The food industry is currently undergoing a period of consolidation. There are high profile mergers, such as the proposed merger between Sysco and US Foods, currently being challenged by the Federal Trade Commission (FTC). But the phenomenon is much broader. The Food Institute recorded 503 mergers in the food industry in 2014, a significant increase over the 311 mergers recorded in 2013. That same organization has also reported 37 supermarket mergers in 2014, up from 28 deals in 2013.
All mergers and acquisitions in the United States are subject to the antitrust laws. This is true even if the merger is below the dollar threshold that requires notification of the merger to the Department of Justice (DOJ) and FTC pursuant to the Hart Scott Rodino (HSR) Act.
For food companies considering a merger or acquisition, what are best practices in regard to getting the merger through the antitrust process? There are three main areas of focus:
First, if the merger is between two companies that are horizontal competitors (i.e., they provide products or services that are substitutes), pay close attention to the economics. This may mean hiring an economic expert and undertaking some up-front economic analysis.
Second, proactively manage the companies’ internal documents. These documents are critical if the companies hope to have the agencies allow the merger to proceed prior to the end of the waiting period required by the HSR Act. They also are important if the merger raises questions or is challenged by the reviewing agency. No matter how strong the arguments may be in support of the merger, they may be totally undercut by harmful documents.
Third, proactively manage the merger process. Permitting the companies to coordinate too closely, or the acquiring company to control decisions of the to-be-acquired company, may result in an antitrust violation separate from the anticompetitive effect of the merger itself.
Pay Attention to the Economics
Mergers and acquisitions are governed by Section 7 of the Clayton Act, which is forward looking. The courts and agencies are trying to predict whether the merger will have anticompetitive effects in the future. The overarching concept of merger analysis is that mergers should not be permitted to create, enhance, or entrench market power or to facilitate its exercise. Market power is the ability to raise prices without losing so many customers that the price increase is unprofitable.
One predictor of whether a merger will create or facilitate market power is concentration. The theory is that high concentration in an industry is likely to lead to market power. This theory requires definition of the relevant market, the calculation of market shares, and the application of a measure of concentration known as the Herfindahl Hirschman Index.
Concentration, however, can be an imperfect predictor of future market power. This conclusion was reinforced by the release in August 2010 of revised Horizontal Merger Guidelines for the DOJ and FTC. These guidelines placed significant emphasis on a theory of unilateral competitive effects.
Most products and services offered by companies in the food industry are differentiated. In other words, even horizontal competitors that provide products and services that are arguably substitutes offer different products and services. For example, supermarket chains can offer shopping experiences different from other chains, such as specialty meat and fish counters, in-store bakeries, imported foods, prepared food counters, and even sit-down eating facilities. Such differentiated offerings appeal to different consumer tastes.
The result of such differentiated offerings is that, if a food service company, say competitor A, were to raise prices, some consumers would remain loyal to A, some would divert to competitor B, some to competitor C, some to competitor D, and so forth.
The theory behind the unilateral competitive effects analysis used by the agencies is that, if competitor A and competitor B were to merge, and competitor A were to raise prices, would enough customers divert to competitor B to make the price increase of the now combined firms profitable.
An analysis of such unilateral competitive effects frequently may require calculation of diversion ratios, own-elasticities of demand, and cross-elasticities of demand. Such calculations often use scanner data and apply first order differential equations. In certain cases, merger simulations are undertaken. This also involves mathematical calculations applying linear algebra, among other tools.
The use by the agencies of unilateral competitive effects theory means that companies that are horizontal competitors should consider hiring economists with expertise in merger analysis. These economic experts may be necessary to counter the agencies’ own economic experts who will be focusing on this theory.
Proactively Manage Internal Documents
If companies considering a merger meet certain dollar thresholds, the HSR Act requires that the companies notify the agencies of the merger and wait a prescribed period of time before closing.
