Getting complex cross-border deals across the line
As authorities pay more attention to novel competition issues in merger control reviews, or dust off previously unfashionable theories of harm, merging parties need to anticipate and prepare for this additional scrutiny. They should expect and plan for authorities to test high-profile deals from a variety of different angles that go beyond the basic assessment of merger-specific price effects.
We anticipate that 2018 will bring a renewed focus in some jurisdictions on:
- merger effects on innovation competition in R&D intensive industries;
- common ownership of competing companies as evidence of co-ordinated effects; and
- conglomerate effects relating to the ability of a merged entity to leverage a strong market position from one market to another.
Competition authorities have long recognised that innovation – in addition to price and product quality – is a relevant component of competition. However, they have traditionally limited the analysis of the likely impact of a merger on innovation to the overlaps between the merging parties’ marketed and (late-stage) pipeline products.
That is changing. In particular, the European Commission has recently applied more expansive theories of harm involving innovation:
- in the pharmaceutical sector, there are clear signals that the Commission has become less receptive to the argument that it is too speculative to consider early-stage pipeline products in an overlap analysis. In J&J/Actelion, for example, the Commission required the parties to offer a remedy for an overlap between two early-stage insomnia pipeline products; and
- in Dow/DuPont, the Commission concluded that the merger between two leading agrochemical companies would give rise to traditional unilateral price effects. Of greater note, it added that the parties would find it profitable to reduce their overall R&D investments, resulting in a reduction in the number of new pesticides brought to the market in the future. The US DOJ, on the other hand, concluded that the market conditions in the US did not provide a basis for a similar conclusion (notwithstanding the absence of an established difference in market conditions between the US and the EU).
Economists have traditionally considered the relationship between competition and innovation to be too complex to predict whether a merger is likely to reduce or increase innovation. However, a number of recent publications, including some by members of the European Commission’s Chief Economist Team, have taken a less nuanced position affirming that mergers between competitors can be expected to reduce the incentive to invest and innovate (in the absence of efficiencies).
Although the debate is ongoing as to whether the Commission’s innovation theory in Dow/DuPont is based on sound economics and meets the required evidentiary standards, our experience from a number of ongoing cases indicates that, in the EU, mergers will remain subject to close scrutiny as to how they impact innovation, regardless of the industry sector.
Whether competition authorities will consider a transaction as giving rise to innovation concerns will depend on a variety of factors. These include the general industry features (eg concentration levels, drivers of innovation in the industry, any evidence of the impact of past industry consolidation on R&D output, etc) and the closeness between the merging parties in terms of innovation efforts.
I expect the impact on innovation to remain an important aspect of merger reviews in the EU, in particular in R&D-heavy sectors. Although different agencies are adopting different approaches in this area, merging parties need to be aware of the risk in multijurisdictional filings that there will be additional focus on innovation.
The effects of common minority investment have been a subject of interest in US competition law in recent years. The theory is that institutional investors with holdings in multiple competing firms may have the incentive to dampen competition, either by facilitating co-ordination among portfolio companies or by pressuring portfolio companies to adopt common strategies. The US antitrust agencies have shown interest in recent controversial empirical studies that have attempted to link the growth of common ownership with reduced capacity and higher prices in several industries, including airlines, banking and retail pharmacies.
Although common ownership has not traditionally featured significantly in merger reviews, there are signs that this is changing, particularly in oligopolistic industries where authorities are starting to evaluate common ownership as evidence of co-ordinated effects.
In the EU, again in Dow/DuPont, widespread common ownership in the agrochemicals industry was viewed as an ‘element of context’ by the Commission that implied a greater level of concentration than traditional concentration metrics like market shares or Herfindahl-Hirschman Index (HHI) calculations suggested. The Commission argued that common shareholdings likely had a negative impact on price and innovation competition in the agrochemicals industry – and used as evidence of this the influence exerted on companies by supposedly ‘passive’ common minority investors.
