The Federal Court has declined to block Metcash’s proposed acquisition of Franklins
The case is one of a small number of contested merger cases to reach the Federal Court, and it may provide an opportunity for the ACCC to further refine its merger review processes, including by giving greater transparency over the evidence on which it intends to rely to oppose a merger.
Even though the case was heard on an expedited basis, it took about nine months to reach judgment.
The ACCC has 21 days to decide whether it wishes to appeal the judgment to the Full Court of the Federal Court.
Implications of the case
Contested merger cases are likely to continue to be rare and confined to situations where there is only one viable bidder for the assets (similar to the AGL/Loy Yang A case), giving the sole viable bidder time to contest the Commission’s decision to block the deal.
If there is more than one viable bidder for the asset, the seller of the asset will usually not be prepared to spend nine months in a court battle and will usually sell the assets to one of the other viable bidders (even if at a lower price).
For their part, acquirers may prefer to offer undertakings in order to achieve clearance, rather than wait for the Commission to block the deal and commence court proceedings.
The loss for the Commission, and Rod Sims’ new role as Chairman of the Commission, may present an opportunity for the Commission to further fine tune its merger clearance process, including by giving more transparency about the evidence it is relying on when it proposes to block a merger or acquisition.
The key issues in the Metcash case were:
- Whether there was a separate market for the wholesale supply of packaged groceries to independent supermarkets in New South Wales and the Australian Capital Territory, which excluded Woolworths and Coles, as the ACCC contended. The Court rejected the ACCC’s contention, finding instead that there may be a market for the supply of grocery products generally by retail.
- Whether there were viable alternative bidders to Metcash for Franklins (the counterfactual), as the ACCC contended. The Court rejected the ACCC’s contention, finding instead that viable alternative bidders (who would be acceptable to Franklins) did not likely exist.
There have been a handful of proceedings brought by the Commission to block proposed mergers, but most of those proceedings have been discontinued before the substantive issues were determined by the Court.
The last time the Court heard, and delivered judgment on, the substantive issues in an application by the Commission to block a merger or acquisition was 1990, in the Arnott’s/Cereal Foods (Nabisco) case, and the last time the Court heard and delivered judgment on the substantive issues in an application by the merger parties contesting the ACCC’s decision to oppose a merger was in 2003, in the AGL/Loy Yang A case.
Background to the case
Metcash is Australia’s largest independent grocery, fresh produce and liquor wholesaler and distributer, servicing independent grocery retailers throughout Australia, including those under the IGA and Supa IGA banners.
Franklins operates 80 corporate owned and ten franchised Franklins supermarkets in New South Wales.
On 1 July 2010, Metcash entered into an agreement with Pick n Pay to acquire all of Franklins for $215 million. On 17 November 2010, the Commission announced that it would oppose Metcash’s proposed acquisition of Franklins. Following the Commission’s declaration, Metcash notified the Commission that it intended to complete the acquisition. The Commission applied to the Federal Court for a final injunction to prohibit the proposed acquisition on 8 December 2010.
Further details on the background to the Commission’s application for a final injunction can be found in a previous client alert.
Commission’s challenge to the proposed acquisition
The Commission’s case focused on two principal issues:
- market definition; and#
- the counterfactual.
Market definition - would there be a merger to near monopoly?
The Commission considered that the relevant market was the wholesale supply of packaged groceries to independent supermarkets in New South Wales and the Australian Capital Territory.
The Commission alleged that the suppliers to the market are Metcash, Franklins, and, to a lesser extent, SPAR. The Commission also contended that Franklins was Metcash’s closest competitor in the market.
The Commission argued that if the acquisition was to proceed it would be a merger to near monopoly in a market with high barriers to entry - Metcash would become the only wholesaler capable of supplying large format independent supermarkets and would shut down Franklins’ wholesale operations.
The Court’s findings on market definition
The Court was not persuaded that there is a separate market for the wholesale supply of packaged groceries to independent supermarkets. The Court considered that the retail level of the market was important because:
- Metcash is not simply a wholesaler. Metcash is closely involved in the retail process, through ownership and through contract;
- Metcash is acquiring Franklins to acquire retail stores (albeit with the hope of expanding the volume of its wholesale sales), rather than to acquire Franklins’ wholesale assets. Metcash intends to shut down Franklins’ wholesale assets over time;
- constraints at the retail level affect the wholesale level. The major supermarket chains act as a very significant constraint on the capacity of independent retailers to increase price or decrease services without losing business; and
- the retail market is highly competitive.
Counterfactual: were there viable alternative bidders for Franklins?
The second important element of the Commission’s case was the counterfactual scenario. The Commission contended that if the acquisition by Metcash were not to proceed, a third party would acquire Franklins and:
- procure the wholesale supply of packaged groceries by acquiring and continuing to operate the Franklins assets;
- establish their own wholesale operations in New South Wales and the Australian Capital Territory; or
- use the volume of sales generated by the Franklins stores to sponsor the establishment of a third party wholesaling operation for the purpose of supplying those stores and other independent supermarkets not committed to taking supply from Metcash.
The Commission argued that this would deliver a substantially less detrimental outcome for competition because the numbers of suppliers in the market would not be reduced.
In contrast, Metcash argued that if the acquisition by Metcash were not to proceed, the Franklins stores would be sold to one of the major supermarket chains; would be sold to an independent grocery retailer; or would be closed.
The Court’s finding on the likely counterfactual
The Court was not persuaded that a third party would likely make an offer to acquire Franklins’ assets, that would be accepted by Pick n Pay.
The uncertainties surrounding the terms of any potential binding offer from a third party made it a matter of pure speculation as to whether a binding offer might be made, let alone whether it would be accepted by Pick n Pay.
Further, the Court found that the Commission had not presented evidence to support its assertion that Woolworths, Coles or Metcash would be prohibited from acquiring stores that might be disposed of by Franklins in a store by store sale process.