Assessing antitrust risk in M&A transactions

The Antitrust Division of the U.S. Department of Justice has signaled a renewed focus on antitrust enforcement in mergers and acquisitions, and at a time when M&A activity is at an all-time high.

In recent speeches, two senior officials with the Justice Department pledged that, together with the Federal Trade Commission, the agencies continue to thoroughly review M&A activity and vigorously act against anticompetitive behavior, particularly as it concerns deals among substantial competitors. “The Antitrust Division has embraced its role as the cop on the merger beat,” William Baer, acting associate attorney general for the Antitrust Division, said in remarks at the American Antitrust Institute’s annual conference on June 16.

Attorney General Loretta Lynch reiterated this message in separate remarks at the American Bar Association’s Antitrust Law Spring Meeting. “The Department of Justice is as committed to fair, open, and competitive markets as it has ever been,” she said.

An increasing number of antitrust challenges to proposed mergers bears that out. Over the past seven years, the Antitrust Division successfully challenged or secured the abandonment of 39 mergers—more than double the 16 successful challenges or abandonments during the previous eight-year period, Baer said.

Currently, antitrust enforcers are reviewing two proposed mergers involving the country’s largest health insurers—Anthem’s proposed takeover of Cigna and Aetna’s proposed acquisition of Humana. In recent remarks at the Antitrust in Healthcare conference, FTC Chairwoman Edith Ramirez made clear that the FTC similarly remains vigilant and active in the healthcare market.

Other investigations underway at the Antitrust Division, Baer added, surround “major consolidation among large agricultural chemical and seed manufacturers,” referring to DuPont’s planned merger with Dow Chemical.

Furthermore, the Justice Department and FTC in April issued a joint statement reaffirming the importance of preserving competition in the defense industry. The statement describes the agencies’ framework for analyzing defense industry mergers and acquisitions and emphasizes that the antitrust agencies work closely with the Department of Defense.

“The more complex the deal—and the more markets it potentially endangers—the greater our skepticism that divestiture will safeguard competition, and if we believe that no good solution exists, then we will prosecute our suits to the very end.” 

Lorett Lynch, Attorney General, Justice Department

“In the defense industry, the agencies are especially focused on ensuring that defense mergers will not adversely affect short- and long-term innovation crucial to our national security and that a sufficient number of competitors, including both prime and sub-contractors, remain to ensure that current, planned, and future procurement competition is robust,” the agencies said.

“As part of an investigation, the agencies will consider any procompetitive aspects of a proposed transaction, including economies of scale, decreased production costs, and enhanced R&D capabilities,” the joint statement continued. “However, if a transaction threatens to harm innovation, reduce the number of competitive options needed by DoD, or otherwise lessen competition, and therefore has the potential to adversely affect our national security, the agencies will not hesitate to take appropriate enforcement action, including a suit to block the transaction.”

Merger mania

The increasingly aggressive antitrust focus on mergers comes at a time when the United States is in the midst of a merger wave. As Compliance Week previously reported, research by financial software company Dealogic found that global merger and acquisition activity reached a recordbreaking $5 trillion in 2015.

“It isn’t just the number of proposed deals that makes this a unique moment in antitrust enforcement; it’s their size and their complexity,” Lynch said. In fiscal year 2015, for example, 67 proposed mergers were valued at more than $10 billion—more than double the number of proposed mega mergers from the previous fiscal year.

The rise in mega mergers, in part, account for the increase in antitrust investigation activity in M&A transactions, given that larger transactions are more likely to be challenged than smaller transactions. According to recent analysis of merger investigations and enforcement activity conducted by Cornerstone Research, transactions exceeding $1 billion accounted for 49 percent of all “second requests.”

If a second request is issued, the merging parties must provide the Antitrust Division with additional documents and information. Such requests may require substantial disclosure of company data and documents.

“Merger review really is very fact-specific,” says Kostis Hatzitaskos, a principal at Cornerstone Research who focuses on antitrust and competition matters. “Companies and their antitrust counsel really need to think of every merger on its own merits and think about any competitive challenges that the agencies might bring.”