The challenge for 2018 will be to anticipate the deals in which common ownership may be an issue and find ways to test the proposition that common ownership softens competition. It remains to be seen whether other authorities will follow the European Commission’s lead in this area – in the UK, for example, the apparent reticence of the Competition and Markets Authority (CMA) may change in light of the recent wave of shareholder activism across Europe and particularly in the UK. However, companies will need to follow such developments closely given the considerable scope for application by authorities in the future. In any event, this is another non-traditional element that parties should factor into their merger control risk analysis.
The reaction to the US-based literature on common ownership has been far-reaching. The European Commission in Dow/DuPont heavily cited this and we know that US authorities consider common ownership issues in their merger investigations. With this backdrop on both sides of the Atlantic, it is important that we recognise common ownership issues early and proactively manage the risk.
Conglomerate and vertical effects
The conglomerate effects theory of harm has fallen out of common use by the European Commission since GE/Honeywell back in 2001. However, a series of recent cases in a diverse range of industries indicates that the Commission is looking at issues around conglomerate effects with renewed interest.
In recent cases, the Commission has articulated serious concerns about the relationship the proposed transactions would create between merging parties selling complementary products. In particular, the Commission investigated concerns that the transactions would increase the parties’ ability and incentive to:
- bundle complementary products, ‘squeezing out’ competing products; and
- degrade the interoperability between their products and a rival’s competing downstream product, in favour of their own downstream product.
In these cases, the Commission required commitments to allay conglomerate concerns. For example, in Broadcom/Brocade, clearance was conditional on commitments covering non-discrimination measures and firewalls, to resolve concerns about technical degradation of interoperability and/or misuse of confidential information. In Microsoft/LinkedIn, commitments concerned access to Microsoft’s application programming interfaces (APIs) and options for customers to disable LinkedIn features, to resolve concerns about the integration of LinkedIn into Microsoft’s programmes and denial of access to competitors to its APIs. There is continuing focus on this theory of harm in a number of ongoing cases (including Qualcomm/NXP and Essilor/Luxottica).
Traditionally, US authorities have approached conglomerate effects and other non-horizontal merger theories with considerable scepticism. By way of example and contrast with the European Commission, the DOJ cleared the Qualcomm/NXP deal without conditions in early 2017, just as it had cleared GE/Honeywell without conditions in 2001. Very recently, however, the DOJ filed in federal court to block the AT&T/Time Warner merger, the first time in decades that a US agency has litigated an injunction on a non-horizontal merger theory. Although the role of political influence on the DOJ’s decision has been raised in related media coverage, the case would not have been filed without a recommendation from DOJ career staff, and the prosecutorial and judicial precedent will be significant to future conglomerate and vertical transactions.
Merging parties operating in complementary markets cannot be complacent about the level of scrutiny regulators will exercise on their deal. A lack of overlap does not mean authorities will necessarily wave the deal through. By their nature, conglomerate concerns can often be difficult to remedy.
Merging parties will have to think about how to manage the advent of these new and developing theories of harm in terms of deal planning and risk allocation. Navigating these challenges successfully from both the M&A and the antitrust perspective will be mission-critical for successful complex global mergers in the year ahead.
Rick Georg van Aerssen, Partner, Frankfurt, London and Düsseldorf, and Co-head of Global Transactions
Looking ahead in 2018
Companies planning complex deals in 2018 are advised to prepare early and well and should think outside the box as authorities test high-profile deals from a variety of different and, in some cases, novel angles.
- Be prepared for an investigation on the different parameters of competition; whereas the focus of merger analysis has traditionally been on potential price effects, competition authorities may navigate into more speculative areas and assess the impact of a transaction on overall levels of innovation and R&D in the industry.
- Analyse common shareholdings in each merging party and their competitors, particularly in oligopolistic industries with significant shareholdings owned by common financial investors.
- Anticipate conglomerate effects in circumstances where the merging parties operate in complementary fields where at least one of the parties has market power.