1 Mergers qua Competition Regime H.S. Chandhoke Partner, Luthra & Luthra Law Offices

L&L August 30, Contents 1. Coverage 2. Mergers: Basic Concepts 3. Rationale for Merger Regulation 4. Types of Mergers 5. Motivation for Mergers 6. Adverse Effects of Mergers 7. Facts and Figures 8.Cross Border Mergers

L&L August 30, Contents 9. Mergers in India 10. Merger Control Provisions in India 11. A Balancing Act 12. The Legal Framework 13. The Competition Act Decided Cases

L&L August 30, Coverage The three core areas covered in the Competition Law across the globe are:- 1. Anti-competitive agreements; 2. Abuse of Dominant Position; and 3. Regulation of Combinations including mergers. The first two areas are prohibited ex post while the regulation of merger is generally ex-ante.

L&L August 30, Mergers: Basic Concepts Merger - combination of two or more enterprises whereby the assets and liabilities of one are vested in the other, with the effect that the former enterprise loses its identity. Amalgamation – combination of two corporate entities where the assets and liabilities of both are vested in a third entity, with the effect that both former entities lose their identities to form a new entity.

L&L August 30, Mergers: Basic Concepts Competition Act 2002 Section 2(a) Acquisition – the acquiring, directly or indirectly of shares, voting rights, assets or control over management or assets, of another enterprise.

L&L August 30, Mergers: Basic Concepts Section 2(h) Enterprise – means a person who is engaged in any activity relating to production, storage, supply, distribution, acquisition or control of any goods, or the provision of services, or in investment or securities, either directly or indirectly, but does not include sovereign functions of the government.

L&L August 30, Basic concepts Combination includes: Acquisition of control, shares, voting rights or assets by an acquirer of an enterprise; [section 5(a)] Acquiring of control by a person of an enterprise where the person already has control over another enterprise engaged in production, distribution and trading of similar or identical or substitutable goods/services; Merger or amalgamation between or amongst enterprises

L&L August 30, Rationale The rationale for merger regulation is simple – It is far better to prevent firms from gaining market power than to attempt to control market power once it exists. Effective merger policy requires a judgment concerning the impact of merger on competition before the merger has occurred.

L&L August 30, Rationale The whole philosophy is based on an ancient English Maxim: Prevention in better than cure. It is better to prevent and prepare rather than to repent and repair – Navjot Singh Sidhu

L&L August 30, Types of Mergers Horizontal : between enterprises in the same product market and at the same level of the production or distribution cycle. Vertical: between enterprises that operate at different levels of the production or distribution cycle. Conglomerate: between enterprises operating in different markets.

L&L August 30, Horizontal and Vertical Mergers Raw Material Producer/Supplier Manufacturer Wholesaler Retailer Consumer

L&L August 30, Motivation for Mergers To diversify the areas of activity and thereby to reduce business risks; To achieve optimum size so as to reap the benefits of economy of scale; To reduce the duplicate expenses and thereby to improve the profitability; To serve the customer better;

L&L August 30, Motivation for Mergers To have cohesiveness in control of the organisation; To grow without any gestation period; Inorganic growth is believed to be much faster compared to organic growth.

L&L August 30, Adverse Effects of Mergers Mergers especially horizontal reduces the number of players and consequently the competition in the market; Mergers amongst rivals is invariably unfriendly to consumers; Mergers often results in increased market share and thereby leads to dominance which makes the resultant enterprise complacent

L&L August 30, Adverse Effects of Mergers and thereby brings inefficiency in the organisation; Mergers between healthy and unhealthy enterprises reduces the tax liability and thereby makes the States exchequer poor; Mergers often fail to create harmonisation in human relation.

L&L August 30, Facts & Figures on Mergers 1 Worldwide mergers and acquisitions in the first quarter of 2005 exceeded $589 billion. Combined with $670 billion in Q that amounts to over $1.2 trillion over 6 months. 1 Source: Thomson Financial Services

L&L August 30, Facts & Figures on Mergers Asian M&A in Q amounted to $36 billion (rise of 32.9% over Q1 2004) consisting of a total of 1,355 transactions (a decline of 12.9% from Q1 2004). South Korea ranked first in terms of transaction value while China ranked first in terms of number of transactions.

