People in the Know: Sistema-Gals: India is Next

No. When we built our strategy we were prepared for fluctuations of the market. Therefore we were helped by the tool of financial hedging – the insurance of currency. For example, irrespective of any change in the exchange rate we receive monetary resources at the rate that was at the moment of the transaction was concluded. This is a bit more expensive because of the insurance payment. The crisis has more likely struck those companies which work with small banks. We do not work with banks that are not class A. It is difficult to imagine a situation whereby Sberbank, VTB or Gazprombank would have no money.

What has changed in the company since its shares have been put on the stock exchanges?

With publicity everything has profoundly changed and over the last two years the company has gone through a jump in development: from its structure to requirements for projects and the functioning of the whole business. For example, before I used to put on my hard hat and boots to inspect construction and I supervised everything, while today the methods of management have improved. Previously each premises under construction had a managing director, a chief engineer, and a head architect, and now there is one single unit for each development, the primary goal of which is to organize and control the execution of investment projects, and as a result we have uniform standards of work.

We have also systematized work for every project, we have launched an ERP-system. We studied Russian and world experience of the introduction of such systems within construction companies. We developed methodology, approved regulations, and integrated the software program. Today we have a uniform system of document circulation, design management and finance administration by which affiliated companies also work. Accumulation of all data in one database allows us to see at any moment at what stage a project is at, what approvals have been received, and whether any projects are behind.

Has the structure of the company changed?

To the existing structure civil construction has been added, which is engaged in managing all construction work for all projects of the company, and, in particular, in decreasing the cost price of construction. To supervise this area we have hired Roland Rollov, who previously worked for Hochtief. This structure actually works as the general contractor: it is responsible for making sure all contractors are reliable, that safety on the building sites is observed, etc. This does not mean that the site and money is handed over to the general contractor and it constructs everything. That works are carried out to high standards and on time, also requires the management of the general contractor. The management of assets is allocated to a separate block, which analyzes the portfolios of projects and structures it depending on the current problems of the company. If before there was a financial package then now there is a financial and investment package - we think about the management of our portfolio of debt.

In May Fitch changed its rating of the company in connection with the deterioration of its liquidity. What is connected to the increase in the company’s debts or, perhaps, the fall in its own resources?

In 2007 we moved to the active stage of realization of some key projects. We also raised the liquidity of our current portfolio, we acquired several projects in bonus segments. This also demanded the attraction of additional, external financing. In 2008 we plan to use more actively design financing, that alongside the sale of residential buildings and the growth of investment income will promote the long-term improvement of liquidity of the company.

So it’s not a reaction to the world financial crisis?

Our real estate market is young, and all Russian companies have a lot of debts. In fact banks only start financing projects after the company has invested 20-30 per cent, but the cheapest resources remain credit.

By how much has credit increased for you?

By 1 per cent.

Since the placement of Sistema-Gals’ shares they have fallen in price by 40 per cent? What is connected to this?

All quotations are falling. With a falling market it is difficult to expect one company to rise.

How many projects does the company currently have in its portfolio?

This year the number of projects has practically not changed – a little more than 100. We are guided by high class segments of the market – class A offices, class A shopping centers, elite housing. In total we have more than 5.8 million sq.m. But now we are changing our strategy – we are selling small projects from our portfolio (with areas less than 30,000 sq.m) at the pre-design stage, thus all over again we raise their investment value due to the reception of approvals. We are also increasing the number of large projects.

Why is this?

Re-sourcing expenditures on small premises to larger-scale premises. If you quickly sell these 30,000 sq.m premises then on the development of areas measuring 500,000 sq.m you are guaranteed to earn for a long time. Our new strategy is not to develop small bits everywhere, but to expand them. For example, we are developing a site in Sochi, and buying neighbouring land. Not necessarily border to border, but nearby. We are also buying land plots around our site in Khamovniki. This strategy allows for us to manage several sites at once from one center.

How many affiliated structures are there within the company?

A few more than a hundred, and 99 per cent of them are design organizations: one project - one company. There are not many operational: Sistema-Gals itself, which manages the real estate of CitiGals, Mosdachtrest, which is responsible for the area of renting summer residences, Bolshoi City and the recently bought Gorky-8.

Why does Cushman & Wakefield / Stiles & Riabokobylko estimate your portfolio of projects at more than the company’s value on the stock exchange?

In connection with the general situation on the financial markets, investors show a certain discount on companies in the real estate segment. And Cushman uses a conservative approach. They estimate the set of current values of premises which cannot be considered as an estimation of the portfolio in the context of sale in it’s entirely.

What projects have you bought and what have projects have you sold?

We bought the Gorky-8 and Khamovniki settlements. We sold Kamenny Ostrov (Stone Island), Rochdelskaya, and 13 Kostyansky. The company is currently considering buying about 30 sites: 15 in Moscow, five in Ukraine, three in St. Petersburg, and one in Nizhny Novgorod and Sochi.

Why did you decide to buy the Gorky-8 project? What was its business appeal?

