State of Affairs in US Merger Review – Lessons Learned
In the last year, the US antitrust regulators successfully challenged multiple transactions in court and forced companies to abandon several other transactions as a result of threatened enforcement actions. What do these cases portend for future mergers transactions? What should parties be doing to enhance the likelihood of their deal successfully navigating regulatory scrutiny? Looking back at the different cases, there are some trends that we see developing in the government’s positioning on mergers, and these should be kept in mind as parties contemplate mergers and acquisitions moving forward.
The agencies have had a very active litigation docket. Examples of cases litigated in the past year include:
FTC v. Sysco / US Foods. The Federal Trade Commission (FTC) obtained a preliminary injunction halting the proposed combination of leading food distributors, and the parties abandoned the transaction.
FTC v. Staples / Office Depot. The FTC obtained a preliminary injunction blocking this combination of corporate office suppliers, and the parties abandoned the transaction.
US v. Electrolux / General Electric. The US Department of Justice (DOJ) sued to block the combination of two leading producers of ovens and ranges, and GE abandoned the transaction during the litigation.
US v. Tribute Media. DOJ obtained a restraining order blocking the combination of newspapers in Southern California.
US v. Halliburton / Baker Hughes. DOJ sued to block a combination of oilfield services companies, and the parties abandoned the transaction.
FTC v. Steris / Synergy. The FTC sought an injunction barring a combination of medical device sterilization companies on grounds that the deal would eliminate a “potential” competitor, but the court denied the injunction.
FTC Hospital Merger Challenges. The FTC has been very active in challenging hospital mergers, seeking federal court injunctions for combinations in West Virginia, Pennsylvania (Hershey) and the Chicago area. The FTC lost in Pennsylvania. The other cases remain pending.
Abandoned Transactions. In several recent matters, the parties abandoned a transaction after the government stated its intention to sue. An example is Tokyo Electron / Applied Materials.
Substantive Standards and Theories
Narrow markets / price discrimination markets are here to stay. The concept of price discrimination markets, where sales of products to a discrete group of customers may be a market, has been part of the agencies’ analysis for years, and it was stressed in the 2010 Horizontal Merger Guidelines. Now, that concept is becoming firmly established through the courts. In Sysco / US Foods, the court accepted a market limited to foodservice distribution to national customers. In Staples / Office Depot, the court accepted a market definition of sales of office products to a small number of very large customers. In the General Electric / Electrolux case, the DOJ alleged that sales of appliances to builders and others through a contract channel was a separate market, and General Electric ultimately abandoned the transaction. In addition, these challenges demonstrate that the regulators will challenge a transaction that harms large, powerful customers, even if the transaction does not harm other customers. “Buyer Power” is not winning the day as a litigation defense. Having won these recent cases, we can expect the agencies to be more aggressive in their use of markets limited to particular categories of customers.
The big picture is important. Deals that are transformative in an industry are more likely to face significant scrutiny, even if the individual overlaps may appear manageable when looked at in isolation. For example, in Halliburton / Baker Hughes, it was clear that there were competitive concerns in many product areas, and the parties negotiated a robust divestiture obligation into the merger agreement. When the DOJ sued to block the deal, it alleged the transaction would lessen competition in over twenty individual product markets, but the DOJ also alleged that the merger combined two of only three companies that offered a broad suite of products and services and that were leading innovators in the industry.
Innovation is increasingly important. Even if a divestiture package can resolve current product overlaps, if the merging parties are two of few firms pushing the boundaries to develop new innovations, the government is likely to object. This was a concern that caused the DOJ to reject the remedy package in the Tokyo Electron / Applied Materials matter, and was also featured in the Halliburton / Baker Hughes complaint.
Customer support and a good reason for the deal remain key factors. The government still relies heavily on customer views of the marketplace to conduct its investigation and to support its cases. If a transaction is likely to create customer concern, it has much higher odds of being challenged and blocked. If the parties have a good, procompetitive rationale for the deal, it is important to get that message out to customers and solicit their support. Doing so may make customers fans of the deal rather than opponents.
Investigations of significant transactions are taking a very long time—sometimes a year or more. Several of the cases that have resulted in challenges took well more than a year from announcement to conclusion. This has implications for negotiating a merger agreement. In order to increase deal certainty, it is important to negotiate a drop dead date that provides sufficient time to obtain all of the global regulatory approvals. On the other hand, a seller may want to have the option of a shorter drop dead date that allows it to abandon the transaction without having its business in limbo for a year or more if, after engaging the regulators, it appears that approvals are unlikely.
The government is cementing a real home court advantage in the District of Columbia. Most merger challenges are brought in federal court in the District of Columbia. The government has obtained favorable law in the DC Circuit, which it does not always have when it challenges transactions outside of the District. The government has won all of its merger challenges in DC going back several years. Some of these cases (Sysco and Staples) developed new law on product market definition that favors the government. On the other hand, the government lost a hospital merger challenge filed in Pennsylvania and another merger challenged in Ohio. The courts outside of the District appear less deferential to the agencies.
