On October 31, 2011, Judge Beryl Howell of the U.S. District Court for the District of Columbia enjoined the merger of H&R Block and 2SS Holdings Inc., handing the Department of Justice-Antitrust Division its first trial victory in a merger challenge in years. Two weeks later, on November 15, 2011, H&R Block announced that it would not pursue an appeal and was dropping its bid for 2SS Holdings Inc. Significantly, this is also DOJ’s first merger challenge after publication, in August of 2010, of the antitrust agencies’ revised Horizontal Merger Guidelines, the document that outlines the agencies’ analytical approach to merger enforcement.
There are three notable aspects to the case: the manner in which the merger was analyzed, the evidence relied upon to enjoin the transaction, and the potential ramifications for future merging parties.
Market Definition and Structure are Still Important
H&R Block, the country’s largest provider of tax-assisted preparation services and the secondleading provider of computer programs that assist tax filers in preparing their taxes themselves, sought to acquire rival 2SS Holdings Inc., maker of TaxAct software products. TaxAct is the country’s third largest supplier of tax assistance software. The government argued that the merger would lead to fewer free tax assistance software products, as TaxAct had pioneered free online tax preparation services combined with low-cost add on features. DOJ claimed that the merger would also result in higher prices for those products that companies charge for and potential coordination among the remaining suppliers of such products.
The revised merger guidelines, published last year, emphasized a flexible approach to merger analysis focusing on competitive effects as opposed to a market-based structural analysis. Indeed, while the previous iteration of the Guidelines began the antitrust analysis by first defining the relevant market in which the merging parties’ products competed, the present Guidelines begin the analysis with evidence of adverse competitive effects. Notwithstanding this shift in analysis, the Court employed the traditional framework, stating: “Merger analysis begins with defining the relevant product market.”
DOJ pushed for a narrow market definition that includes only digital do-it-yourself (DDIY) tax preparation products. Three firms — H&R Block, TaxAct, and Intuit (maker of TurboTax) — accounted for approximately 90% of the market, according to IRS data, with Intuit having the largest share of approximately 62%. In contrast, the merging parties argued that the relevant market in which to analyze the competitive effects of the acquisition was far broader. Defendants stressed that tax filers have numerous tax preparation options, including not only DDIY tax preparation products, but also “assisted” tax preparation through a tax professional (such as H&R Block, Jackson Hewitt and traditional accountants) and taxpayers who did their own taxes using the old fashioned pen and paper method.
In accepting DOJ’s market definition, the Court used the traditional method of defining the relevant market by examining the products’ cross-elasticity of demand, or willingness of customers to substitute between products based on changes in the relative prices of those products. This analysis led the Court to find that customers decided how to prepare their taxes based on the complexity of their tax returns and not on the price of the preparation method. Taxpayers were more likely to switch from one DDIY product to another in response to an increase in price rather than to a tax professional or pen and paper. This indicated that the narrow digital do-it-yourself product market advocated by DOJ was the proper market within which to examine the competitive effects of the merger. The Court noted that TaxAct competed against its larger rivals, H&R and Intuit, by focusing on quality, customer service, and price.
After defining the market narrowly as that for DDIY tax preparation products, the Court proceeded to determine whether the structure of the market was such that the transaction would likely produce anticompetitive results. Applying the traditional market concentration calculation based on the Herfindahl- Hirschmann Index, the Court found that the DDIY market was highly concentrated and agreed with the government that the merger would lead to a further sharp increase in market concentration. The Court thus held that there was a rebuttable presumption that the transaction violated the antitrust laws.
Defendants attempted to rebut DOJ’s prima facie case by arguing that entry into the market would constrain any price increase and that the transaction would produce efficiencies that would outweigh any potential anticompetitive effects. The Court rejected both arguments. Entry was unlikely, the Court found, based not only on a theoretical analysis, but on the testimony of industry executives. Even defendants’ executives admitted that it takes years to build a credible reputation in the industry, indicating that competition from smaller companies was not an immediate threat to the larger players. The Court also found that the procompetitive efficiencies offered by H&R/TaxAct to rebut the presumption of anticompetitive effects from the merger were either not specific to the merger or unverifiable. Accordingly, the Court held that defendants failed to rebut the presumption of illegality established by DOJ and permanently enjoined the transaction.
The bottom line is that while the agencies may eschew formal market definition in their own analysis of a transaction, courts still focus on traditional structural analysis, at least in the first instance. Parties entering into a transaction with a competitor must think long and hard about what market they compete in and whether a credible argument can be made that the market is “concentrated” and will only become more so after the proposed transaction.
The Parties’ Documents Can Hold the Key
The opinion serves as another reminder that while a party’s documents can rarely save a transaction, they certainly can kill one. The Court’s opinion is replete with citations to the parties’ ordinary course documents that described competition among the merging parties and other DDIY makers as being particularly intense, especially compared with other tax preparation methods. The Court also cited defendants’, as well as their investment bankers’, characterization of the transaction in support of its finding of a narrow DDIY market.
Specifically, the Court focused on documents created by H&R Block and TaxAct, along with their investment bankers, indicating that the two companies viewed themselves as each other’s chief rivals, along with Intuit, and determined business strategy based on the pricing and product offerings of the other members of the “Big Three” in the DDIY market. Internal documents also differentiated the DDIY market from the assisted tax preparation market and showed that the average price for assisted tax preparation was at least three times higher than the average price for DDIY products. The general lack of price competition between the two tax preparation options, with very limited exceptions, reinforced the Court’s view that DDIY was a separate product market.
While the Court also relied on the testimony of executives and expert econometric opinion, these forms of evidence were largely confirmatory in nature. As was the case in the FTC’s recent victories in litigated merger cases – e.g., Whole Foods, CCC Holdings – the parties faced an uphill battle to overcome the plain language of their own ordinary course documents. Merging parties in the future would be wise to take heed. This is especially true with respect to transaction-related documents – parties must ensure that investment bankers and consultants do not draft documents that highlight the potential competitive effects of the transaction or the narrow nature of the market in which the parties compete.
The Victory Will Only Increase DOJ’s Leverage
The present merger challenge marks the first time DOJ has litigated a merger case since its failed attempt to prevent Oracle from acquiring PeopleSoft in 2004. It is also its first merger trial victory in over eight years. The implications of the H&R Block case may well linger for some time. The victory gives DOJ another arrow in its quiver when negotiating with merging parties. Given its reticence over the last several years to take cases to trial, parties may have arguably held a firmer stance when negotiating with DOJ concerning potential “fixes” to their transaction. The H&R Block victory, however, may increase DOJ’s bargaining power as parties negotiating with DOJ must now factor in the very real possibility that DOJ will take its case to court.
