Investigating Mergers and Acquisitions

1. Investigating Mergers and Acquisitions Mark Woodward African Competition Forum Workshop March 25, 2013

2. The Goals of Merger Analysis • The central goals of merger analysis and enforcement are: • To identify and prevent mergers that create or enhance market power • To accomplish goal #1 without delaying or obstructing mergers that enhance competition and benefit consumers

3. U.S. Legal Background • U.S. Law • Clayton Act Section 7 – prohibits mergers and acquisitions where the effect “may be substantially to lessen competition, or to tend to create a monopoly” • U.S. courts develop case law interpreting Clayton Act Section 7 • U.S. competition agencies issue merger guidelines applying Section 7

4. Purpose of U.S. Horizontal Merger Guidelines • Stated rationales: • Assist business community and antitrust practitioners by increasing transparency • Assist courts in developing appropriate analytical framework • Goals: • Transparency/clarity • Predictability/certainty • Consistency

5. 2010 U.S. Horizontal Merger Guidelines • U.S. Merger Guidelines revised in 2010 • Reject rigid interpretation of the analytical framework and specific standards • Merger analysis is fact-specific process not limited to single methodology or tools • New section on adverse effects evidence • Market definition not end in itself or even necessary starting point • Updated hypothetical monopolist test • Expanded discussion on unilateral and coordinated effects • New discussion on ease of entry

6. Overall Framework • Coordinated Effects (§ 7) • Powerful Buyers (§ 8) • Entry (§ 9) • Efficiencies (§ 10) • Failure and Exiting Assets (§ 11) • Mergers and Competing Buyers (§ 12) • Partial Acquisitions (§ 13) • Overview (§ 1) • Evidence of Adverse Competitive Effects (§ 2) • Target Customers and Price Discrimination (§ 3) • Market Definition (§ 4) • Market Participants, Market Shares, and Market Concentration (§ 5) • Unilateral Effects (§ 6)

7. Themes and Evidence • Enhancing market power as central theme of HMG • “[M]ergers should not be permitted to create, enhance, or entrench market power or to facilitate its exercise.” • A merger enhances market power if the merger is “likely to encourage one or more firms to raise price, reduce output, diminish innovation, or otherwise harm customers as a result of diminished competitive constraints or incentives” • Non-price effects included as potential harm

8. Themes and Evidence • Common types of evidence (HMG Section 2.1) • Actual effects observed in consummated mergers • Direct comparisons based on experience • Natural experiments: historical events, experience in similar markets • Market shares, level of concentration, and change in concentration • May lead to rebuttable presumption of anticompetitive effects • Substantial head-to-head competition between merging parties • Actual or likely potential competition absent the merger • Particularly relevant for evaluating unilateral effects • Elimination of maverick (a firm that plays a disruptive role in the market to the benefit of consumers)

9. Themes and Evidence • Common sources of evidence (HMG Section 2.2) • Merging parties • Emphasis on contemporaneous ordinary course of business documents • Business decisions taken by the merging firms can be informative about industry conditions • Explicit or implicit evidence about the merging firms post-merger plans • Customers • Particularly on reactions to post-merger price increases, attractiveness of substitutes, competitive effects • Other industry participants and observers • Suppliers, distributors, complementary product manufacturers, competitors, analysts

10. Market Definition (HMG Section 4) • Market definition plays two roles • Identifies the line of commerce and section of the country in which the competitive concern may arise • Allows agencies to identify market participants and measure market shares, market concentration, and the increase in concentration • Market definition is not an end in itself • Agencies’ analysis need not start with market definition • Evidence of competitive effects can inform market definition

11. Market Participants, Market Shares and Concentration (HMG § 5) • Significance of market shares, concentration and changes in concentration • Higher market shares SUGGEST market power • Large merged firm may be able to reduce output and increase prices unilaterally • Higher concentration level SUGGESTS less competition (fewer significant competitors) • High concentration may make it easier to coordinate output reductions and price increases • Higher changes in concentration SUGGEST greater merger impact

