Principles of Merger Antitrust

Law I:Substance, Reporting, Purchase Agreements

Dale CollinsBeau Buffier

Kelly Karapetyan

October 14, 2009

2

Why Think About Antitrust? Antitrust issues in transactions may affect:

Whether a transaction should proceed at all Legal work in analyzing and preparing for regulatory review Cost and effort of regulatory review process Valuation of transaction Timing of transaction Structure of deal and the assets to be acquired Risk-shifting covenants (i.e., antitrust divestiture risk) Closing conditions Extent of due diligence and integration planning Content of press releases and customer/employee

communications

3

Agenda Substantive merger antitrust principles

Horizontal mergers Other theories of anticompetitive harm

Merger control reporting United States Europe Rest of world

Antitrust provisions in the purchase agreement

Will not cover merger investigations or remedies

ASK US BACK!

4

Substantive Merger Antitrust Principles

5

U.S. Legal Standard

Clayton Act § 7 prohibits mergers and acquisitions that may substantially lessen competition or create a monopoly in any line of commerce (product market) in any part of the country (geographic market)

Mergers tend to lessen competition when they threaten to hurt an identifiable set of customers through Increased prices Restricted market supply Reduced product or service quality Reduced rate of technological innovation or product improvement

6

Horizontal Mergers

Combination of two firms with competing products

Primary evidence probative of anticompetitive effect Number of realistic alternatives available to customers Company documents Customer interviews

7

Horizontal Mergers

Key is number of practically available alternative suppliers: 5 4 Almost always clears absent significant customer

opposition 4 3 Close case but can clear with some significant

procompetitive justification, customer support and little

customer opposition and no bad documents 3 2 Usually challenged; requires compelling customer

support to clear and no bad documents 2 1 Always challenged; no efficiency defense

8

Horizontal MergersS

igni

fican

t Com

petit

ors

Enforcement Outcomes

AllCustomer complaints

Hotdocuments

2 to 1 234/239 (98%) 40/40 (100%) 10/10 (100%)

3 to 2 242/278 (87%) 27/28 (96%) 4/5 (80%)

4 to 3 140/188 (74%) 13/14 (93%) 7/9 (78%)

5 to 4 58/92 (63%) 0/0 0/0

6 to 5 19/48 (40%) 3/3 (100%) 1/1 (100%)

7 to 6 3/23 (13%) 0/0 0/0

8 to 7 6/21 (29%) 0/0 0/0

9 to 8 0/11 (0%) 0/0 0/0

10 to 9 2/5 (40%) 0/0 0/0

10+ 0/20 (0%) 0/0 0/0

9

Horizontal Mergers “Realistic alternative supplier”

Customers must regard supplier as a realistic alternative to merging firms

Fringe firms do not count Geographic coverage Product breadth Reputation

“Hot” company documents Suggest the merging companies are close competitors of one

another in some overlapping product Suggest that there are few realistic alternatives to merging firms Suggest that business model behind transaction is

anticompetitive (e.g., higher prices, reduced innovation)

Horizontal Mergers

Customer complaints Generally about price The merging companies are close competitors of one another in

some overlapping product Customer “plays” the companies off one another to get better

prices Insufficient number of realistic alternatives to preserve price

competition post-merger Customer conclusion: Customer will pay higher prices as a result

of the merger

10

Horizontal Mergers

Other considerations High market shares

Not helpful BUT not decisive if sufficient alternatives exist

Effect on competitors In U.S., irrelevant unless it hurts customers BUT one of the best predictors of enforcement action in the EU

Efficiencies Heavily discounted by enforcement agencies BUT important to provide a procompetitive deal motivation

DOJ/FTC Merger Guidelines NOT a good predictor of enforcement outcomes But used as the roadmap in litigation

11

Other Theories of Anticompetitive Harm Unilateral effects

Important special case in niche market segments Merging firms offer a uniquely close substitutes for each other’s

overlapping product

Elimination of potential entrants

Vertical mergers Foreclosure of competitors

Input foreclosure Distribution foreclosure

Raising costs to rivals

“Portfolio effects” Have not seen in United States since 1960s Used to block GE/Honeywell in the EU

12

FTC Second Requests by Theory

Theory

Number ofSecond Requests

(FY1996-2007)

Horizontal (including unilateral effects)

210

Vertical 25

Potential competition 17

Buyer power (monopsony)

9

Joint venture 3

Other 5

Filing withdrawn 73

Closed after “quick look” 42

Total 384

13

14

Defending a Transaction

Dual approach to defense: Transaction is procompetitive Transaction is not anticompetitive

Develop transaction rationale that will support these theories: Combined company will make money by

