a decrease in revenues and profits in the past couple of years, in part due to economic slowdown. The firm is partly insulated from this by virtue of their strength in the Australian market, but their lack of diversification continues to put them at risk. The firm's tactics and objectives appear to be relatively congruous. However, despite placing an emphasis on the development of human resources, the company is essentially family-run, which is a deterrent to top talent. Also, despite the importance of the U.S. market to Westfield, they have only one American on their Board, indicating a lack of knowledge in the U.S. market at the top of the company.

Despite the global economic slowdown, Westfield has several opportunities for growth. However, the company's risk aversion means that it would require a leap of faith for them to move aggressively into the Asia Pacific market or to expand rapidly in the U.S. And UK via acquisition. More likely, the best option for the firm, given their internal capabilities, is to stay the course. This will help them to weather the current economic storm, and allow them to retool over the next couple of years to better take advantage of opportunities when the global economy heats up again.

Background

The Westfield Property Group is one of the world's largest retail property management firms. The company's primary business is the operation of shopping malls. The Sydney-based company is listed on the Australian Stock Exchange and has a market cap of AU$25 billion. The company operates a total of 119 shopping centers in Australia, New Zealand, the United Kingdom and the United States. All told, the company manages a portfolio of over 10 million square meters of retail space worth $63 billion. In 2007, Westfield turned a profit of $3.4 billion on revenues of $5.9 billion.

The Westfield Group began in 1956 when two immigrants, John Saunders and Frank Lowy, set up a retail development in the Sydney suburb of Blacktown. The two had operated a delicatessen, a coffee lounge and a small property venture to that point, but had seen the potential of a larger-scale retail operation in the area. At the time, shopping malls were unknown in Australia. The trend was nascent in the United States, and the first two shopping centers arrived in Australia in 1957. In July, 1959, the first Westfield shopping center opened in Blacktown. Within weeks of opening the center, offers for partnerships and joint venture came pouring in. The partners took up some of these offers and began to develop multiple properties in the Sydney area. By 1960, the duo took Westfield Properties public.

From that point, the company experienced slow but steady growth, opening properties in major cities and suburbs across Australia. Their first big move overseas came in 1977, when they opened a mall in Connecticut. The company experienced strong U.S. growth in the 1980s. The 1990s saw further expansion, to New Zealand and the United Kingdom, and the company began to take the form in which it exists today. The company bought into the Mall at the World Trade Center in 2001, only a few weeks before the terrorist attacks, and would eventually sell their interest in the property a couple of years later, only to re-buy into the project in 2008. A wide variety of transactions in the past eight years has significantly increased the size of Westfield's real estate portfolio to its current state. In 2004, the current incarnation of the Westfield Group was formed, when subsidiaries Westfield Holdings, Westfield Trust and Westfield America were merged into a single group.

Currently, Westfield's 119 properties are divided as 55 in the United States (5.8 million square meters); 44 in Australia (3.5 million square meters); 12 in New Zealand (0.4 million square meters); and 8 in the United Kingdom (0.4 million square meters). These properties have a total of 22, 763 retail outlets and are worth a total of a$62.2 billion. The company is the largest retail property manager in the world by market cap. The company's competitors include British Land in the UK and Centro in Australia. In the United States, competitors include Simon Property Group, General Growth Properties, Voronado Realty and Macerich.

As a vertically integrated company, Westfield has three main business activities, all pertaining to their shopping centers. The first is Property Management, which comprises mainly of the marketing and leasing of retail space in their centers. Key elements of this activity include the retailer mix, creating a positive shopping experience and fostering an environment that encourages shopping. This part of the business drives most of the year-over-year revenues. As with any retailer, the key measure for this part of the business is same-property sales, that is, the incremental growth in sales from the same property one year to the next.

The second main business activity is Property Development. This involves the design and development of new shopping centers. Westfield also arranges the construction and leasing of key anchor stores under this activity. The anchor tenants are dealt with in this activity because their presence mitigates the risk inherent in the construction of new shopping centers. Construction does not commence until anchor tenants are in place. Some of the key anchor tenants used by Westfield include Wal-Mart, JC Penney, Coles, Woolworths and cinema operators.