It is a good project: elite housing, in which we specialize. The settlement needs to be completed and rented out, and it will be worth 50 per cent more straight away. There is already a bank, shop, services, and a clinic measuring 30,000 sq.m is under construction. We have also bought a land plot next to Gorky-8 measuring 61 hectares where we plan to also build.

Why don’t you want to sell the cottages?

Renting is the same business as selling. Probably it takes longer to recoup expenditures, but it brings a stable investment income independent of fluctuations on the market.

From July 1 Detsky Mir will be closed for reconstruction. Is it already known what format the shop will take?

The process of approval for the project with the authorities, and also passing internal regulations has been long. Reconstruction will take about two years, and the volume of investments will be about $200 million. The shop will become a modern family shopping center – there will be a wide range of children's, youth and sports shops. There will also be a cinema, a supermarket, restaurants and a cafe. As a result of reconstruction the usable area of the building will increase. Different retail concepts are currently being considered.

Have you already chosen the general contractor?

As a matter of fact, we will function as the general contractor together with our partner, TopFloor.

How is the Pekin reconstruction project coming along?

We have legalized all the papers, and have solved land issues. But the reconstruction is not only the renovation of the hotel, but also the construction of new buildings on the adjoining territory. We have a larger site - about 2 hectares between the Garden Ring and Brestskaya ulitsa. Here there will be both offices and retail areas, and another hotel. The main thing is to take a complex approach. The engineering communications for the project should first all be laid, and new buildings constructed. Restoration of Pekin will then begin. Now initial works are taking place in parallel with negotiations with hotel operators. We will start construction this year.

Earlier you said that Pekin would be managed by Intourist. Have your plans changed? The location of this hotel assumes the level of 5+* and Intourist does not have such experience. We will therefore involve a top-level operator.

Will such a hotel be demanded?

In Russia there is a catastrophic lack of hotels, and not only economy class, but also 5*. For example, hotels in Moscow are the most expensive in Europe: in the Hyatt you can’t get anything for less than $800, whereas in Rome a room of such level would cost $450-$600. Thus the fillability of our hotels is 100 per cent. And in the Kosmos, for example, 130 per cent – i.e. for some visitors it is necessary to put folding beds in rooms.

Has the legal dispute concerning Hotel Sport been resolved?

We are not involved in the court proceedings, but our partners are (it is the tenant vs. the former proprietor of the hotel). Therefore as a result of the conflict we’re not losing any time. We’re currently completing the project under a concept by Foster and Partners. It will be a high-altitude complex consisting of five crystal-shaped towers with complex designs. Here there will be offices, a hotel and retail areas - the project will become the centre of gravity for Leninsky prospekt.

How is the sector of road construction developing?

In general we’re still working on old orders (Zvenigorodskaya highway, the designing of the Central Ring Road in the Moscow region and the Moscow – Minsk motorway), and we have a set of small orders. But on the whole, road construction activities do not make up more than 10 per cent of the companies total activity, and it’s pointless to expand at the moment because legislation is not clear on how to make profit in this field.

At the end of 2007 you announced the creation of a joint venture with France’s Apsys. How did this go?

The program of development of our company assumes the construction of shopping centers measuring 50,000-150,000 sq.m in cities with a population of more than 1 million. After analysing the retail real estate market in the regions we understood that in partnership with the French we can compete more successfully. Apsys has great experience, they operate a number of shopping centers across France, and in Poland are retail leaders. In addition, they aren’t represented in Russia, which means our projects will be unique. The representative of Apsys, together with us, have looked at sites in Moscow, Kazan, Nizhny Novgorod, and St. Petersburg.

Was the sale of 50 percent of the construction project of the Kamelia hotel in Sochi to Arabian company Saraya motivated by the same reasons?

Yes. We looked for a strategic partner: there are no such 5+* hotel and apartments managed together in Russia. There are only ideas. We were attracted to Saraya by their experience - the company had participated in the construction and management of large resort projects in the United Arab Emirates and Jordan, and now they are building four similar projects.

Do you plan other similar alliances?

There are plans to conclude another strategic partnership with a western company to manage premises. Practice shows nobody has the experience of managing high quality real estate in Russia yet.

How does the publicity of Sistema-Gals influence it?

It reduces the length of time it takes to complete transactions – because lots of investors trust in you. You have been checked by lawyers and auditors many times. If you’re not a public company, the conclusion of agreements can take a year and a half, but in our case it is a question of several months. An IPO also opens access to cheaper credits.

At what stage is one of Sistema-Gals’ biggest projects – Bolshoi City?

The program is intended for 20 years. The development and approval of town-planning documentation will take several more years. The concept of development of this territory was approved by the government of Moscow in 2007. Then under an order by State Unitary Enterprise MTsORT and with our participation a general plan of development of Bolshoi City was developed, which should be approved by the end of this year. In parallel we conducted research on the development of the project in terms of the lay out of the areas, transport and engineering schemes. First of all we are developing the lay-out of quarters that have dilapidated 5-storey buildings there - about 300 hectares of 983 hectares. On approval of all documentation there will be a tender and the winner will acquire the contract for construction. Large proprietors, such as us or Don-Stroi, are developing the documentation of the sites, but construction is not being conducted yet. It will get interesting when tenders for the laying of roads and other construction will be announced.