Increasing value to customers and thereby increasing customer demand for its products

Not by squeezing customers on price, quality or service

Defending a Transaction Best defense is a good offense: Customers benefit from

the merger Lower costs of production, distribution, or marketing make

merged firm more competitive Elimination of redundant facilities and personnel Economies of scale or scope

Accelerated R&D and product improvement Greater combined R&D assets (researchers, patents, know-how) Complementaries in R&D assets Greater sales base over which to spread R&D costs

Better service and product support More sales representatives More technical service support

One-stop shopping for customer convenience Combining product lines

15

16

Defending a Transaction Market will not allow merger to be anticompetitive

Merging parties may appear to compete but in fact they don’t Merging parties compete but there are plenty of other significant

competitors (“realistic alternative suppliers”) Incumbent suppliers Repositioned competitors New entrants

Merging parties compete and there are few if any other actual competitors, but entry is easy and effective

There is some other reason why the combined firm will not be able to harm customers (e.g., “power buyers”)

The Obama Administration

Expect differences only at the margin Somewhat higher confidence that they will not make an error Identifying the problem Fashioning a solution

More skeptical that markets are self-correcting Less likely to credit repositioning in the substantive analysis More demanding in remedies

Continue the skepticism regarding efficiencies What deals would this administration challenge that Bush let go?

Maytag/Whirlpool Sirius/XM

Renewed emphasis on finding anticompetitive vertical mergers

18

Merger Notification

HSR Act Process

Where thresholds met, mandatory notification and observance of waiting period under Hart-Scott-Rodino (“HSR”) Act by both parties to deal Size-of-Transaction Size-of-Person Commerce

HSR Act prohibits closing of a transaction until after the applicable waiting period is over

Reviewed by FTC or DOJ Some industries have special clearance regimes involving other

bodies (e.g. Federal Reserve involvement in banking mergers)

19

HSR Act Waiting Periods

Initial waiting period 30 calendar days generally 15 calendar days in the case of

a cash tender offer, or acquisitions under § 363(b) of bankruptcy code

Possible outcomes: Early termination of waiting period Expiry of waiting period Cleared after Second Request with or without remedies Agencies make application for preliminary injunction in US

Federal District Court

20

HSR Act Filing

Preparation of HSR Filing Takes anywhere from a few days to a few weeks depending on

the transaction

Key information required: Transaction documents Annual reports, financial statements and NAICS revenues Corporate Structure Information:

Majority-owned subsidiaries Significant minority shareholders Significant minority shareholdings

“4(c)” documents

21

HSR Act Filing (cont’d)

4(c) Documents Studies, surveys, analyses or reports Prepared by or for officers or directors of the company (and any

entities it controls) That analyze the transaction With respect to markets, market shares, competition,

competitors, potential for sales growth, or expansion into product or geographic markets

22

HSR Reportability: When to Call Us Asset Deal

Acquisition price + value of assumed liabilities approaches $65 million

Stock Deal Acquisition price for voting securities to be acquired + value of

voting securities already held approaches $65 million Acquisitions of minority interests potentially reportable

Non-Corporate Interests (LLC/Partnership) Deal Acquisition price for non-corporate interests to be acquired + value

of interests already held approaches $65 million and acquisition confers control

Control based on economics: 50% or more of the profits and/or 50% or more of the assets upon dissolution

23

HSR Reportability

"Size-of-Transaction“

As a result of the acquisition, the acquiring person holds voting securities and assets of the acquired person:

“Size of Person”

Acquiring person Acquired person

In excess of $260.7 million* Prima facie reportable without regard to size-of-person

Above $65.2 million up to and including $260.7 million*

1. $130.3MM (in total assets or annual net sales)

$13.0MM (in total assets or annual net sales of a person engaged in manufacturing)

2. $130.3MM (in total assets or annual net sales)

$13.0MM (in total assets of a person not engaged in manufacturing)

3. $13.0MM (in total assets or annual net sales)

$130.3MM (in total assets or annual net sales)

Up to and including $65.2 million*

Not prima facie reportable

* Subject to adjustment

24

HSR Reportability

Determining Whether HSR Thresholds Are Satisfied Size-of-transaction test

Look at the total value of the voting securities and assets of the acquired person which the acquiring person will hold as a result of the acquisition

Includes The securities and assets being acquired PLUS Any previously acquired voting securities PLUS In some circumstances, the previously acquired assets

of the acquired person

25

HSR Reportability

Determining Whether HSR Thresholds Are Satisfied Different valuation rules apply depending on the type of

acquisition: Market price Acquisition price (if determined) Fair Market Value

Asset acquisitions (but not voting securities acquisitions) Must include value of liabilities being assumed by acquiring person