The third main business activity is Fund/Asset Management. Westfield has expanded its activities to provide asset management services. The market for these consists of institutional investors and other investors of equivalent size and sophistication. Some of these investments are undertaken as joint ventures with other large investment firms, or in limited partnership arrangements.

Westfield's organizational structure is broken down geographically. There is a main Global unit and four regional units. This structure supports the company well because Westfield operates mainly in one business, and each geographical unit can deal better with issues pertaining to that nation. The senior executive team is experienced, with an average age of 49 years and an average tenure with Westfield of 13 years.

The Board of Governors for Westfield Property Group is headed by the Chairman Frank P. Lowy, one of the two founders of the company. Three of his sons are also on the Board, including the two Group Managing Directors Steven Lowy and Peter Lowy. In total, the Board's composition includes four executives (three of them Lowys), and nine non-executives. Ten Board members are from Australia, two from the United Kingdom and one from the United States. The experience of the Board members reflects the disciplines important in the property management business. Five come from a law background, five from a finance or economics background, two are Lowy family members with the real estate background and one has a different background.

In 2007, the Westfield Group saw a significant reduction in its revenues and profits. The cost of revenue continued to increase even as revenues decreased. The Group has continued to make investments to grow the company despite the challenging environment. In 2008, the environment has become even more challenging, both in terms of slumping consumer demand due to weakened global economies, but also in terms of a credit crunch that has limited investment opportunities and the willingness of retailers to expand their operations.

The company lacks a strong sense of mission or vision. Their mission, as outlined on their website, is "to deliver investors steady returns and solid long-term capital growth...within a framework that attempts to balance economic, social and environmental issues." These are, of course, the basic strategic objectives of any corporation, as outlined by Milton Friedman. It can be inferred from this not that the company has no clear vision of its future self, but that the vision is essentially a larger version of the current company. Westfield appears to have placed some priority on developing more community, social and environmental aspects to their operations, but these are ancillary to the core strategy of developing and operating shopping centers. Ideally, the company would have more clarity in terms of its strategic objectives regarding market share, revenues, market position, and other broad variables. Without such clarity, the company has a sense of direction but no particular focus.

The Westfield Group is well-positioned as one of the only international retail property management firms. They have considerable room for growth, and a strong track record of generating positive returns for their shareholders. The company is well-insulated against economic fluctuations because of the structure of their leases. They are continuing to develop new projects, and are expected to launch two new projects in Sydney this year, as well as opening a new shopping center in London.

Internal Environment

The Westfield Group's success is predicated on its many strengths. One of the key strengths from which Westfield derives competitive advantage is its human resources program. One of the key competitive drivers in the industry is knowledge, so Westfield has made the development of knowledge, information and wisdom a cornerstone of its strategy. The company not only strives to identify, attract and hire the best talent, but it also has extensive programs in place to bring that talent along. There is a detailed training program, for example. The goal of Westfield's human resources strategy is to grow and nurture key staff members. The firm believes that wisdom derives from experience, and therefore seeks to have executives with a significant amount of work experience and a long tenure with the company. Supporting the human resources strategy are tactics of open communication, fostering diversity, and encouraging the free flow of ideas at the managerial and executive levels.

Another key strength of the Westfield Group is its high occupancy rates and long-term leases. These help the company to weather economic downturns. For example, the current weakness in the U.S. market has not affected the Westfield Group significantly because its properties have a high occupancy rate, currently at 97.3%. Customers are generally locked into long-term leases, ranging from 5-7 years in Australia to 10-15 years in the United Kingdom. This provides stable cash flows that help insulate the company from the economic shocks to which they, being dependent on the retail sector, would otherwise be exposed.

Another strength is the company's vertical integration. Since their very first property in Blacktown, Westfield has undertaken the design, the construction and the operation of their properties themselves. As a result, they have a high degree of control over their operations. This allows them to stay at the cutting edge of developments in the mall industry, something that has afforded them a competitive advantage since the earliest days. It also allows them to cover their risks more effectively. For example, they are able to establish anchor tenants before beginning construction. As a result of vertical integration, Westfield is able to consistently complete projects on time and on budget, giving them a significant source of competitive advantage.