How profitable could this project be for your company?

We don’t have to wait for big profit here. But it gives us something a bit more than simply money: first, it is an opportunity to obtain primary information on all sites. Secondly it is the direct development of our sites: in particular, we have two sites on Magistralnaya ulitsa. Thirdly – it profits us in our plans to create a uniformed management system of communication and engineering networks. We will also receive indirect profit from designing and managing transport infrastructure.

Have the main investors of Bolshoi City been specified?

Not completely. We currently have about 25 contracts with proprietors of territories in Bolshoi City. We offer various conditions of cooperation, and most often the services of developing the development concept of a site.

The project in Astrakhan is a little similar to the Moscow project. What stage is that at now?

To say honestly, we have treated this project rather casually, with not a great deal of purpose. At the request of the Astrakhan authorities Sistema-Gals has completed the planning of the project on 200 hectares in the center of Astrakhan, where there almost 2.8 million sq.m of premises, of which 1.5-1.8 million sq.m will be housing, should be constructed. Having studied the market, we now think we should invest in it. We are now working on the legal component.

What share of the company’s portfolio do regional projects occupy?

Up to 30 per cent. We work in nine regions: Moscow, the Moscow region, St. Petersburg, Sochi, Krasnoyarsk, Nizhny Novgorod, Yalta, Kazan and Kiev.

What projects does Sistema-Gals have in Ukraine?

This market is still embryonic: Everyone is selling and buying, but almost nobody is building. Considering the needs of Kiev, annually here there should be up to 5 million sq.m of various real estate entering the market, while in reality there is 1 million sq.m. everybody asks when will the turning-point come. For this reason many announced programs may drastically change. At the moment we have two development projects in Ukraine: a multipurpose complex in Yalta and a residential complex in Kiev on Vrubelevsky Spusk. In Yalta our project has become one of best in the city. The architectural concept is very effective - three simple ellipsoidal towers with original silver facades. It is premium class with apartments, restaurants, boutiques, a fitness center, SPA center and offices. On the roofs there will be swimming pools and barbecue zones. A helicopter pad has also been stipulated. By the end of the year construction is planned is to start. In Kiev we are participating in a construction project of a residential complex with an area of 100,000 sq.m. The site has good characteristics - it is high up on the right-hand coast of Dnepr near the central part of the city.

What foreign markets do you consider as promising for investments?

I sceptically consider the prospects of the development of markets in Bulgaria and Montenegro. Thus we are considering the Asian direction – Sistema’s telecommunications division has been involved with India, and, thus, already there is a certain infrastructure which would help us to enter the market without serious consequences. I think if we found interesting sites there we would definitely work there in the next three years. We are scrutinizing China, though they have enough of their own developers.

What’s interesting about the Indian market?

India now is how we were six years ago: there is a huge market, which will be under saturated for a very long time. First of all, there are no quality products there, secondly, investors assess the market well. As construction there is on a primary we have something to offer them in a technological sense. In India people practically live on building sites – men bend metal with their bare hands, women carry baskets of bricks on their heads, grandmothers prepare the food there, and children play here also. Even high-altitude buildings in Delhi are being built without cranes. We, as professional developers, can develop many quality sites. If you look at the future, the Russian market sooner or later will become saturated. How now foreigners can’t enter the Russian market, later it will be impossible to enter the Indian market. Which foreigners, for example, work in Russia? The ones who took a share at an early stage, for example Enka. And today I don’t know any western company that could honestly say that only investors and funds come.

How would you characterise today’s situation on the real estate market in Moscow?

For commercial real estate there was a deficit and still is. People buy poor quality premises at the price of class A premises. At $700-$800 for buildings of old factories! As for housing its stable – prices are gradually growing.

Have you felt the mortgage crisis at al?

The elite segment rarely involves mortgages. Maybe because mortgages are expensive. And we have more outright purchases.

Why have sales volumes increased?

I think investors began to withdraw [funds] from securities and invest them in raw materials or real estate. For example, on Rublyovka we planned to sell 40 apartments in a building within a year, but the necessary number of applications were received in three months – we had to raise the price.

Felix Vladimirovich Yevtushenkov was born in 1978 in Moscow. In 2000 he graduated from the A. S. Griboyedov International Institute of Law and Economics. Specialising in law. From 1999 to 2000 he worked as the vice president of Joint-Stock Company Sistema-Gals, and then became the executive director of its industrial department AFK Sistema. In December 2000, he moved to development company Sistema-Gals to the post of deputy general director and head of the strategy and marketing department. Since November 2003 he has bee the general director of Sistema-Gals, and since March 1, 2006 he has been the president of Sistema-Gals.

Sistema-Gals is a Russian development company. Its portfolio of projects includes 103 projects in Russia and Ukraine, of which 80 are development, and 23 are investment and total more than 5.8 million sq.m. Consolidated revenue in 2007 totalled $452.2 million, operational profit - $52 million, and net profit – $34.7 million. 71.1 per cent of shares of Sistema-Gals belong to group of companies AFK Sistema, while 18 per cent are fee float. The market capitalization on the LSE (as of June 5) was $1.6 billion.