L&L August 30, Facts & Figures on Mergers

L&L August 30, Facts & Figures on Mergers - India Late 1980s – 35 mergers – 552 mergers $ 6.5 billion $ 3.7 billion. ( Business & Economy Magazine ) The value of mergers in India more than doubled to $9.32 billion in 2004, from $4.4 billion in ( Bloomberg Feb 2005 )

L&L August 30, Facts & Figures on Mergers - India The first quarter of 2005 itself has seen M&As to the tune of over $3 billion. ( Thomson Financial ) According to PWC study which appeared in Financial Express of August 17, 2005, India recorded second highest growth rate in M&A activities in the first half of 2005, second only to Japan.

L&L August 30, Facts & Figures on Mergers – Asia (ex Japan) Q Figures

L&L August 30, Cross Border Mergers 1 Worldwide Cross Border M&As represent a large portion of the total M&As amounting to $296 billion in 2003, of which Indias participation amounted to $949 million (83 out of 4562 deals). World Investment Report 2004

L&L August 30, Cross Border Mergers The motivating factors for cross border M&As are: Quickest way to grow Acquire tangible and intangible assets Restructure existing operations Exploit synergies Obtain strategic advantages

L&L August 30, Cross Border Mergers However, the overwhelming majority of the cross border M&As involve foreign firms acquiring Indian companies. In cases where such acquisitions involve no increase in economic efficiencies or production capacities, it raises the concern that such M&As simply shift ownership from domestic to foreign hands. Domestic consolidation of enterprises would help Indian enterprises achieve a better bargaining position and reverse the trend.

L&L August 30, Mergers in India From 1991 to date, mergers are not regulated from a competition perspective. The Asian Development Outlook 2005 mentions the impact of M&As in India. It indicates for example – Coca Cola re-entered the Indian market in 1993 by acquiring Parle. Today it has 50% market share of the soda industry. Pepsi gained a major market presence by acquiring Duke in 1988, and now has 48% market share of the soda industry.

L&L August 30, Mergers in India HLL has succeeded in enhancing its market share through a process of Mergers /Acquisitions Product Ice Cream Sauces,ketchups,jams Dental hygiene products Soaps Synthetic detergents Vanaspati

L&L August 30, Merger Control Provisions in India Pre – 1991: Only the MRTP Act, 1969 and the Companies Act, 1956 had merger control provisions. Post – 1991: The Companies Act, 1956; SEBI (Takeover) Guidelines, 1997; and the Competition Act, 2002 now form the backbone of merger control provisions in India.

L&L August 30, A Balancing Act Despite foreseeable advantages, mergers can have an adverse impact on public and consumer interest in terms of higher costs, increased political influence of merged entity and reduced efficiency owing to diversification into unrelated businesses. In dealing with mergers, Competition Law has to balance between encouraging competition and at the same time promoting economic efficiency.

L&L August 30, The Legal Framework 1. The Companies Act, 1956 Sections A, 108A, 17, 319 and SEBI (Substantial Acquisition of Shares and Takeovers) Regulation, The Competition Act, 2002 Sections 5 and 6 deal with Combination and Regulation of Combination respectively.

L&L August 30, Threshold Limits Where a merger proposal comes within the purview of the threshold limits stated under Section 5, notification thereof may be made to the CCI. The Act encompasses a voluntary pre- notification requirement for mergers above a certain threshold limit.

L&L August 30, Acquisition, Acquisition of Control or Merger or Amalgamation By a Person The Resultant Entity must have: (i) in India, assets valued at more than Rs.1000 crores or turnover of more that Rs crores; or (ii) in India or outside India, assets valued at more than US$ 500 million or turnover of more than US$ 1.5 billion. By a Group The Resultant Entity must have: (i) in India, assets valued at more than Rs.4000 crores or turnover of more than Rs. 12,000 crores; or (ii) in India or outside India, assets valued at more than US$ 2 billion or turnover of more that US$ 6 billion.