Lastly, Westfield derives strength from its capital management. As of the end of 2007, the company had $7.7 billion in liquidity, which the company uses to invest, both in new property developments and on the open market. This allows them to engage in income hedging to help protect their investments from foreign exchange fluctuations. The group's expertise in capital management has allowed them to make that function a third component of their business.

Westfield has few weaknesses. One is their lack of diversification. Although they are invested in four countries, 92% of their capacity is located in either the United States or in Australia. This lack of geographic diversification is not unusual in the industry, but it does increase the risks inherent in Westfield's operations. Weakness in the UK and U.S. markets to this point has been offset by strength in Australia, indicating some operating hedge, but overall two markets is insufficient to provide strong insulation against market fluctuations. Moreover, the company only operates in one business. They are very good at retail property management but are exposed to declines in this business. Moreover, the Australian market is becoming saturated, which compromises Westfield's ability to grow business domestically.

Another weakness is found within the composition of their Board of Directors. Although the most important functions are well-represented, there is little geographic representation. Although over 50% of their capacity is located in the United States, only one of thirteen Board members is American. Ten are Australian. This does not reflect the structure of the company's operations nor does it accurately reflect the importance of the U.S. market to the company's success. As a result, Westfield does not have adequate oversight of American operations, because they do not have on their Board enough directors with sound knowledge of the U.S. market.

Lastly, the company appears to suffer from limited innovation potential. There is little room for upward mobility in the company, with the top positions being taken by sons of co-founder Frank Lowy. This can be a hindrance to attracting top personnel; as such talent will recognize that career potential is limited. Westfield appears to provide strong opportunities to learn about the retail property management business, but with the top positions seemingly locked up by family, it is difficult to imagine that the company will be able to execute its human resources strategy to its fullest potential. Moreover, the long-term human resources approach would appear to stifle innovation. The industry is not very dynamic, but should market forces shift dramatically or accelerate rapidly, the firm is likely exposed precisely because of its lack of dynamism.

Westfield is a solid company financially. The income statement shows a decrease in the past year in their revenue earned of 27.5%, mainly on a decline in revenue from property revaluations. However, the core property revenue also posted a decline, of 6.3% last year. Although the company cut expenses slightly (1.3%) the bulk of this was in financing costs rather than operating costs. As a result, the company's profits declined 38.6% last year.

The reduction in financing costs reflects a reduction in debt at Westfield. The company was also able to increase assets. This was a result not only of new project completions but an increase in the value of existing assets year-over-year. As a result of these changes to the balance sheet, Westfield improved its debt ratio to 45.6% from 52.0% and its debt-to-equity ratio to 84.1% from 108.4%. These figures also represent an improvement in leverage from the point when the current incarnation of the company was founded in 2004.

In the past year, the balance sheet has maintained this structure, with the debt ratio increasing slightly to 45.8%. Revenue and net income for the first half of this year, however, was down significantly over any six-month period since the 2004 reincarnation. The company has affirmed guidance recently, however, as a sign that despite the slowdown, the firm's recent performance is more or less as expected.

External Environment

The Westfield Group has several opportunities of which it can take advantage. The market in the United States still has significant room for growth. Westfield has only slightly more capacity in the U.S. than it does in Australia, which indicates substantial growth potential in that market. Moreover, it has access to capital that U.S. retail property developers may not have at present, due to the credit crunch in the U.S. Thus, Westfield's international scope and ability to raise capital in the relatively stable Australian market provides it with the opportunity to move on U.S. competitors whose growth may be stifled by the current economic situation in that country. For example, the company expects to raise $2 billion in the next couple of years as a result of reinstituting its dividend reinvestment plan.

Another key opportunity for Westfield is the Asia-Pacific market. Outside of Japan, Western-style shopping centers are a relatively new concept. Yet, the burgeoning economies of the region have given rise to a substantial middle class. Western-style suburbs have even begun to emerge in larger centers, such as Shanghai and Bangkok. There has been significant contact between Australia's business community and many of these countries in recent decades, so such a move would not at all be without precedent. Furthermore, the growth prospects in the region appear strong, and the Asian economies provide an additional level of diversification for Westfield.

A third potential opportunity is a move to other real estate markets, such as commercial/light industrial. Such a move could take place in Australia or the United States and leverage many of Westfield's existing competitive advantages and core competencies. Such a move would not be without risk, but would provide an additional level of diversification to the firm's earnings.