12. Market Participants, Market Shares and Concentration (HMG § 5) • Identifying market participants • All firms that currently earn revenues in the relevant market • Rapid entrants • Firms not current producers in the relevant market, but that would very likely provide rapid supply in response to a SSNIP without incurring significant sunk costs • Slower entry, and entry involving significant sunk costs, considered in entry analysis • Types of rapid entrants include • Firms that produce the relevant product but to not currently sell in the relevant geographic market and would likely enter in response to a SSNIP • Firms that have the necessary assets and readily available capacity to begin producing the relevant product • Rapid entry more likely where relevant product is homogeneous

13. Market Participants, Market Shares and Concentration (HMG § 5) • Market shares measures • Best available indicator of firms’ future competitive significance in the relevant market • Actual or projected revenues (typically used) • Unit sales where low-priced product can be substituted for a higher-priced product • Available capacity or reserves (exclude committed capacity profitably employed outside the relevant market that it would not likely be used in response to a SSNIP in the relevant market) • Annual data typically used • Market concentration measures • HHI principal measure of concentration adopted by the agencies • HHI calculated by summing the squares of the individual market shares of the firms in the market • Range 0 (atomistic market) to 10,000 (a monopoly) • Increase = double the product of the market shares of the merging firms

14. Significance of Market Concentration Measures • Three classifications of markets • Unconcentrated markets: HHI < 1500 • Moderately concentrated markets: 1500 ≤ HHI ≥ 2500 • Highly concentrated markets: HHI > 2500 • General standards • Small change in concentration: mergers involving an increase less than 100 points “unlikely to have adverse competitive effects and ordinarily require no further analysis” • Unconcentrated markets: merger resulting in unconcentrated markets “unlikely to have adverse competitive effects and ordinarily require no further analysis” • Moderately concentrated markets: merger resulting in moderately concentrated markets that involve an increase of more than 100 points “potentially raise significant competitive concerns and often warrant scrutiny” • Highly concentrated markets: mergers resulting in highly concentrated markets that involve an increase of • 100 to 200 points “potentially raise significant competitive concerns and often warrant scrutiny” • more than 200 points “will be presumed to be likely to enhance market power”

15. Unilateral Effects • Unilateral effects relating to pricing of differentiated products • Unilateral effects relating to bargaining and auctions • Unilateral effects relating to capacity and output for homogeneous products • Unilateral effects relating to innovation and product variety

16. Unilateral Price Effects • Will the merged firm have the ability to successfully raise its prices? • Price effects turn on ability of competing firms to increase production or reposition products in response to a price increase by the merged firm • Generally, unilateral effects occur in differentiated product markets • The products of the merging firms are viewed by many consumers to be better substitutes for one another than the products produced by other firms

17. Diversion Ratios • What is the diversion ratio? • The diversion ratio measures the fraction of all consumers currently purchasing Product A that switch to Product B in response to a price increase DRAB = ΔQB/ΔQA • Our example: If in response to a price increase for Product A, its sales fall by 10 units, and the sales for Product B rise by 5 units, the diversion ratio is 5/10 = 0.50 or 50% A B C D F PROPOSED MERGER -10 5 2 2 1

18. Diversion Ratios • Why is diversion important to unilateral effects analysis? • The diversion ratio reflects the extent of direct competition between the products of the merging firms • Post-merger, the merged firm will take into account the diverted sales (which it now recaptures) when setting price • The higher the diversion ratio of the merging firms’ products, the more likely is significant harm to competition • Significant unilateral effects may occur even though a non-merging product is the “closest” substitute for every merging product • Significant unilateral effects may occur even where overall market concentration is low (HHI levels of limited predictive value)