L&L August 30, Group Group means two or more enterprises which, directly or indirectly, are in a position to: (i)exercise twenty-six per cent, or more of the voting right in the other enterprise; or (ii)appoint more than fifty percent, of the members of the board of directors in the other enterprise; or (iii)control the management or affairs of the other enterprise.

L&L August 30, Control Control includes controlling the affairs or management by – One or more enterprises, either jointly or singly, over another enterprise or group; One or more groups, either jointly or singly, over another group or enterprise.

L&L August 30, Section 6 Any combination entered into which causes or is likely to cause an appreciable adverse effect on competition within the relevant market [section 2(t)] in India shall be void. A person entering into a combination may give notice to the CCI disclosing details of the combination within 7 days of (a) approval of the merger by the boards of

L&L August 30, Section 6 the enterprises, or (b) execution of any agreement for acquisition referred to in 5(a) or acquiring of control. Exception – Section 6 does not apply to share subscription or financing facility or any acquisition by a PFI, FII, bank or venture capital fund pursuant to any covenant of a loan agreement or investment agreement.

L&L August 30, Notification Requirements Pre-notification is compulsory in US and EU. In India, pre-notification is only voluntary. Considering the current phase of growth and consolidation of industry, it was decided against incorporating a compulsory notification requirement. Post- merger notification runs the risk of having to unscramble the merger which usually entails high social cost.

L&L August 30, Inquiry: Section 20 The CCI may inquire into whether a combination is likely to cause an appreciable adverse effect on competition based on its own knowledge or on information provided to it. However, the CCI cannot initiate an inquiry into any combination after the expiry of one year since that combination has taken effect. CCI shall inquire in cases where notice is given under section 6(2).

L&L August 30, Factors to be examined: Section 20 In order to determine whether a combination would have the effect of or is likely to have an appreciable adverse effect on competition, the CCI shall have due regard to the following factors: a)actual and potential level of competition through imports in the market; b)extent of barriers to entry in the market; c) level of combination in the market; d)degree of countervailing power in the market;

L&L August 30, Factors (cont.) e)likelihood that the combination would result in the parties to the combination being able to significantly and sustainably increase prices or profit margins; f)extent of effective competition likely to sustain in a market; g)extent to which substitutes are available or are likely to be available in the market;

L&L August 30, Factors (cont.) h)market share, in the relevant market, of the persons or enterprises in a combination, individually and as a combination; i)likelihood that the combination would result in the removal of a vigorous and effective competitor in the market; j)nature and extent of vertical integration in the market; k)possibility of falling business;

L&L August 30, Factors (cont.) l)nature and extent of innovation; m)relative advantage, by way of the contribution to the economic development by any combination having or likely to have appreciable adverse effect on competition; n)whether the benefits of the combination outweigh the adverse impact of the combination, if any.

L&L August 30, Procedure for Investigation: Section 29 Where the CCI opines that a combination is likely to have an appreciable adverse effect on competition, it shall call upon the parties to respond within 30 days showing cause as to why an investigation should not be conducted;

L&L August 30, Procedure (cont.) After receiving the responses, if the CCI is of the prima facie opinion that the combination is likely to have an appreciable adverse effect on competition it shall direct within 7 days that the details of such combination be published within 10 working days of such direction, in the manner prescribed;

L&L August 30, Procedure (cont.) Objections to the combination are invited from the public within 15 days from the date of publication; Within 15 days of receiving comments, the CCI may call for additional information from the parties to the combination, which is to be furnished within 15 days. After the receipt of all information, the CCI must come to a decision within a period of 45 days.

