As economic integration has made Europe an important player in the global economy, European regulatory procedures have assumed an increasingly central role in antitrust. Any proposed merger between companies with aggregate worldwide sales of more than 5 billion and individual sales in Europe of more than 250 million must win the approval of the European Commission. In some high-profile cases, the commission has either forced companies to sell key assets or completely stopped proposed mergers. For example, in 2001, the commission objected to General Electric’s planned takeover of Honeywell on the grounds that it would reduce competition in the European aircraft industry. As a result, GE walked away from the deal. Although some companies have successfully challenged the commission’s decisions in the European Court of Justice in Luxembourg, victory has come at the price of many months of disruption and delay.
To complicate matters, the rules of European anti-trust are changing. In response to criticisms from companies and member states, the European Com-mission has been conducting a formal review of its antitrust regulations and procedures. The likely end result will be a more complex but business-oriented approach to antitrust that will offer more realistic assessments of a proposed merger’s competitive impact on the industry and on consumers.
In the short term, the commission’s changes will, no doubt, increase uncertainty. And many companies worry that the regulatory process will become even more invasive than in the past. But in the long term, the changes represent an opportunity for companies to engage in a more constructive dialogue with the commission. To do so, however, executives will have to be far more explicit about the strategic logic be-hind proposed deals and how that logic will translate into benefits for consumers. Moreover, the increased complexity of the process will require executives to work in a more integrated fashion with the outside experts—consultants, lawyers, and investment bankers—on whom they typically rely for advice.
New Tests of Competitive Impact
Some of the changes the European Commission is considering involve the principles used to judge the competitive impact of a proposed merger. Since 1990, the chief criterion has been the so-called dominance test. Put simply, the test calculates the market shares of the merged entity within each of its market segments in order to identify any segments where the combined company has a dominant share (usually defined as either greater than 50 percent or more than three times that of the number two player).
Critics have argued that the dominance test is unacceptably static and often leads to abstract (and, in the end, unresolvable) disagreements about the probable impact of a merger. It puts too much emphasis on the existing structure of the market and too little on its subsequent evolution. Especially in fast-moving industries subject to disruptive technologies, current market share can be a poor indicator of the competitive impact of a merger and the consequences for consumers.
Although the dominance test is unlikely to disappear completely, the commission has begun to take into account additional quantitative and qualitative criteria. For example, the new rules incorporate a legal concept called significant impediment to effective competition (SIEC), used in U.S. and French antitrust law, which is a far more realistic measure of the impact of a merger on consumers. In essence, the SIEC test says that the evolution of consumer prices doesn’t depend only on the leader’s market power but is the product of dynamic interactions among multiple factors: the new cost structure and supply curve, the potential for new entrants, the development of new technologies, and shifts in bargaining power among competitors, suppliers, and customers.
In some cases, however, the SIEC test could end up disallowing deals that would have been authorized in the past. In the United States, for example, this principle led the Department of Justice to oppose the merger of Heinz’s baby-food line and Beech-Nut, despite the fact that the combined entity would have been only the second-largest player in the industry, far behind Gerber. The authorities argued that the deal was anticompetitive because distributors needed vigorous competition for two supplier slots in order to keep consumer prices low. With no significant number three left on the market, the top two suppliers wouldn’t have to compete for those slots, and prices would rise substantially.
Another new measure included in the commission’s proposed changes involves a shift in the regulatory significance of the economic efficiencies that a merger generates. Mergers create value in the form of synergies: increased revenues or reduced costs that would not have occurred without the transaction. In the past, the European Commission has generally viewed the existence of synergies as a prima facie indication of increased market power and, therefore, unhealthy market dominance. In the future, however, the commission is likely to consider synergies as an acceptable justification for a merger—as long as it is convinced that some of the value created will be passed on to consumers in the form of lower prices.
In practice, the new efficiency test means that the greater the promised synergies, the more confident regulators will be that consumers will reap at least some of the benefit. For example, some antitrust regulators consider incremental unit-cost reductions in the neighborhood of 50 percent to be a strong indication that consumer prices will drop significantly.
From the commission’s perspective, the SIEC test and the efficiency test are complementary instruments that can help predict whether consumer prices will increase or decrease. From the perspective of shareholders, the tests can gauge a company’s commitment to pursuing efficiencies and, therefore, the likelihood that the commission will approve the deal. However, aligning the commission’s perspective with shareholders’ interests will require companies to determine—and communicate—the appropriate balance between the savings passed on to consumers and those distributed to shareholders.