19. Merger to Monopoly: Case Example • GlaxoWellcome-SmithKline Beecham (2000) • GlaxoWellcome and SmithKline Beecham, which manufactured and marketed numerous pharmaceutical products, proposed to merge • For most products, the transaction raised no significant competitive issues, but it did raise competitive concerns in several product lines, including the market for R&D, manufacture, and sale of second generation oral and intravenous antiviral prescription drugs used in the treatment of herpes infections • Glaxo manufactured and sold Valtrex • SmithKline manufactured and sold Famvir • No other company was producing or developing a similar drug • Entry barriers: regulatory approval created a substantial entry barrier • Merger would eliminate the only competition that existed in the market for second generation prescription oral and intravenous antiviral drugs for the treatment of herpes infections (i.e., merger to monopoly) • Result: Consent agreement requiring divestiture of SmithKline’s Famvir-related assets

20. Pricing of Differentiated Products: Case Example • Nestle-Dreyer’s (2003) • Product market at issue: super premium ice cream • Nestle (Haagen-Dazs brand) = 36.5% market share • Dreyer’s (Dreamery, Godiva, and Starbucks brands) = 19.1% market share • Unilever (Ben & Jerry’s brand) ≈ 42.4% market share • HHIs: Pre-merger = 3,501; Post-merger = 4,897; Change = 1,396 • Quantitative evidence of likely unilateral anticompetitive effects • Econometric analysis of point of sale data showed the diversion ratios between the Nestle and Dreyer’s super premium brands were sufficient to make a significant unilateral price increase by the merged firm likely • Diversion ratios with Unilever’s super premium ice cream were sufficiently high to make a post-merger price increase by Unilever also likely • Result: Consent agreement requiring divestiture of two brands and key distribution assets

21. Pricing of Differentiated Products: Case Example • Fortune Brands-Allied Domecq (2005) • Transaction: Fortune Brands (owner of Knob Creek bourbon) proposed to acquire Allied Domecq’s Maker’s Mark bourbon brand • Candidate product market: premium bourbon • Candidate theory of harm: whether the acquisition would create or enhance unilateral market power for premium bourbon • Econometric analysis of retail scanner data showed • Several other large whiskey brands, including bourbons, competed strongly with Knob Creek and Maker’s Mark • Substantial cross-price elasticities among the several whiskey brands • Diversion ratios among Makers’ Mark and Knob Creek were low • Result: staff closed the investigation

22. Coordinated Effects • Will the merger facilitate coordinated price increases by firms in the market? • Turns on the number of firms in the market and their ability to reach agreement on price or output and detect and punish deviations from the agreement

23. Core Problem for Coordination • Collectively, firms have incentives to coordinate prices: Higher prices → Increased profits BUT Each firm has an incentive to cheat

24. Coordinated Interaction Factors To Consider: • Concentration • Excess capacity • Firm and product homogeneity • Size of buyers • Market stability • Availability of information • History of collusion

25. Coordinated Effects: Case Example • LaFarge-Blue Circle (2001) • Three markets at issue • Cement market in Great Lakes Region • Merged firm = 47% market share; top four firms = 91% market share • Post-merger HHI > 3,000 with increase > 1,000 • Cement market in Syracuse, New York Region • Merged firm = 68% market share; top 2 firms = 100% market share • Lime market in Southeastern United States • Merged firm + Blue Circle joint venture = 85% market share • Product homogeneity: cement is a homogeneous, highly standardized commodity over which producers compete principally on price • Market transparency: producers publicly announced price increases months in advance • Transaction size and frequency: sales transactions tend to be frequent, regular, and relatively small • Competitive constraints: high barriers to entry • Result: Consent agreement requiring certain divestitures

26. Merger Process at FTC - Overview • Review pre-merger filings • Collect public industry information • Interview market participants (customers, competitors, merging parties) • If concerns, issue “second request” for documents and data • Review documents and data • Conduct hearings of merging parties, others • Decide whether to close, challenge, or settle

27. The Whole Foods Case

28. Whole Foods/Wild Oats Merger • Proposed Merger (2007) • “Premium” food stores focusing on natural, organic foods: • Whole Foods • Wild Oats • Other regional stores • Other supermarkets in United States: • Safeway, Giant, Kroger, Albertsons, many others

29. Product Market • FTC: Premium Natural Organic Stores (PNOS) • Defendants: PNOS, Conventional Supermarkets, Trader Joe’s, Gourmet Stores like Wegmans, Club Stores, etc.