L&L August 30, Orders: Section 31 The Commission has to pass final order within 90 working days (subject to certain exception) from the date of publication, failing which the Merger is deemed to have been approved; The Commission is vested with a power to approve the Merger, or approve with modifications, or to reject the merger;

L&L August 30, Orders In case the modification suggested is agreed to by the parties, the merger is approved and in case modifications are not agreed to, the Merger is refused and the agreement will be declared void;

L&L August 30, Orders modifying the Merger Divestment Requiring access to essential inputs/facilities Dismantling exclusive distribution agreements Removing no-competition clauses Imposing price caps or other restraints on prices Refrain from conduct inhibiting entry

L&L August 30, Penalty: Section 44 If any party to a combination makes a false statement or omits to state any material particular, such person is liable for a penalty between Rs. 50 lakhs and one crore.

L&L August 30, Usage Even though the factors and procedure contained in Competition law seem comprehensive, experience has shown authorities very rarely block proposed mergers. The European Commission has prohibited 19 proposed mergers out of a total of 2827 notified (0.65%) between 1990 and July 2005.

L&L August 30, Usage The Competition Commission of the UK since being set up in 2003 has found adverse competition effects in only 5 cases and prohibited only 3. The US Federal Trade Commission and Department of Justice combined challenged only 36 out of 1014 mergers notified in 2003 leading to 12 consent orders and 16 abandoned transactions.

L&L August 30, Decided Cases FTC v. Staples Inc. [970 F.Supp (DDC 1997)] In 1997, the two largest office superstore chains in US, Office Depot and Staples Inc. announced their agreement to merge. The Federal Trade Commission (FTC) opposed the merger on the grounds that it was likely to harm competition and lead to higher prices in the market for the sale of consumable office supplies sold through office superstores.

L&L August 30, FTC v Staples Inc. (cont.) The FTC argued that voluminous evidence – structural, documentary and statistical – supported the conclusion that the proposed merger would raise prices for office supplies. The relevant market in this case was held to be office superstores and that the merged entities would have a dominant market share between 45% - 100% in many geographic markets.

L&L August 30, FTC v Staples Inc. (cont.) Office superstores were held to be different from other office supply retailers in terms of appearance, size, format, the number and variety of items offered, and the type of customers targeted. In the absence of a merger, the separate entities were competitors and would have targeted each others market and kept prices low. The efficiencies argued for were held not to be sufficient to offset price increase.

L&L August 30, Cases GE-Honeywell [Case No. COMP/M.2220] On October 22, 2000 a merger was announced between two American based companies General Electric and Honeywell. GE makes, sells, and services large aircraft engines. Honeywell makes small aircraft engines, avionics components, and non-avionics components, such as environmental control systems, wheels and brakes, and auxiliary power units.

L&L August 30, GE-Honeywell This was case of a conglomerate merger, where the only substantial horizontal overlap occurred in the supply of military helicopter engines and in repair and overhaul services for certain Honeywell aircraft engines. However each party was a leader in its respective market. At $42 billion it was the largest industrial merger in history.

L&L August 30, GE-Honeywell The USDOJ cleared the proposed merger on the condition that GE divest Honeywells helicopter engine business and to license a new competitor to maintain and repair certain Honeywell engines. Due to the size of GE and Honeywells European sales, the merger had to be approved by the European Commission (EC) as well.

L&L August 30, GE-Honeywell The EC found that GE had a dominant position in the aircrafts engine market while Honeywell had a dominant position in the avionics and non-avionics sectors. These products being complementary to each other, the EC held that the merger would allow the new entity to bundle their products, giving it an advantage over competitors.

L&L August 30, GE-Honeywell This advantage would lead to the exit of rivals and ultimately the elimination of competition altogether. The EC thus blocked the merger.

L&L August 30, Selected Reading Antitrust Law Developments, American Bar Association (ABA), 5 th ed., ABA Section of Antitrust Law. Gellhorn, Ernest, Kovacic, William E., and Calkins, Stephen, Antitrust Law and Economics in a nut shell, 2004, West Publishing Co., MN. Goetz, Charles J., McChesney, Fred S., Antitrust Law: Interpretation and Implementation, 2002, Mathew Bender & Co, Lexis Nexis, NJ. Whish, Richard, Competition Law, 5 th ed, 2003, Butterworths.