Do not read too much into the court’s questions and procedural rulings. In Staples, the court was at times skeptical or openly critical of the government’s case, especially around defining the product market narrowly based on a small subset of corporate customers, as well as the government’s alleged market of “office supplies” that excluded ink and toner when those products were purchased under office supply contracts. Despite those signs from the bench, the court granted the FTC a preliminary injunction.
The government may be more likely to challenge a merger when there are other bars to closing. In several recent transactions, the US agencies have challenged transactions in court when there were other procedural bars to closing prior to the merger drop dead date. For example, in Halliburton / Baker Hughes, there was an ongoing EC Phase II investigation that meant the parties could not close their transaction even if they prevailed against the DOJ’s preliminary injunction motion. While the government is always prepared to litigate to judgment when it files a case, in some cases the government may be emboldened to file if it recognizes that the parties are likely to abandon the deal due to other pending regulatory approvals.
The agencies are more demanding in seeking effective remedies. If a transaction raises a competitive harm, in many cases it may be “fixed” through a divestiture of the business creating a competitive concern. The agencies are becoming more demanding in what they require. The FTC has seen several divestitures fail with the divestiture buyer unable to operate the divested assets profitably. In light of those failures, the agencies are becoming more stringent in requiring the divestiture of a complete, stand-alone business, rather than cobbling together a package of assets that have not previously operated as a stand-alone business. The DOJ’s complaint in the Halliburton / Baker Hughes matter criticized the parties’ divestiture proposal. Even though the parties were willing to divest many billions of dollars in assets, they involved pieces and parts from both companies and did not include what the DOJ thought was a cohesive business. Deputy Assistant Attorney General David Gelfand noted in a speech that, “Not all deals are fixable.” In some cases, “the only remedies that parties are able to offer are ones that would involve breaking up assets, breaking up businesses and creating risks that consumers would have to take that assets would become competitive again someday.” Merging parties need to evaluate closely, at the outset, whether there are competitive issues and whether those issues reasonably can be remedied. A contractual divestiture obligation clause with a threshold that is large enough to cover the overlapping product, but not large enough to cover the business making that product, may not provide the seller with contractual protection.
“Buyer up front” is now the standard. The agencies think having a buyer up front identified before they accept a remedy proposal is important. In the past, merging parties could often identify the divestiture package and then get a period of months after closing to divest that package of assets. Now the agencies are insisting on buyer up front in most cases. This helps them ensure the asset package is viable, and that they have a good buyer that is motivated to and capable of operating the divested business to maintain competition. For parties, this means that it takes longer to get through the regulatory process because they will need to select a buyer, negotiate a deal, and convince the agency that the buyer and divestiture package are adequate before they can obtain regulatory clearance on their main transaction.
Reverse break fees are increasingly at risk. Parties have used reverse break fees for a long time. However, the increased aggressiveness in challenging transactions combined with the heightened standards for acceptable remedies means that break fees are increasingly at risk. Very large break fees were paid by the buyer in transactions such as General Electric / Electrolux, Sysco / US Foods, Staples / Office Depot, and Halliburton / Baker Hughes. Interestingly, the government may also consider whether the target will be a stronger rival in the event a deal is blocked and receives a sizable reverse break fee. Because of the need to get the analysis right up front, it is critically important for the buyer to read-in enough people and provide enough data access to allow antitrust counsel (and economists, in some cases) to conduct the work to provide a strong assessment of the likelihood of a competitive issue, and to assess whether, and how large, a remedy would be required in order to obtain clearance.
Suggestions for merger clearance
In sum, given the government’s success in many recent merger challenges, companies contemplating mergers (or impacted by mergers) should consider the following:
Undertaking enhanced antitrust review of potential transactions, incorporating the Government’s latest theories, including its revived use of the “potential competition” theory and its frequent use of narrow customer-focused markets;
Getting “second” (or “third”) opinions from expert counsel on potential transactions to insure that potential antitrust risks are fully evaluated;
In the evaluation process, review those key internal documents likely to be produced in a Second Request and vet the analysis with knowledgeable business personnel involved in the overlapping product areas (including “reading-in” to the deal those personnel likely to be interviewed by government enforcers);
Where serious antitrust objections are anticipated, consider locating “buyers up front” for cohesive packages of assets;
In cases where government objections are anticipated, preparing early to litigate the transaction and building into transaction documents adequate time for litigation;
As a customer or competitor of merging parties, evaluate the likely effect of a transaction on your business and consider presenting to the agencies (potentially with others similarly situated) objections to the transaction.
As government enforcers frequently stress, merger challenges to transactions are still the exception, not the norm, so most M&A deals should still survive regulatory scrutiny with proper advanced analysis and preparation.