To help compliance and antitrust counsel better identify patterns in investigation and enforcement activity, the Cornerstone report for the first time this year included an Enforcement Focus Indicator (EFI), which evaluates the share of second requests in each industry sector relative to its share of transactions.

According to that data, pharmaceuticals, manufacturing, and information transactions received the largest share of second requests relative to the share of reported transactions in those industries in fiscal year 2014 (the most recent year that the Antitrust Division issued enforcement data). Industry sectors that historically have received the least amount of second requests have been professional services, finance, and utilities.

Historically—from FY 2005 through FY 2014—approximately 20 percent of all cleared transactions received second requests. Nearly 60 percent of challenges resulted in consent decrees, seven percent led to court proceedings, and another 34 percent have resulted in abandoned or restructured transactions, the Cornerstone report stated.

Merger remedies

In their remarks, both Baer and Lynch stressed that the mere act of divestiture is not enough—the idea that if companies simply spin off a few assets, the Justice Department will withdraw its objections and the merger can proceed. “That simply isn’t true,” Lynch said.

“The more complex the deal—and the more markets it potentially endangers—the greater our skepticism that divestiture will safeguard competition,” Lynch added. “And if we believe that no good solution exists, then we will prosecute our suits to the very end.” 

Baer expressed a similar sentiment. A merger remedy “needs to preserve the status quo ante in affected markets by effectively addressing any and all anticompetitive effects arising from the transaction,” he said. “Partial remedies do not cut it; they do not warrant shifting some portion of the risk posed by the merger back to consumers and competition.”

WILLIAM BAER ON M&A ENFORCEMENT

William Baer, acting associate attorney general for the Antitrust Division, describes how the Justice Department assesses anti-competitive activity in merger challenges.
In all our merger challenges—whether or not the combined shares give rise to a presumption of antitrust harm—we are committed to developing evidence showing the risk of injury to competition. We employ a variety of quantitative and qualitative tools aimed at predicting the likely result. We make the best estimate of anti-competitive effects that our evidence allows, and we will not bring a case based on the presumption where a holistic view of the evidence shows an anti-competitive effect is unlikely. Of course, there are also times when market shares alone understate the likely anti-competitive effects of a transaction.
We look at traditional downstream effects, but we also look at upstream competitive dynamics. Sometimes upstream markets are characterized by bargaining between large companies, but that does not mean antitrust laws step aside. When the elimination of competition through merger gives rise to substantially increased bargaining leverage, that is an antitrust concern. Last year, Comcast sought to acquire Time Warner Cable. The merging cable companies did not overlap in any downstream markets. Yet the two companies combined provided almost 60 percent of high-speed broadband internet service to U.S. householders. The merger would have given Comcast too much power over content providers that relied on interconnecting to its network to deliver content. It risked giving the combined firm the ability and increased incentive to thwart disruptive innovators such as Netflix, Amazon Prime and Sling TV—providers of online video services that had begun to threaten the dominance of cable video services that Comcast and others provide. Together with our (Federal Communications Commission) colleagues, we forcefully articulated those concerns to Comcast, which promptly pulled the plug on the deal.
Prior experience informs our current enforcement efforts. For example, understanding the importance of takeoff and landing slots to airline competition was key to our challenge to United Airlines’ effort to increase its dominance at Newark airport. These regulatory bottlenecks can give incumbents the tools to foreclose rivals. We previously had seen how our insisting that United sell its Newark slots to Southwest when it merged with Continental in 2010 had increased flight options and lowered prices on many routes to and from that congested airport. Last year we challenged United’s effort to acquire more. It was an easy call. With 73 percent of slots—and more unused slots than any other individual airline held—United had no legitimate competitive justification for acquiring an additional 2 percent at Newark.
Prior experience informs our view of competition in telecommunications markets too. In the cellular telephone industry, competition increased following our successful challenge to the AT&T/T-Mobile deal. As new deals were proposed we looked at each on its individual merits, incorporating what we learned from prior matters. When T-Mobile proposed to acquire MetroPCS, a relatively small provider of low-cost cell phone service on a month-by-month basis, we investigated the potential for the deal to reduce competition; but we concluded it held a greater potential for consumer benefits. MetroPCS was low priced, but its geographic reach was limited. After the merger, MetroPCS rolled out that plan across much of the country using T-Mobile’s much larger network. Other proposed deals in this space looked questionable to us. When Sprint’s owners suggested that they planned to acquire T-Mobile, threatening to reduce the number of national providers from four to three, we made clear such a deal involved an unacceptable risk-reward proposition for consumers.
Source: Department of Justice

