Following an eight-month merger review process, on 13th August 2012, MOFCOM conditionally cleared Wal-Mart’s acquisition of control of Shanghai Yishiduo E-Commerce Co., Ltd. (Yihaodian), the largest online supermarket in China.
This is the second time that MOFCOM has applied “leverage theory” to intervene in a transaction, following the Coca-Cola/Huiyuan prohibition decision in 2009. In its decision, MOFCOM ruled that Wal-Mart would have the ability to leverage its competitive advantages in the brick-and-mortar supermarket retail sector into the online retail and Value Added Telecommunications Business (VATB) markets to eliminate or restrict competition in these markets.
To address these concerns, MOFCOM imposed conditions confining the scope of the transaction to the online direct sales business of Yihaodian only, prohibiting Walmart from providing network platform services to trading parties through Yihaodian, and expressly precluding Wal-Mart from offering VATB services through Yihaodian via a Variable Interest Entity (VIE) structure. This is the first conditional clearance case involving the online retail sector and it is also the first time that MOFCOM has explicitly prohibited the use of a VIE structure when imposing a remedy.
Parties and the Transaction
The target, Shanghai Yishiduo E-Commerce Co., Ltd. (Yihaodian) (Yihaodian), is currently the largest online supermarket in China offering 250,000 kinds of commodities to over 20,000,000 users.
The acquirer, Wal-Mart, is one of the world’s largest supermarket chains. In 2011, Wal-Mart, via its wholly owned subsidiary GEC 2, increased its stake in Yihaodian’s parent company, Niu Hai Holdings, from 17.7% to 51.3% (the Transaction). Upon completion of the proposed transaction, Wal-Mart will own a controlling interest in Niu Hai Holdings and will thus control Yihaodian.
MOFCOM identified Wal-Mart’s business as principally engaged in brick-and-mortar supermarket retailing. Yihaodian’s business was identified as encompassing both online direct sales and Value Added Telecommunications Business (VATB), i.e. providing an online trading platform for other online sellers and consumers. MOFCOM determined the relevant product market to be the B2C online retail market and the China domestic market as the relevant geographic market. However, the MOFCOM decision did not provide much explanation as to how the relevant market was defined. In particular, it is unclear whether the B2C online retail market, as defined by MOFCOM, includes both the online direct sales and VATB businesses of Yihaodian. Interestingly, the proscribed remedies are specifically imposed on the online direct sales market and the VATB market, and are not specifically addressed to the B2C online retail market, the product market as defined by MOFCOM in this case.
MOFCOM concluded that the acquisition may have the effect of restricting or eliminating competition in the B2C online retail market in China for the following reasons:
Ability of Wal-Mart to leverage its competitive advantages in brick-and-mortar supermarket into the online direct sales business which Yihaodian is active in: Without providing any details of its analysis in the decision, MOFCOM concluded that, following the transaction, with its “sophisticated warehousing and distribution system, wide range of supply channels and brand recognition”, Wal-Mart would be able to leverage its competitive advantages in the brick-and-mortar supermarket market into the online retail market and substantially increase the competitive advantages of the post-transaction entity in the latter market.
Ability of Wal-Mart to leverage the combined competitive strength of its brick-and-mortar supermarket and newly acquired online direct sales business into the VATB market: MOFCOM also extended its investigation into China's VATB market and determined that, if Wal-Mart were to enter the VATB market via Yihaodian, it would be able to leverage the combined strength of its brick-and-mortar supermarket and newly acquired online direct sales business to build an advantageous position in China's VATB market, enhancing its pricing power over the users of the online trading platform, and thereby potentially eliminating and restricting competition in China's VATB market.
To address the above competition concerns, MOFCOM imposed the following remedies on Wal-Mart:
- The scope of the acquisition by Wal-Mart shall be limited to the online direct sales business of the existing network platform of Yihaodian;
- Following completion of the Transaction, Niu Hai Shanghai, the parent company of Yihaodian which would be controlled by Wal-Mart, may not provide online trading platform services to other trading parties without first obtaining a VATB business permit;
- Following completion of the Transaction, Wal-Mart must not operate the current VATB business of Yihaodian through a VIE structure.
It is noteworthy that, in this decision, MOFCOM for the second time applied the “leverage theory” to intervene in a transaction. In its prohibition of Coca-Cola’s acquisition of Huiyuan in 2009, MOFCOM ruled that, given Coca-Cola’s dominant position in the carbonated soft drinks market, it would have the ability to leverage its market power in that market into the juice market and thus eliminate or restrict competition in the latter market. In this decision, MOFCOM again applied “leverage theory”, ruling that Wal-Mart would have the ability to leverage its market power in the brick-and-mortar supermarket business into the online retail market and, further, into China’s VATB market.