33. Investigational Hearing Testimony John Mackey, CEO of Whole Foods: “One of the motivations is to eliminate a competitor. I will not deny that. That is one of the reasons why we are doing this deal. That is one of the reasons why we are willing to pay $18.50 for a company that has lost $60 million in the last six years. If we can’t eliminate those stores, then Wild Oats, frankly, isn’t worth buying.”

34. Epilogue • FTC lost case at district court level after 2-day hearing • Rejected FTC’s product market definition • Appeals court reversed, ruling for FTC • Found FTC had met its burden of proof • But parties had already merged • FTC settled with Whole Foods • Requiring certain stores be divested

35. How to Proceed Expeditiously Top 10 Tips To clear Non-problematic Transactions To Narrow and Refine Issues

36. TIP ONE • Begin investigation even before receiving formal filing/notification from merging parties. • Trade press • Mass media • Citizen complaints • Notification courtesy copy (merging parties may come in for pre-notification consultations and provide a draft filing)

37. TIP TWO • Start fast. Immediately begin gathering information to determine whether the transaction can be promptly cleared or is potentially anti-competitive.

38. TIP THREE • Check media sources of information. • Web sites of merging parties • News stories • Google • Presentations to securities analysts

39. TIP FOUR • Check institutional knowledge • Experienced staff on earlier matters • Prior written assessments of industry

40. TIP FIVE • Check other government agencies. • Sectoral regulators • Other government experts • Securities filings

41. TIP SIX • Prioritize and focus. • Are there competitive product and geographic overlaps? • Does the available information suggest any compelling way the transaction poses a potential competitive problem? • Is there any information that rules out a potential for a competitive problem, such as a large number of significant competitors or low barriers to entry? • Are there leads for further investigation?

42. TIP SEVEN • Contact the parties. • Learn parties’ view on antitrust issues. • What is the rationale for the transactions? • Do they expect to generate any efficiencies? • Have the parties’ business people educate you. • Talk to the marketing people or the person that can tell you how prices are set or negotiated • Ask the parties to back it up. Obtain key ordinary course of business document such as – • strategic and business plans • market shares/studies • board presentations on deal, particularly those describing any synergies from the transaction • pricing plans

43. TIP EIGHT • Interview customers, suppliers and competitors. • Verify any facts supporting clearance or approval or confirm any concerns. • Start early -- arranging interviews is time-consuming. • Learn from competitors • Product overlaps…how firms compete on price, service or innovation. • Entry conditions…market shares, market structure, and history • Learn from customers • The number and strength of competitors? • What substitutes are available? • Do they have any concerns? • Are there anecdotes of past competition between the merging parties.

44. TIP NINE • Develop an investigation plan • Focus! • Prioritize! • Continually reevaluate! Shift the focus of the investigation according to the facts learned!

45. TIP TEN • Test any competitive concerns by disclosing them to the parties. • The disclosure will help you to learn the evidence and arguments that you will need to overcome in any challenge.

46. International Competition Network • ICN has adopted two documents addressing the procedural aspects of merger notification and review: • Guiding Principles for Merger Notification and Review • http://www.internationalcompetitionnetwork.org/uploads/library/doc591.pdf • Recommended Practices for Merger Notification Procedures • http://www.internationalcompetitionnetwork.org/uploads/library/doc588.pdf • Non-binding aspirational statements intended as guidance for all members • Incorporate best practices across ICN member agencies • Agencies should seek to coordinate their review of mergers that may raise competitive issues of common concern