In a period of economic, political and regulatory change, how can companies plot the right course for M&A success?
Merger control in a changing world
Global economic growth is back on the agenda and companies are once again looking to position themselves for success by pursuing mergers and acquisitions. But what are the prerequisites for success in an increasingly disrupted world?
Welcome to the second White & Case merger control publication, the first edition of which was warmly received. Earlier this year, it became apparent that an update was required, not so much driven by regulatory change, but rather to take into account policy shifts.
For example, we have seen the US catch up with Europe in relation to vertical mergers, the AT&T/Time Warner review being the most prominent recent example. At the same time, the European Commission has forged ahead again with a focus on conglomerate mergers and innovation markets. Perhaps the Dow/DuPont merger has attracted the most attention, as authorities now get out their telescopes and look far into the horizon to identify anti-competitive harm. There is a sense among the Commission’s hard-liners that in the past too many mergers wriggled through without proper analysis. Our own view is that it may be legitimate to look ahead to try and identify harm (after all, that is what merger control is all about), but this long lens should not be forgotten when it comes to reviewing the synergies that a merger may create. However, Europe has set the tone, and we expect other authorities to follow.
Europe also seems to be taking the lead (and others will follow due to the prospect of publicity-garnering fines) in relation to procedural infringements. The argument for pursuing companies for inaccurate filings, for example, is that such violations call into question the very system of merger control. Be that as it may, due process needs to be followed in such cases, and this may divert valuable resources to past cases as opposed to dealing with the current case load. In other words, pursuing a few flagrant cases may be necessary to set a precedent, but they should not become regular items on the authorities’ agendas (bringing with them attendant increases in filing times, and costs). Our view is that the authorities should confine their focus to statements that would have yielded a very different outcome, not mere technical infringements.
This leads us to the subject of gun-jumping. Again, viewed from afar, this should not be a problem in no-issues filings, and authorities typically have the tools to unwind a completed merger. The maxim ‘no harm, no foul’ ought to be applied to these cases to ensure that valuable resources are not frittered away on them.
In sum, our assessment is that the global system of merger control continues to limp along. However, the costs associated with a system containing myriad controls are increasingly high. Looking ahead, we wonder whether a fundamental overhaul is needed to ensure that transactions that pose no problems are not saddled with the costs imposed by the global system. (Yes, this will mean some authorities will have to relinquish jurisdiction in certain instances, safe in the knowledge that a transaction will be reviewed elsewhere.)
But more importantly, we continue to believe that the system of mandatory pre-merger review is fundamentally flawed and that instead we should shift to a system of voluntary merger control in which only mergers that present genuine issues need to be notified. Ironically, when commentators question whether the UK system of merger control needs to change in light of Brexit, one of the things that we would not change is the voluntary nature of the system.
The European Commission is increasingly concerned that market consolidation will harm innovation and has changed dramatically the way it examines the impact of mergers on innovation. Merging parties should be prepared for it.
When it comes to mergers within the digital landscape, the greatest challenge for regulation is to strike the right balance as regards enforcement. How are EU authorities taking action and what does this mean for the innovation economy?
The European Commission is paying greater attention to investors who hold stakes in multiple companies in the same industry and considering how this concentration of influence might have an anti-competitive effect.
In the European Union, an increasing number of merger clearances are being given on the condition that the parties offer suitable remedies. During Margrethe Vestager's first three years as Commissioner for Competition, a total of 64 conditional clearances have been granted. This constitutes a 42 per cent uplift compared to previous Commissioner Joaquín Almunia's final three years in office.
A conditional clearance will most likely require the parties to divest a part of their business, as has been the case for more than 80 per cent of remedy cases over the past three years. (In 2015, 90 per cent of conditional clearances required a divestiture of some kind.) In fact, the European Commission's (EC's) policy explicitly prefers structural remedies—which require merging parties to make divestments that change the market structure—over other types of remedies.
Every remedy has a subtle difference. While the divested business should be viable to allow the purchaser to compete effectively with the merged entity on a lasting basis, the structure of the divestiture may vary to account for competitive concerns. For example, it may affect global R&D facilities to tackle innovation concerns (as in Dow/DuPont), employ a transitional supply agreement to address viability concerns (as in Staples/Office Depot), or licensing arrangements to enable the purchaser to market the divested business under the merged entity's stronger brand (as in Danone/The WhiteWave Foods Company).
Although rare, non-structural remedies—such as promises not to act in a certain way in the future—do exist. Over the past three years, 11 out of 64 remedy cases were resolved with a purely behavioural remedy. They are accepted 'only exceptionally in specific circumstances,' such as in 'conglomerate structures'.
For instance, on 25 February 2016, the EC conditionally cleared the conglomerate concerns in Dentsply/ Sirona with a behavioural remedy. The EC maintained that the merging parties would have significant market power that could foreclose competing suppliers of dental 'blocks' from a sizeable part of the 'chairside CAD/CAM system' market. To remedy this, the EC required an access remedy from the parties, including the extension of existing licensing agreements with competing block suppliers until 2026. The EC took the unusual step and noted that 'remedies other than divestiture remedies appear best suited to directly address the [conglomerate] concerns raised.'
In November 2017, Qualcomm updated its remedy package to allay the EC's concerns in Qualcomm/NXP Semiconductors. Qualcomm first offered a set of commitments on 5 October 2017. It is understood that the October package offered to carve out all standard essential patents (SEPs) from the transaction, and committed Qualcomm not to assert certain patents owned by NXP (in particular Near Field Communication Technology – NFC). This package was market tested and viewed as inadequate by market participants. The November package added on the behavioural obligation on Qualcomm to ensure the interoperability of NXP's NFC platform with other parties.
