The latest major deal to collapse under pressure from antitrust enforcers did not fail due to high combined market shares in existing product markets. Applied Materials, Inc. abandoned its 18-month pursuit of Tokyo Electron Limited amid concerns by the Antitrust Division of the U.S. Department of Justice and foreign antitrust regulators regarding potential harm to future industry innovation. Companies contemplating a transaction should be mindful that antitrust authorities will take a close look at the deal’s potential impact on innovation, particularly in industries where a small number of competitors with large R&D budgets are viewed as driving innovation. Implementing remedies to address regulators’ concerns regarding the loss of competition to innovate may present practical challenges not involved in the divestiture of a business line for an existing product or service. In addition to assessing current product and service overlaps, parties contemplating a merger should carefully consider how antitrust authorities may view the transaction’s likely effect on industry innovation.

DOJ’s Review of the Deal

In September 2013, U.S.-based Applied Materials announced plans to acquire Japanese rival Tokyo Electron in a $9.4 billion all-stock deal. The merger would have combined the number one and number three global suppliers of semiconductor manufacturing equipment.1 The DOJ issued a Second Request in December 2013. More than a year later, in February 2015, the parties submitted a “coordinated global remedies proposal”2 intended to resolve concerns of the DOJ and foreign competition regulators.3 On April 24, 2015, the DOJ informed the companies that the proposed divestiture package was insufficient. Shortly thereafter, and more than 18 months after the deal announcement, Applied Materials and Tokyo Electron abandoned their plans to merge.

According to the companies, the DOJ’s concerns focused on “overlaps between the compan[ies’] current and pipeline products as well as general effects of the merger on future innovation.”4 In particular, the DOJ stated that the companies’ proposed remedy package would not have alleviated the deal’s impact on “the development of equipment for next-generation semiconductors.”5 The DOJ also expressed concern that the transaction would have combined “the two largest competitors with the necessary know-how, resources and ability to develop and supply high-volume non-lithography semiconductor manufacturing equipment.”6 Tokyo Electron’s CEO expressed his surprise at DOJ’s concerns regarding “products under development, which are not sold to the customer, [for which Tokyo Electron] cannot have any [current] market share,” noting that the DOJ’s focus “was totally different from … [the company’s] initial expectation.”7

Key Takeaways

While the DOJ and Federal Trade Commission have long examined the likely effects of a transaction on merging parties’ incentives to innovate, potential harm to innovation has become an increasingly prominent agency concern.8 Earlier this month, Comcast Corp. and Time Warner Cable Inc. abandoned their $45.2 billion merger amid a number of DOJ and Federal Communications Commission concerns, including the deal’s potential negative impact on the growth of online video streaming. Comcast’s proposed divestiture of 3.9 million cable subscribers proved insufficient to satisfy the DOJ’s concerns regarding the harmful impact to innovation by content and streaming services.9 Concerns over a loss of innovation also featured prominently in the DOJ’s successful suit to unwind Bazaarvoice Inc.’s acquisition of PowerReviews Inc.10 Likewise, in 2014, the FTC had innovation concerns related to the Nielsen Holdings N.V./Arbitron, Inc. transaction based on its conclusion that the companies were “best- positioned” to provide a yet-to-be-developed cross-platform audience measurement service in a “future market … with … concomitant uncertainty.”11 Nielsen agreed to divest Arbitron’s cross-platform audience measurement services (including software, know-how, data, and related technology) to comScore, Inc., a buyer approved by the FTC.12

Applied Materials and Tokyo Electron also sought to resolve antitrust concerns through a divestiture of assets to a proposed buyer, but the proposal failed to satisfy the DOJ. Although implementing divestitures may be relatively less challenging in industries that involve regularly buying and selling of pipeline products, such as the pharmaceutical industry, R&D divestitures in other industries can prove quite complex.  Merging parties should expect that agency scrutiny of divestiture buyers will be more pronounced where a divestiture involves R&D/innovation because, unlike a divestiture of existing operations, innovation is future activity, the success or failure of which remains critically dependent on the capabilities and expected incentives of the divestiture buyer. Agency concerns regarding the sufficiency of a proposed set of divestiture assets and the ability of a proposed buyer to compete effectively can be particularly challenging in this context.

The termination of the Applied Materials/Tokyo Electron transaction provides a stark reminder that the antitrust agencies will closely scrutinize innovation and R&D when assessing the competitive effects of a proposed transaction. Companies should be advised that a complete antitrust risk analysis must include an assessment of the competitive dynamics of the innovation markets implicated by the proposed deal alongside existing products and services, especially when the parties are among a small number of competitors seen as  leading industry innovation. Finally, companies  planning deals with potential innovation implications should be prepared for prolonged review periods that will include extensive vetting of proposed remedies.