Substantive Merger Analysis

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SUBSTANTIVE MERGER ANALYSIS

Private equity firms should be mindful of substantive merger

analysis each time they buy or sell a portfolio company. Although this is

primarily a concern when firms are engaged in strategic acquisitions or

sales to strategic buyers, antitrust merger enforcement issues can arise

even in transactions viewed by the private equity firm primarily as

financial investments, if the investment is being made in a company that

competes (or may compete) with an existing holding. Each transaction

the private equity firm engages in with a company that competes, even to

a small degree, with an existing holding of the firm, regardless of

whether it results in complete or partial ownership, may bring antitrust

scrutiny. At a minimum, substantive merger analysis should be

performed to help assess the speed with which a transaction is likely to

get regulator y approval–a concern in any private equity transaction. And

of course, if antitrust enforcement agencies (and ultimately the courts)

determine that a transaction is likely to cause anticompetitive effects in a

relevant market (e.g., by leading to higher prices, reduced output, or

reduced quality), the transaction could be barred altogether.

This chapter provides an overview of the analysis that the Agencies

and courts employ in administering the antitrust laws concerning

mergers. Specifically, the chapter explains the analytical framework as it

applies to typical transactions: horizontal mergers, potential competition

mergers, vertical mergers, and acquisitions of partial ownership interests.

A private equity firm could find itself directly or indirectly involved in

any of these types of transactions, depending on the competitive

relationship between the two portfolio companies involved in a

transaction, and it is thus important for private equity firms to understand

how agencies and courts analyze these mergers or acquisitions affecting

these relationships. Ultimately, being aware of the types of transactions

that could give rise to antitrust risk will make private equity firms better

equipped to anticipate and manage that risk and ensure that transactions

are priced and effectuated as efficiently as possible.

74 Private Equity Antitrust Handbook

A. Horizontal Mergers

A horizontal merger, as defined in the 2010 Horizontal Merger

Guidelines (Guidelines), is a merger or acquisition between actual or

potential competitors.1 Under Section 7 of the Clayton Act, a merger or

acquisition is illegal if the “effect of such acquisition may be

substantially to lessen competition, or to tend to create a monopoly.”2 As

the Supreme Court reminds us, this standard is concerned with

“probabilities, not certainties.”3 In other words, to prove a violation of

the Act, it need only be shown that a merger is “likely” to substantially

lessen competition or tend to create a monopoly.4

1. Theories of Harm

An acquisition by a private equity firm, like an acquisition by any

other entity, will be found likely to substantially lessen competition if it

is likely “to create, enhance, or entrench market power or to facilitate its

exercise” by encouraging one or more companies to raise prices, reduce

output, reduce product quality, slow innovation, or otherwise harm

consumers.5 The Guidelines identify two ways in which companies may

accomplish these effects—unilaterally or through coordination with

competitors.

a. Unilateral Effects

A reduction in the number of competitors in a market may enable the

combined entity on its own to unilaterally raise prices, reduce output,

reduce innovation, or cause other harm to consumers.6 These effects are

referred to as “unilateral” effects.

1. U.S. DEP’T OF JUSTICE & FED. TRADE COMM’N, HORIZONTAL MERGER

GUIDELINES § 1 (2010) [hereinafter GUIDELINES], available at

http://www.ftc.gov/os/2010/08/100819hmg.pdf.

2. 15 U.S.C. §18.

3. Brown Shoe Co. v. United States, 370 U.S. 294, 323 (1962); see also

Hosp. Corp. of America v. FTC, 807 F.2d 1381, 1389 (7th Cir. 1986)

(“Section 7 does not require proof that a merger or other acquisition has

caused higher prices in the affected market. All that is necessary is that

the merger create an appreciable danger of such consequences in the

future.”).

4. See FTC v. H.J. Heinz Co., 246 F.3d 708, 713 (D.C. Cir. 2001).

5. GUIDELINES, supra note 1, § 1.

6. Id. §§ 1, 6 (“The elimination of competition between two firms that

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Substantive Merger Analysis

Concerns about unilateral effects arise most frequently in markets

with differentiated products where the merging entities sell products that

compete closely and head-to-head with one another. The anticompetitive

danger is that, following a merger, the combined entity will find it

profitable to raise prices on one or both of the competing products

because sales that would previously have been lost to one competitor by

the other (making the price increase unprofitable) are now “recaptured”

by the combined entity.7 Courts and agencies will look at a variety of

evidence to determine the closeness of competition between the merging

parties and likely effects on competition, including documents,

testimony, customer surveys, and customer switching patterns.8 To prove

results from their merger may alone constitute a substantial lessening of

competition.”).

7. Id. § 6.1 (explaining that unilateral effects “are greater, the more the

buyers of products sold by one merging firm consider products sold by

the other merging fir m to be their next choice.”).

8. Id. Internal documents have played a prominent role in successful

challenges to mergers. See, e.g., FTC v. Whole Foods Market, 548 F.3d

1028, 1045 (D.C. Cir. 2008) (quoting statement by Whole Foods CEO

that company to be acquired was “the only existing company that has the

brand and number of stores to be a meaningful springboard for another

player to get into this space. Eliminating them means eliminating this

threat forever, or almost forever.”); United States v. Bazaarvoice, Inc.,

No. 13-cv-133, 2014 WL 203966, at *14-15 (N.D. Cal. 2014) (citing

statements by Bazaarvoice CEO that company to be acquired “could

mount a significant challenge” and “[t]hus, leaving them out there is a

significant risk” and by Bazaarvoice co-founder that the merger would

“[e]liminat[e] [] our primary competitor” and provide “relief

from . . . price erosion”); FTC v. ProMedica Health Sys., Inc., 2011 WL

1219281, at *16 (N.D. Ohio Mar. 29, 2011) (quoting statement in notes

distributed to St. Luke’s executives that “[a] ProMedica . . . affiliation

could still stick it to employers, that is, to continue forcing high rates on

employers and insurance companies”); Complaint ¶¶ 24, 34, 40, United

States v. Nat’l CineMedia, Inc., 14-cv-8732 (S.D.N.Y. Nov. 3, 2014)

(quoting NCM executive’s statement that the parties were the only “two

national players in the preshow space,” advertising sales head’s statement

that NCM “will not lose [to NCM] on price” and “must do whatever we

need to do and win these head to head battles,” and senior executive’s

statement that “[w]e need to buy [Screenvision] before either us or

[Screenvision] does a stupid deal”); Complaint ¶ 5, Pinnacle Entm’t., Inc.,

FTC File No. 131-0064 (May 28, 2013) (quoting statements that

Pinnacle’s and Ameristar’s casinos would “compete directly” and that

Ameristar planned to “clean [Pinnacle’s] clock”).