On Feb. 3, the Federal Trade Commission (FTC) challenged Edgewell Personal Care’s proposed $1.37 billion acquisition of Harry’s. Edgewell owns Schick and another brand, making it one of the two leading manufacturers of wet shave razors. Harry’s, according to the FTC complaint, is “a uniquely disruptive competitor in the wet shave market and has forced its rivals to lower prices …” Folks in the business community found this challenge surprising given that Harry’s reported market share was only about 2.5%. The FTC challenge not only offers lessons for antitrust practitioners, as we will see, but is a cautionary tale for M&A lawyers responsible for drafting acquisition agreements.
The business community should not have been quite so surprised by the outcome in the Edgewell-Harry’s deal. For several years, the federal antitrust agencies, particularly the FTC, have been developing a concept known as “nascent competition.” To understand the development of the nascent competition concept, we have to travel back in time to the development of a related concept, “potential competition.” Under this moniker, the antitrust agencies challenged substantial competitors’ attempts to acquire firms that had not yet entered the market. The agencies used two theories. Under the “actual” potential competition theory, the potential entrant was poised to enter the market. The entry would result in more competition and lower prices. Under the “perceived” potential competition theory, incumbent firms were keeping prices at a competitive level to deter the potential entrant from actually entering. The courts were frequently skeptical of these theories, and several courts, and in fact the FTC, raised the burden of proof, requiring clear proof of future entry.
The antitrust agencies became so dissatisfied with these standards that they started looking for ways around them, positing things like innovation markets and R&D markets. Then, in the 2010 Horizontal Merger Guidelines (the Guidelines), the agencies employed the conventional level of proof relating to acquisitions involving potential competitors. According to the Guidelines, the “lessening of competition … is more likely to be substantial, the larger is the market share of the incumbent, the greater is the competitive significance of the potential entrant, and the greater is the competitive threat posed by this potential entrant relative to others.”
But the Guidelines went beyond the ordinary scope of potential competition in several respects. They indicate a concern where one of the merging firms “has the capabilities that are likely to lead it to develop new products in the future that would capture substantial revenues from the other merging firm.” Another concern is where “one of the merging firms has a strong incumbency position and the other merging firm threatens to disrupt market conditions with a new technology or business model.”
Despite all this, the Guidelines did not help the FTC when in 2015 it tried to stop Steris’ acquisition of Synergy Health. Both firms provided contract sterilization services for medical devices, but Synergy was not competing in the United States. There were only two such companies in the U.S. market, one of which was Steris. The FTC alleged, however, that Synergy was a potential entrant. But the court reviewing the FTC’s attempt to enjoin the acquisition sided with the merging parties, holding that Synergy was not a likely entrant.
Nevertheless, the antitrust agencies, particularly the FTC, have been on a recent tear in their application of nascent competition theory. The possible motivation for this focus might be the criticism of the agencies for not challenging acquisitions of high-tech nascent competitors, for example, Facebook’s acquisition of Instagram.
Before Edgewell and Harry’s, the FTC applied nascent competition theory in its challenge to CDK’s acquisition of Auto/Mate. CDK was one of two dominant firms providing computerized Dealer Management Systems (DMS) to new car dealers. Auto/Mate was a much smaller DMS provider, with a market share of less than 2%. But according to the FTC, Auto/Mate was an “innovative, disruptive challenger.” The FTC also challenged Illumina’s proposed acquisition of PacBio. The FTC alleged that Illumina was trying through the acquisition to maintain a monopoly in next-generation DNA sequencing. The FTC claimed that if Illumina was able to consummate the acquisition, Illumina would be “extinguishing PacBio as a nascent competitive threat.” While PacBio probably had no more than a 2.5% market share, it was “poised to take increasing sequencing volume from Illumina in the future.”
