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.
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 recent months, 'common ownership'—whereby investors hold minority stakes in multiple companies active within the same industry—have come under increased scrutiny in the context of merger control. In February of 2018, Margrethe Vestager said that the European Commission is 'carefully' looking into the matter and has begun investigating the extent to which common ownership actually exists.
It would not be surprising if the analysis finds the phenomenon quite prevalent, at least in listed companies. That is because many institutional shareholders own stakes in businesses that compete, especially 'tracker funds' which invest in all constituents of any stock market index. While the holdings may not be large in percentage terms, these investors can often be among the businesses' largest shareholders and, in value terms, the stakes are often substantial.
However, one must draw a distinction between the fact that a number of investors may have shareholdings in competing businesses and whether they can influence the decisions of those companies. Various economic studies have investigated the potentially detrimental impact that common ownership can have on competition, and whether the phenomenon disincentivises businesses within the same industry from battling for market share. The value of this kind of research, and the need to expand it, has been recognised by competition authorities. The issue has come under the spotlight again more recently, following the merger between two agrochemicals giants, Dow and DuPont. Speaking last October at UCL's Transformations of Competition Law conference in London, for example, Carles Esteva Mosso, the European Commission's deputy director-general for mergers, signalled that the studies are firmly on the regulator's radar, as Vestager's recent comments have confirmed.
Esteva Mosso noted that the Dow/DuPont case was the first in which common ownership formed a part of the Commission's substantive analysis. He explained that 'the common shareholding in the agrochemical industry' was 'taken as an element of context in the appreciation of any significant impediment to effective competition'.
While the deputy director-general went on to say that no definitive conclusions about the future of the Commission's merger review can yet be drawn, the issue is quite clearly gaining prominence. It should also be noted that, while the analysis given to the issue in Dow/DuPont is unprecedented, the Commission's Horizontal Merger Guidelines mention cross-shareholdings as facilitating possible co-ordinated effects, both by providing a channel for the exchange of information between competitors and in providing 'help in aligning incentives among the coordinating firms'. Though the Guidelines refer to cross-shareholdings between competitors, the underlying issues relating to common ownership— shareholders owning a stake in several competing businesses—are very similar.
So, with this in mind, what are the potential effects on merger review going forward? What would an increased focus on common ownership mean in practice? How might different industries feel the impact?
First, if common ownership is to form a new focus for the Commission, it is very likely that a case-by-case approach will be adopted. The impact of the issue on competition will vary by industry, and by the specific nature of the activity in which companies are engaging. At its heart, this is because the nature of healthy competition and what drives that varies so widely by sector.
An industry's stage of development is likely to be one of the considerations. The tech sector, for instance, is still relatively young, and innovation is constant. Giants like Apple, as well as a wealth of startups and disruptors, are locked in a fastpaced race to out-innovate one another. Investors often back multiple entities in such a race to hedge their bets, and have at least some stake in whichever company comes out on top with the next best product, platform or system.
Moreover, while the technology sector is consolidating, it is doing so in interesting ways. When large tech firms buy up small ones, they often pit them against one another, treating their portfolio of companies as bets on the future. In this context, the potentially anti-competitive effects of common ownership may be somewhat mitigated.
In older, more established industries meanwhile, where the scope for innovation is naturally more limited, any impact of common ownership may be more amplified or adverse.
This is not, therefore, a case of onesize- fits-all. How rules are applied and enforced will depend on the specific businesses under scrutiny and the deal under review. Any merger will be analysed in context, with an understanding of how investor activity affects the incentives that companies have to compete.
In addition, the behaviour of individual shareholders is likely to be a major consideration. In fact, the identities and conduct of those shareholders with common ownership positions are likely to be particularly relevant.
Increased shareholder activism and attempts to influence target companies' management have attracted considerable attention over recent years. Demands for chair resignations, board seats and strategy reviews are increasingly common. In the Dow/DuPont case, Esteva Mosso highlighted the Commission's consideration of what fund managers 'said publicly about how they use their stakes', finding that 'many of them are not simply passively managing the stakes… but interacting with the management' of companies.
This activism complicates the analysis of common ownership positions. Activist investors with stakes in multiple companies within an industry may well seek to exercise their influence in ways that have the potential to dampen competition—whether directly or indirectly. With an interest in the performance of their overall portfolio, they may use their influence to try, for example, to encourage consolidation or a particular direction among the companies in which they hold a stake.
As such, the consideration of common ownership in any particular scenario will involve an examination of how the investors in question exercise their influence, and what that means for competition. In particular, the analysis needs to distinguish between determining the extent to which a shareholder may have a stake in various companies in the same sector and whether it can, or will, seek to influence the decisions of those companies.
It is interesting to look at the new focus on common ownership within a broader context. Some view the developments as part of a wider drive by the European Commission to expand its remit and the boundaries of merger control more generally. Is this a case of mission creep?
Proposals to expand both the range of deals and specific issues covered in the Commission's merger review analysis have been under consideration for some time. For example, the Commission does not currently possess the authority to assess the acquisition of minority stakes under its merger control rules and has considered proposals to allow it to do so, as authorities in the UK, Germany and Austria can. Similarly, the Commission has also recently proposed a framework for screening foreign direct investment (FDI), raising potential national security or public order concerns. Initiatives like FDI screening or looking at common ownership may indicate a general attempt by the European Commission to cast its net wider and broaden its reach.
Companies and advisers should follow these developments closely, to ensure they are prepared for any change in direction or expansion of Commission activity. With Brexit approaching, this is a particularly important time for businesses with UK operations—the UK's exit from the EU presents an opportunity for competition authorities at both a national and European level to review their position and set the tone for the coming months on some of these issues.
It is still early days. Esteva Mosso himself has said companies should not read too much into the approach taken in the Dow/DuPont case. It may well be that this is nothing more than a storm in a teacup—time will tell.
It is important, however, that companies and investors understand this issue. It is likely the Commission and other competition authorities will monitor any new research or findings on the subject of common ownership closely, especially if activist investors continue to seek to drive the policy of the companies in which they may only own a very small stake. It seems unlikely that Dow/DuPont will be a one-off case, and we may well see common ownership becoming a feature of merger analysis in the future, in cases where a number of competitors in a particular industry are listed companies, and may therefore have a number of common shareholders.
Video: Common ownership under scrutiny
Partners Marc Israel, Mark Powell and Axel Schulz discuss how competition regulators investigate issues relating to common ownership.