Westfield's strengths have allowed their revenues and profits to be relatively stable despite a substantial number of threats in the external environment. Chief among those threats is the economy, in particular in the U.S. And in Australia. The economies of these countries can impact Westfield in a number of different ways. Because Westfield's customers are retail outlets, the company is subject to demand fluctuations that are tied to consumer spending. Consumer spending in turn is affected by a wide range of economic variables. These include consumer confidence, interest rates and inflation. Reduced consumer confidence will lower purchases, which in turn will reduce profitability for retailers. This will lower the demand for retail spaces. Interest rates and inflation can not only affect consumer demand but can also affect the value of the rents earned by Westfield. Remember that Westfield's tenants typically sign long-term leases. A strong upward shift in inflation or interest rates will reduce the future value of those cash flows.

Economic fundamentals also hint at a long-term strategic threat to Westfield. The company's robust growth in the U.S. market has been fueled in part by the insatiable demand of the U.S. consumer. However, the American consumer is saturated with debt to the point where future growth may be forced to slow. Moreover, the imbalance between U.S. consumer spending and Chinese consumer saving represents a serious threat to the stability of the global economic system. The U.S. consumer must slow spending, regardless of the current economic state, in order to maintain global economic stability. Because of the high level of dependence that Westfield has on U.S. consumer demand, this economic reality represents a strong threat to their U.S. growth potential.

As an international company, Westfield is also subject to exchange rate risk. The company's cash flows can be hedged in a number of different ways. The most viable for Westfield is the operating hedge, wherein foreign-earned income is plowed back into development in the foreign country. However, the effects of exchange rate risk on the income statement cannot be hedged, and the company can suffer reduced earnings if the value of the U.S. dollar in particular declines sharply against the Australian dollar.

The retail property management industry is also subject to strong competition. In the U.S. In particular, the industry is relatively fragmented. There are a number of strong regional competitors against which Westfield is competing. For the most part, Westfield is larger than any of these, but this can also be a disadvantage in that Westfield may not have the same level of local knowledge as the local firms. Furthermore, Westfield has different competitors in each country, reflecting the reality that very few firms in this industry transcend national borders. The presence of many strong competitors makes it more difficult for Westfield to address any one competitor directly and specifically.

A fourth threat is the potential lack of anchor stores. The construction of a new shopping center does not commence until suitable anchor stores are found. However, many markets are becoming saturated for key anchor tenants, which may reduce their willingness to anchor a new center by Westfield. This threat may be minor but its impacts would be huge were this situation to manifest. Westfield is heavily dependent on anchor stores, such that attracting them is conducted by an entirely different business unit than regular retail outlets. Any decline in ability to attract or retain anchor stores will result in a reduction of Westfield's ability to grow.

Strategic Analysis

In terms of their everyday operations, Westfield is in a sound position. Although recent economic events have depressed earnings somewhat, the company has continued to be profitable. Westfield has strong financial capacity, having just raised $2 billion on their dividend reinvestment scheme. Thus, despite weak capital markets and a credit crunch in the United States, Westfield's financial position is very sound. They are liquid and have reduced their debt load in the past year.

Westfield has consistently demonstrated competency in marketing. The company has added and developed properties rapidly over the past decade but in that time has also managed to keep occupancy rates low. Even now, the economic slowdown has only reduced U.S. occupancy rates incrementally. This stands as testament to Westfield's ability to not only develop good malls but to fill them as well.

Westfield's management team has been cultivated from within. The advancement process is slow, so by the time a manager arrives at a senior position he or she is very experienced in retail real estate management and has a long tenure with the company. In terms of corporate governance, the firm's directors accurately reflect the functional skills needed to succeed in the retail real estate industry. In addition, the firm's financial performance appears to reflect economic circumstance and a general lack of diversification rather than any specific weaknesses in management.

Westfield is positioned well to defend against adverse economic circumstances. The company appears to have long ago recognized the cyclical nature of consumer spending and developed operational hedges against that reality. While the long-term leases generate consistent revenue streams, the company does still have exposure to economic downturns, as the disappointing performance of their U.S. subsidiary this year indicates. However, management has done an excellent job accounting for economic cycles and therefore Westfield does not appear to have suffered as much as many other firms have as a result of the slowdown.