The HSR notification and report form requires production of all studies, surveys, analyses, and reports prepared by or for directors and officers for the purpose of evaluating or analyzing the acquisition with respect to market shares, competition, competitors, markets, potential for sales growth or expansion into product or geographic markets. Such documents must be produced whether prepared by company personnel or investment bankers, consultants or other third-party advisors. Any confidential information memorandum must also be produced. In addition, any studies evaluating or analyzing synergies and/or efficiencies prepared by or for officers or directors must be produced.
The agencies broadly view what is a study, survey, analysis, or report. They need not be formal, but could include emails, handwritten notes on the back of an envelope, PowerPoint slides, or director’s notes taken at a meeting of the board.
Food companies considering a merger should proactively manage the creation of such documents to make sure that they truly represent the facts and are not so poorly written that they will be misunderstood.
Often the documents attached to the HSR report form are the only documents available to the agencies during the initial 30-day waiting period. The agencies are permitted to let the merger proceed prior to the expiration of this period. This is known as “early termination.” The opportunity for merging parties to take advantage of early termination is substantially dependent on the documents produced with the HSR report.
Even if the merging companies are not granted early termination, internal documents are extremely important. The strongest arguments for allowing the merger to proceed can be completely undermined by weak or damaging documents.
Manage the Merger Process
In addition to making sure that the contemplated merger will pass antitrust muster, food companies considering a merger must make sure that the merger process itself does not result in an antitrust violation.
As noted above, the Hart Scott Rodino Act requires companies considering a merger to notify the DOJ and FTC of the merger and wait a prescribed period of time before closing. During this period, the companies are often exchanging confidential information as part of due diligence and engaging in preclosing planning so that they can “hit-the-ground-running” when the deal closes.
However, such preclosing conduct could itself create an antitrust violation. There are three areas of concern: first, the acquiring firm could engage in improper preclosing control of the to-be-acquired company; second, the acquiring and to-be-acquired firm could be engaging in improper preclosing coordination; and third, the exchange of confidential information could be deemed to facilitate an antitrust violation. The first two concerns are commonly called “gun-jumping.”
Both the antitrust agencies and the courts recognize that an acquiring company has a legitimate interest in the to-be-acquired company conducting business in such a way that the value of the business has not been diminished prior to closing. Consequently, it is entirely appropriate to include in the purchase agreement standard and customary terms requiring the to-be-acquired company to conduct its business in the ordinary course and in substantially the same manner as it has been conducted in the past. However, care must be taken to insure that the requirements do not cross-the-line and become gun-jumping. Such control could be viewed as collusion in violation of Section 1 of the Sherman Act or the transfer of beneficial ownership prior to the end of the prescribed waiting period in violation of the HSR Act.
Similarly, preclosing coordination may also result in a violation of the antitrust laws. The agencies recognize the value of preclosing coordination. However, horizontal competitors that are merging must keep their independence until they are allowed to close. Best practices regarding preclosing planning and coordination require that those employees participating in such activities not have responsibility for sales, pricing, and output decisions. The use of outside consultants to establish “clean teams” may be necessary.
The same analysis applies to the exchange of confidential information during the due diligence process. Care must be taken to make sure that those employees involved in the competitive process – sales, pricing, or output decisions – are not given access to confidential information of the other company. A confidentiality agreement limiting access to due diligence information and data is essential. Again, it may be necessary to employ third-party clean teams.
The antitrust laws can create significant obstacles to a merger and acquisition. To successfully navigate those obstacles, best practices in certain key areas are essential.
About the author
Jeffery M. Cross is a Partner in the Litigation Practice Group and a member of the Antitrust and Trade Regulation Group at Freeborn & Peters LLP in Chicago. He has nearly 40 years of trial experience representing a variety of corporations and businesses throughout the country on antitrust and trade regulation issues. He also has experience in mergers and acquisitions, including counseling clients in the area, working with economists to develop economic support for mergers and acquisitions, responding to government requests for documents and negotiating with the government. He can be reached at [email protected] or 312-360-6430.