Not to be outdone, the Department of Justice (DOJ) challenged Sabre’s proposed acquisition of Farelogix. According to the DOJ, Sabre is the “dominant” provider of booking services for airlines. While Farelogix had only a 3%-4% share of the market, it had introduced new technology and was poised to grow significantly. The DOJ and the two parties have just completed a bench trial and are awaiting a decision.
What can antitrust aficionados learn from this recent merger enforcement activity? First, the challenges to acquisitions involving nascent competition involve concentrated markets where the acquirer is typically a dominant firm or one of two dominant firms. Second, the acquisition target is a small firm that is rapidly growing or has developed a disruptive technology. Harry’s departs modestly from this generalization. If there is a dominant firm in the wet shave market, it would be Gillette, not Edgewell. Given Edgewell’s smaller market share and Harry’s small share, the change in the Herfindahl-Hirshman Index (HHI) would have been only 200 points.
We have to be careful, however, not to make too much of the label “nascent competition.” In all of the so-called “nascent competition” matters, the HHIs were within guideline thresholds where the acquisition at least “raise[d] significant competitive concerns,” whether or not the acquisition involved a purported nascent competitor. The real test will come if and when one of the antitrust agencies challenges the acquisition of a nascent competitor that has not yet entered the market.
For the time being, to determine whether an acquisition of a nascent competitor will run into trouble at the antitrust agencies, the first question to ask is whether the proposed acquisition satisfies the concentration thresholds in the Guidelines that raise significant competitive concerns. Of course, the antitrust agencies do not challenge plenty of deals that raise such concerns. So even if the answer to the question is “yes,” the next question to ask is whether the nascent competitor is unique in some way despite a small share of the market. Does it have a one-of-a-kind technology? Has it grown rapidly? Does it have a credible plan showing likely speedy growth? Has it already had a procompetitive effect on market prices? Is it otherwise a disruptive competitor? The more “yes” answers, the more likely it is that the merging parties will be spending some quality time at the FTC or DOJ.
On the M&A side, the nascent competition challenges raise the question of how to handle the antitrust risk. The main way such risks are handled is through provisions in the acquisition agreement that deal with termination of the agreement and that allocate the antitrust risk. It is standard for acquisition agreements to demand that both parties make reasonable efforts to obtain merger clearances. Some acquisition agreements specifically require both parties to litigate with the antitrust agencies at least through the preliminary injunction phase of litigation. Other acquisition agreements prohibit either party from pulling out of the deal for an extended period. Well-crafted competition covenants can also allocate antitrust risks. For example, the entire antitrust risk could be transferred to the acquirer through a “hell or high water” provision that requires the proposed acquirer pay the full price for the acquired assets even if the deal is enjoined. (After an injunction, a trustee for the acquirer then sells the assets at issue to the highest bidder, compensating the proposed original acquirer in whole or in part the price paid for the assets.) Another approach requires the acquirer to agree to divestitures and other remedies if that is what the antitrust agency requires. A third approach requires the proposed acquirer to pay a breakup fee if the acquisition is not consummated in a specified period.
The Harry’s acquisition agreement did oblige the parties to use reasonable best efforts to achieve consummation of the acquisition. Reasonable best efforts in this agreement, in fact, required the parties to “tak[e] all steps as may be necessary to obtain Consent or clearance from, or to avoid an Action by, any Governmental Authority [and to] defend[ ] any Actions, whether judicial or administrative, challenging this Agreement or the consummation of the transactions contemplated hereby, including seeking to have any stay or temporary restraining order entered by any court or other Governmental Authority vacated or reversed. …” On the other hand, there was no breakup fee and the acquisition agreement permitted either party to terminate the agreement on Feb. 8 (with certain exceptions). Edgewell terminated the agreement soon thereafter. The termination date is very surprising. The acquisition agreement is dated May 8, 2019, providing only 10 months to get to consummation. In the first half of 2019, 75% of the FTC’s significant merger investigations lasted more than 16 months and only one lasted fewer than 10 months.