In terms of other strategies, Westfield appears to have honed their strategies well to suit their needs. The company has recognized the value of human resources as source of competitive advantage in an industry where knowledge, wisdom and experience are key success traits. Their accounting practices and corporate governance are strong, in order to defend against the risk of fraud or other adverse outcomes of poor practices. Overall, Westfield is a very well-run company that is well-positioned given the current state of its internal and external environments.

Strategic Alternatives

Over the years, Westfield has taken great strides in building consistency and predictability into their business.

As a result of this conservative management approach, the company's greatest risk comes from the state of the economies in the United States and Australia. The current situation has resulted in both opportunities and threats to Westfield. Thus, four main courses of action emerge as potential alternatives for Westfield's strategic thrust in the coming years.

The first is to continue on the current growth trajectory. The company has been on its present course for the past decade or so, focusing on expansion in the U.S. And Australia and dipping their toes slowly into the UK and New Zealand markets. Westfield has sufficient capital to continue on its current trajectory even in the event that the economic downturn becomes worse. The firm is liquid and profitable, and is therefore operating from a position of strength. Moreover, to continue to follow the existing strategy leverages Westfield's core competencies. Lastly, Westfield does not at present have any particular strategic mission other than to continue on its present course. Such a decision would limit upside potential but would be congruous with the firm's present mission and competencies.

The second alternative is to retrench until the full impacts of the economic slowdown are known. This would involve halting new projects temporarily. Advantages to this would be to further insulate the firm against the slowdown - under these economic circumstances occupancy rates for the new projects could be unusually low. This would also help the firm maintain stability in the event that the slowdown hits Australia, which can reasonably be expected. The disadvantage is that the firm fails to take advantage of its relative strength to take advantage of opportunities in the market.

The third alternative is to move into the Asia Pacific market. This would have several advantages. One is that Westfield would become further diversified with the addition of an extra geographic region. If the economies is the Asia-Pacific region advance anywhere near the level of Western economies, the opportunities for growth are near limitless in this region. This would give Westfield the opportunity to get into these markets relatively early, allowing it to grow into a dominant player such as they have done in Australia. These markets, however, are subject to more risk than western markets. Moreover, the legal and cultural systems are drastically different, adding a dimension of potential operational difficulties that Westfield has not yet experienced in the course of its international growth.

The fourth alternative is to shift towards more growth by acquisition. This method would leverage the company's solid financial position and access to capital to acquire competitors and properties at values that have been depressed by the economic slowdown. This strategy could be employed in the most depressed countries - the United States and the United Kingdom - to build Westfield's market share in these areas rapidly. The firm has expressed an interest in this mode of expansion and it is relatively congruous with their current competencies and structure. There remains significant room for growth in both of these countries. The biggest risk factor is that asset values in both countries could remain depressed for a long time. Some pundits have predicted that the U.S. will enter into a long recession. Worse, the tactics that the U.S. government appears to want to employ to handle the crisis closely mirror those of the Japanese government in the early 1990s. There are differences between the two situations but the underlying principles at work suggest that the result of the U.S. approach to the problem today may ultimately have a similar outcome of salvaging the economy at the cost of prolonged recession.

The specter of this outcome would dramatically increase the risk of this option, particularly if Westfield increased its leverage to finance these acquisitions.

Recommendation

It is recommended that Westfield pursue its current course of action. The company is fairly conservative and risk averse. At present there are strong risks associated with each of the other options, except retrenchment. Retrenchment, however, does not fit with the company's mission to growth shareholder wealth. Expanding into the Asia Pacific region is inherently riskier given the higher risk associated with those economies, not to mention the lack of familiarity Westfield has with those markets. Expanding their acquisition program dramatically would increase the firm's leverage. While the economic slowdown has not yet hit Australia, there is little reason to believe that it will not in the next year or so. Increasing leverage in a time of slowdown is not a sound strategy, unless the slowdown is going to be minor and short. At present, there is a significant risk that the global economic slowdown will be neither minor nor short. Thus, the course of action that is not only most congruent with the firm's existing competencies and competitive advantages, but also is the most suited to the threats present in today's economic environment, is to stay the course and expand incrementally in their existing markets.