Some mergers are susceptible to a negotiated settlement. Although acceptable remedies come in different shapes and sizes, Baer said, they tend to share the following features:

The remedy should be structural, preserving an independent competitive force in the marketplace, rather than simply placing limits on the merged firm’s ability to use or profit from increased market power. 

The structural relief should involve divesting standalone business units rather than simply product lines that need to be stripped from an infrastructure that the merging parties intend to retain. 

The divested business needs to be fully capable from day one to preserve the status quo competitive dynamic in the market.

The buyer of the divested business should be known and financially sound, and the transaction needs to be relatively free of entanglements—supply or IP licensing arrangements, for example—with the merged firm.

The attempted Halliburton and Baker Hughes merger offers a prime lesson in a deal gone bad. In that case, the Justice Department sued to block the merger, valued at nearly $35 billion that would have brought together the second and third largest oilfield service companies in the world—alleging that Halliburton’s proposals did not come close to preserving open economic competition.

“As our complaint made clear, that deal threatened harm to competition in 23 separate markets for oilfield products and services that were important to ensuring a domestic and independent supply of energy,” Baer said.

In some cases, however, a merger resolution outside of court is possible. Both Lynch and Baer cited Anheuser-Busch InBev’s proposed acquisition of Grupo Modelo, which would have resulted in the combination of the largest and third-largest brewers in the United States, as a model example.

In that case, both parties agreed to divest all of Modelo’s American holdings to a fully independent competitor, resulting in stronger competition in the U.S. beer market. “In cases like this one,” Lynch noted, “if companies can present a detailed and workable plan that eliminates the risk of market dominance, we’ll work with them to find the way forward.”

Due diligence

Prior to any merger or acquisition, the acquiring company needs to first conduct a proper level of due diligence. Philip Urofsky, a litigation partner at law firm Shearman & Sterling, recommends the following three-stage process:

Stage 1. Conduct a risk evaluation of the target company: “Where is it doing business? Who are its major customers? Are any of them state-owned entities?”

Interviews should be conducted with the company’s chief compliance officer, general counsel, or head of internal audit to find out if the company has had any investigations, or has recently made any voluntary disclosures, Urofsky says. “Have they had any investigations? Have they made any voluntary disclosures? You want to be satisfied that they have proper procedures in place and have resolved any past issues.”

The company behind the purchase isn’t the only party that has compliance obligations; sellers should be prepared with answers to these questions, and should have completed any investigations and remediated any issues, “not just [swept] them under the rug,” Urofsky says.

Stage 2. If the target company presents a high risk either because of its customer base or geographic region, a second phase of due diligence might be needed. “This is not an investigation,” Urofsky says. Rather, it’s an expanded level of due diligence focused on a particular project or region, he says.

That involves taking a look at internal or external audit reports and talking to the regional head of legal or compliance to determine if they have their arms wrapped around the issues in that particular high-risk region.

Stage 3. If the company finds a potential bribery or sanctions issue, the third stage of due diligence would involve conducting an investigation, if the acquiring company still wants to go through with the deal at that point.

In these circumstances, the seller is responsible for obtaining and reviewing data, conducting interviews, preparing reports, and perhaps in the midst of all this making a voluntary disclosure to the government.

Following a transaction, if any weaknesses are found in the policies, procedures, or controls, the acquiring company immediately should be prepared with an integration plan, Urofsky says. This entails implementing new policies, procedures, and controls, training on them, testing them, he says, “all for the sake of being able to make the argument down the road that if there is a problem, you were already on top of it.”