Notably, in the most recent merger cases authorised with remedies, the Italian Competition Authority has often imposed a combination of structural and behavioural remedies and in some cases only non-structural remedies. In the RTI/Gruppo Finelco case (2016) the authority requested only behavioural measures, including prohibitng the merged entity from concluding other advertising concession contracts, to limit potential vertical and conglomerate effects which could be produced by the merger. In April 2017, in the Gruppo Editoriale l'Espresso/ Italiana editrice case the authority also only imposed behavioural measures considered capable of neutralising the horizontal overlaps between the merging parties in the relevant market. In January 2018, in case 2I Rete Gas/ Nedgia, the most recent merger case authorised with remedies, the authority imposed structural measures consisting of the divestment of certain local activities as well as behavioural remedies aimed at lowering barriers to entry to the market.
Case of delay
When structural remedies are required, there is also now a higher chance that the closing of the deal will be delayed as the EC increasingly requires merging parties to agree to upfront/fix-it-first purchaser clauses.
Usually, merging parties offering remedies can close a transaction once they receive the EC's conditional clearance. A suitable purchaser has to be identified following clearance within a set period. But when the EC has concerns about whether a suitable purchaser can be identified, an upfront buyer or fix-it-first clause can be used. An upfront buyer clause requires the parties to agree not to close the transaction until the EC approves the purchaser and the underlying agreements. A fix-it-first clause goes one step further, and obliges the parties to find a suitable purchaser and enter into a legally binding agreement during the EC's administrative procedure.
In 2015, one in five remedy decisions included an upfront buyer or fix-it-first purchaser clause. By 2016, this number increased to one in three—a trend that continued into 2017, when approximately 33 per cent of decisions imposed a purchaser clause.
In practice, these clauses provide leverage to remedy buyers: Merging parties anxious to close may settle for a 'fire sale' of the divested assets. Yet Ball/Rexam is an example of the potential sluggishness of the process. This merger within the global canning sector was conditionally cleared on 15 January 2016 with an upfront buyer clause included in the remedy. Ball had noted pre-clearance that there was 'no assurance that buyers satisfactory to Ball and the regulators' could be found. Indeed, it took three months for Ball to propose a suitable purchaser to the EC. It took another three months for the EC to conclude on the suitability of the purchaser and the underlying agreements, demonstrating the delay the process can cause to closing. The deal finally closed six months after the parties received the EC's conditional clearance decision.
In early 2017, the United States Federal Trade Commission (FTC) released a report analysing the effectiveness of past merger remedies (between 2006 and 2012) and outlining best practices going forward. The report confirms the FTC's preference for structural remedies, such as divestitures, over behavioural remedies that often require extensive monitoring to enforce. The Department of Justice (DOJ) has not released a similar official report, but Makan Delrahim, the recently confirmed head of the DOJ Antitrust Division, echoed the FTC's preference for divestiture over behavioural remedies in a recent appearance at New York University.
The FTC report found divestiture of an ongoing business (a set of assets immediately capable of being a stand-alone business) to be more effective than divestiture of selected assets. The distinction focuses on the ease with which a standalone business divestiture may be transitioned to the buyer, compared to assets that take more effort to be incorporated into the buyer's existing framework before successfully competing in the market. For the FTC to accept a divestiture of selected assets, the parties may be expected to show why divestiture of an ongoing business is infeasible and demonstrate how the selected assets can operate as a viable and competitive business.
The FTC also expressed concern over the 'hold-separate' period, during which assets identified to be divested remain in the control of the seller. The FTC stressed the importance of independent managers empowered to make real-time decisions to maintain the assets' competitive value during the interim period before divestiture is complete.
Recent FTC and DOJ enforcement actions have been consistent with this policy directive. For example, the FTC recently required Abbott Laboratories and Alere Inc. to divest two product lines to obtain clearance, and the DOJ ordered CenturyLink and Level 3 Communications to divest certain overlapping aspects of their telecommunications businesses.
China attracts controversy
In China, the Ministry of Commerce (MOFCOM) has increasingly imposed patent-related remedies on merging parties as a condition to approval. This approach has been criticised for diverging from enforcement approaches taken in other jurisdictions. However, it appears to be an ongoing trend that may create uncertainty, particularly for mergers involving high-tech companies.
To date, a majority of mergers drawing mandatory remedies in China are foreign-to-foreign mergers. Of the 33 transactions on which MOFCOM has imposed conditions since the Anti-Monopoly Law (AML) entered into force in 2008, all but five involved foreign-to-foreign transactions.
Merging parties should be prepared for a prolonged review waiting period, particularly in mergers involving the technology industry. MOFCOM recently imposed a hold-separate period on a high-tech consolidation, a remedy that has not been used in at least four years. This controversial remedy requires the merging parties to ensure various aspects of their operations remain independent for two years. MOFCOM's reviews of proposed high-tech mergers are often influenced by local vendors' objections to sector consolidation.
Since the end of 2014, MOFCOM has penalised non-compliance with imposed remedies, including monetary fines up to ¥500,000 (approximately €64,000). That trend continued into 2017. In addition, MOFCOM maintains jurisdiction to order the dissolution of the merger, disposal of shares or assets, the transfer of the business, or adoption of other measures to restore the market situation. Despite this position, MOFCOM has never yet ordered dissolution of a non-complying merger. To date, all 19 MOFCOM penalties have been monetary fines imposed for failure to file, rather than for post-filing noncompliance.