While “leverage theory” does have some currency in Europe (where it is called “portfolio power” or “conglomerate merger effects”), it is still rare for the competition agencies to apply it in practice. In fact, the guidance of the European Commission in this area indicates that “conglomerate mergers, in the majority of cases, will not lead to any competition problems”. Moreover, “leverage theory” is generally not followed by other important competition agencies, such as those in the US.
In applying “leverage theory”, a competition agency would typically need to show that, post-concentration, an undertaking with a dominant position in one market may leverage its market power in that market into the neighboring market to engage in anti-competitive tying and bundling.
Unfortunately, given the lack of details in relation to the market definition applied in this case and the reasoning behind its decision, MOFCOM failed to show why and how “leverage theory” should be applied in this case. First, MOFCOM did not define the brick-and-mortar supermarket business, in which Wal-Mart is active, as a relevant product market, which would be a starting point for a competition assessment under “leverage theory”; secondly, MOFCOM merely described Wal-Mart as “a major player” in the global and PRC retail markets but does not offer details as to how it has established that Wal-Mart holds a dominant position in the brick-and-mortar supermarket market. Unusually, the decision did not include market share data for Wal-Mart and its competitors, which has been relied on as a major indicator of an undertaking’s market power in MOFCOM’s previous conditional clearance decisions; finally, even assuming that Wal-Mart holds a dominant position in the brick-and-mortar supermarket market, MOFCOM would still be expected to show how Wal-Mart would be able to leverage its market power from the brick-and-mortar supermarket market into the online retail and VATB markets. For example, a typical approach to leveraging a competitive advantage from one market into another is through anti-competitive bundled sales. However, it is unclear how bundled sales could be realised between the brick-and-mortar supermarket market and the online retail/VATB markets.
Another noteworthy point of this case is that, for the first time, MOFCOM explicitly dealt with the issue of VIEs in a merger clearance decision. Under a typical VIE structure, the foreign investor will establish a wholly foreign-owned enterprise (a WFOE) in China and the WFOE will control the operation of a domestic enterprise controlled by the nominee of the foreign investor (the Operating Company). The Operating Company will hold all the operating licenses and permits required for the operation of the relevant business which would otherwise be restricted to foreign investors. The WFOE and the Operating Company, together with other relevant parties, will enter into various contractual arrangements to allow the WFOE (and, indirectly, the foreign investor) to effectively control the Operating Company and to enable the foreign investor to extract the economic benefits generated by the Operating Company (often in the form of “service fees” payable by the Operating Company to the WFOE).
The VIE structure was first used by Sina Corporation in 2000, one of the first Chinese Internet companies to list on Nasdaq. It has since been widely adopted, particularly in the value-added telecoms sector (e.g., internet content provision, online gaming, online retail, and online media) to circumvent the restrictions preventing foreign parties from holding controlling stakes in this sector. Despite its widespread use, the legality in China of the VIE structure has long been uncertain and its use has given rise to controversy.
The explicit prohibition of the use of a VIE structure by Wal-Mart to operate the VATB business of Yihaodian in this decision, while not an express declaration as to the illegality of the use of the VIE structure, indicates MOFCOM’s negative attitude towards the use of VIE structures.
This attitude has at least two important implications. First, if a transaction that is subject to antitrust review by MOFCOM contains a legacy VIE structure (for example, the target was previously controlled through a VIE structure), while MOFCOM, as the merger review authority, may not take a view as to the legality of the previous VIE structure, it may prohibit the new foreign buyer from taking advantage of the previous VIE structure to circumvent foreign investment approvals. Second, MOFCOM’s negative attitude towards VIE structures, in the merger review context, may also reflect a broader shift in the PRC government’s attitude towards these structures. As MOFCOM would need to consult with other relevant sector regulators during the merger review process (in this case, the Ministry of Industry and Information Technology, the telecom regulator), MOFCOM’s position in this decision regarding the VIE structure may be supported by as yet undeclared policies (for example, foreign investment policies) as formulated by other regulators.
In this decision, MOFCOM for the second time applied the controversial leverage theory to impose remedies on a foreign acquirer. However, it failed to justify, in any detail and with clarity, its adoption of this competition theory. The remedies imposed by MOFCOM seem to mainly reflect the authority’s concern over Wal-Mart’s expansion from the traditional brick-and-mortar supermarket into the VATB business, where foreign investment is restricted, thus inviting the question whether and to what extent MOFCOM has taken into consideration industrial policy concerns in its merger review. In addition, the explicit prohibition of the continuing use of the VIE structure by Wal-Mart in this case has also sent a clear message to foreign investors that the Chinese government does not welcome the VIE structure and that the authorities may be less tolerant of the use of such structures in the future.