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
Final with Speaker Notes

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
Final with Speaker Notes

6. Overall Framework 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)
Coordinated Effects (§ 7)
Powerful Buyers (§ 8)
Entry (§ 9)
Efficiencies (§ 10)
Failure and Exiting Assets (§ 11)
Mergers and Competing Buyers (§ 12)
Partial Acquisitions (§ 13)
Final with Speaker Notes

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
Final with Speaker Notes

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)
Final with Speaker Notes

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
Final with Speaker Notes

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
Final with Speaker Notes

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
Final with Speaker Notes

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
Final with Speaker Notes

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
Final with Speaker Notes

14. Significance of Market Concentration Measures
Three classifications of markets
Unconcentrated markets: HHI < 1500
Moderately concentrated markets: ≤ 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”
Final with Speaker Notes

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
Final with Speaker Notes

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)
Final with Speaker Notes

19. Merger to Monopoly: Case Example
Glaxo Wellcome-SmithKline Beecham (2000)
Glaxo Wellcome 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
Final with Speaker Notes

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
Final with Speaker Notes

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
Final with Speaker Notes

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
Final with Speaker Notes

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. Top 10 Tips How to Proceed Expeditiously
To clear Non-problematic Transactions
To Narrow and Refine Issues
Final with Speaker Notes

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)
Final with Speaker Notes

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

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

39. TIP FOUR Check institutional knowledge
Experienced staff on earlier matters
Prior written assessments of industry
Final with Speaker Notes

40. TIP FIVE Check other government agencies. Sectoral regulators
Other government experts
Securities filings
Final with Speaker Notes

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?
Final with Speaker Notes

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
Final with Speaker Notes

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.
Final with Speaker Notes

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

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.
Final with Speaker Notes

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
Recommended Practices for Merger Notification Procedures
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
Final with Speaker Notes