In addition to changes in the principles used to evaluate a merger’s competitive impact, other changes will affect the regulatory process itself. In particular, there will be a major strengthening of the European Com-mission’s internal analytic resources and industry competence. For example, the commission has just appointed a chief economist to analyze proposed mergers from a business perspective. But this much higher level of professionalism and industry knowledge will come at the price of far more transparency from would-be acquirers. Applying the SIEC and efficiency tests will require the commission to have access to internal information such as business plans, negotiation support materials, integration plans, and all documents describing postmerger market dynamics. The practical consequence is that companies will have to take antitrust concerns into account much earlier in the process and incorporate them in all written documents used in the preparation phase, especially those describing expected synergies or the postmerger evolution of prices.
Preparing for the New Rules
Although the precise consequences of the European Commission’s new rules and practices are not yet clear, companies need to start adapting today. Three steps in particular are critical:
Create a more rigorous and more integrated M&A process. In the past, companies have usually focused on a deal’s financial details with their investment bankers and left their lawyers to handle the commission’s regulatory requirements. In the new environment, that division of labor no longer makes sense.
Passing the SIEC and efficiency tests requires a complex synthesis of industry knowledge, strategic thinking, and legal expertise. Executives will need to understand—and be able to explain to regulators—how consumers and competitors will react to a proposed merger and what the price dynamics are likely to be for different market segments. Part of the business case will be to show how the proposed merger will help consumers without unduly harming shareholders. Companies will need to back up their claims with hard evidence based on customer interviews and on analyses of price elasticity, market segmentation, and competitive dynamics. This fundamental economic analysis will also need to be translated into the appropriate legal language in order to demonstrate how the merger will meet the commission’s criteria, as well as integrated into the financial projections that management and investment bankers present to the financial markets.
All these imperatives will require companies to establish a cross-functional antitrust team that addresses the strategic logic, financial impact, and regulatory requirements of a proposed deal in an integrated, holistic fashion. It’s a development that leading European antitrust lawyers have begun to recognize. “The new rules will force lawyers to work more closely with economists and consultants,” says Didier Théophile of the Paris firm Darrois Villey Maillot Brochier, which has an extensive cross-border M&A practice in Europe. The need for increased collaboration among lawyers, bankers, consultants, and other external experts represents “a new era,” adds Hugues Calvet, of the French firm Bredin Prat, who has handled many landmark mergers before the European Commission. “Having more coordinated teams working together on a single agenda will better serve corporate clients.”
Anticipate “remedies” and plan for them in advance. When companies approach M&A in a more integrated fashion, they will be in a position to take a more active approach in their dealings with the commission. For example, when the commission anticipates difficulties with a proposed merger, the regulatory process enters a far more detailed—and public—“Phase II.” Typically, the would-be acquirer proposes certain “remedies” (usually asset sales), which the commission either accepts or rejects. The highly public nature of the Phase II process means that companies forced to sell assets are usually negotiating the sales with their hands tied behind their backs. That’s why many companies consider a Phase II inquiry a deal breaker and include a condition to that effect into their binding propositions with potential acquirers or targets.
An alternative approach is to anticipate the remedies that authorities are likely to accept and negotiate prices with potential buyers before the announcement of the deal. Sometimes, it is better to accept a certain amount of pain up-front by defining the deal that the commission will probably approve (and lining up potential buyers before the merger goes public) than to risk outright rejection or a Phase II inquiry.
That’s the approach that Canadian aluminum maker Alcan took in its 2003 bid for French rival Pechiney. To avoid a repeat of the commission’s 1999 rejection of a three-way merger of Alcan, Pechiney, and Switzerland’s Alusuisse-Lonza Group, Alcan came to the commission with a detailed plan for selling critical assets in order to meet anticipated objections to the deal. As a result, the deal was approved less than three months after its proposal.
Keep control of every dimension of the deal. As the commission’s rules and procedures evolve, the antitrust process will inevitably become more complex. Acquirers must negotiate with the seller and the commission simultaneously, and consider the interests and points of view of diverse intermediaries: lawyers, bankers, consultants, and local division managers. To remain in control of all aspects of a deal, companies should appoint an individual to oversee the process. This “project manager” should be in charge of managing all the players and coordinating the business, financial, and legal dimensions of the transaction. Does the proposed deal promise enough efficiencies to gain the commission’s approval? What will its impact be on margins and, consequently, on the price that shareholders are willing to pay the seller?
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It’s impossible to predict the ultimate impact of the European Commission’s new approach to antitrust regulation. Nevertheless, executives need to devise strategies now to manage the inevitable uncertainty. Companies that organize themselves to anticipate the changes will be in the best position to build a more constructive dialogue with the commission. Indeed, knowing how to navigate the new rules of European antitrust may well become an important source of competitive advantage in M&A.
Jérôme Hervé
René Abate
Jérôme Hervé is a vice president and director and René Abate a senior vice president and director in the Paris office of The Boston Consulting Group.
You may contact the authors by e-mail at:
herve.jerome@bcg.com
abate.rene@bcg.com
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