Voting securities deals Can exempt from the transaction value, any consideration specifically

earmarked for debt repayment

26

Selected Exemptions

Intraperson exemption Exempts acquisitions in which the acquired and acquired person

are the same by reason of holdings of voting securities or having the right to 50% or more of the profits or assets upon dissolution of a non-corporate entity

Investment exemption Hold no more than 10% of target’s outstanding voting securities

(15% for certain Instituational Investors) N.B. must be a purely passive investment intention

27

Selected Exemptions Convertible voting securities

Exempts acquisitions of options, warrants and other convertible voting securities if the securities do not carry present voting rights (to elect board members)

HSR filing may be required prior to the conversion if thresholds are met

“Ordinary Course of Business” Often comes up in the context of financial institutions buying/selling

used durable good such as planes and rail cars which it owned for financing purposes and portfolios of financial products (e.g. loans).

As long as the financial institution maintains some type of similar financing unit, OCB can apply (but not with respect to portfolios of credit card receivables), even if a corporate unit it sold.

28

Foreign Acquisition Exemptions Any acquisition of target with significant non-U.S. assets,

exempt unless: FMV of U.S. assets exceeds $65.2 million; or Assets located outside the U.S. generated sales into the U.S. (in

the aggregate) of more than $65.2 million in its most recent fiscal year

29

Foreign Acquisition Exemptions “Foreign-Foreign No-Control”: Acquisitions of non-U.S.

voting securities by non-U.S. persons exempt unless the acquisition will: confer control of the issuer; and the issuer (including all entities controlled by the issuer) either:

holds assets located in the United States (other than investment assets, voting or nonvoting securities of another person, and certain other assets) having an aggregate total value of over $65.2 million; or

made aggregate sales in or into the United States of over $65.2 million in its most recent fiscal year

30

HSR Act Review ProcessTypical Domestic Transaction

Announcedeal

File HSR forms

Second requestissued

Second requestconference

Second requestcompliance

Formal end of HSR waiting period

Final agencydecision

Initial waitingperiod

(30 days)

Document production and interrogatory responses(approximately 2-3 months)

Final waitingperiod

(30 days)

Voluntary extension(up to 3 months as necessary)

Customerrollout

– First telephone call (voluntary request)

– First presentation– Follow-up meetings– First DOJ/FTC customer

interviews– First DOJ/FTC competitor

interviews– Filings in other jurisdictions

– Second request conference– Collect and review documents– Prepare interrogatory responses– Depositions of employees– Additional meetings– Follow-up DOJ/FTC customer interviews and

affidavits– Follow-up DOJ/FTC competitor interviews

– Final meetings with staff– Meetings with senior staff

– Negotiate consent decree (if necessary)

0 0.5 month 1.5 months 3.5-4.5 months

4.5-5.5 months

31

32

Antitrust Considerations inDrafting Acquisition

Agreements

Antitrust & Acquisition Agreements Key Antitrust Issues

Relevant merger control filings Which merger clearances should be disclosed in reps and

warranties? Which merger clearances should be closing conditions?

Cooperation on regulatory matters Where and when to make merger filings? How much information sharing? Agreement on specific tactics and timing? Agreement to litigate any challenges to the acquisition?

Antitrust risk-shifting provisions Settlement and divestiture commitments Reverse breakup fees

Drop-dead date and termination provisions

33

Antitrust & Acquisition Agreements “Consents and Approvals” Reps and Warranty

Merging parties typically represent that the execution of the agreement and consummation of the transaction will not require any consents and approvals except for compliance with the HSR Act or ECMR (if applicable)

For other jurisdictions: Parties can identify in advance all other specific jurisdictions, but this

requires significant due diligence and agreement up-front Parties typically refer to all “applicable”, “all required foreign

approvals” or all “necessary foreign approvals” (generally understood as those with mandatory suspensory effect)

May have a carve out for those foreign filings that would not have a material adverse effect if not obtained

34

Antitrust & Acquisition Agreements Antitrust Conditions Precedent

Typical conditions (if applicable) Expiration or termination of HSR waiting period ECMR approval

For other jurisdictions, there are a variety of approaches Ignore them List each non-U.S. clearance specifically Limit foreign antitrust clearance conditions to those “required by law”

or that “would prohibit the consummation of the transaction” or that if not obtained (i) are or would be reasonably likely to have a material adverse impact or (ii) if not obtained would result in a criminal violation

35

Antitrust & Acquisition Agreements “No Injunctions or Restraints” Condition

Typically provide that no restraint, preliminary or permanent injunction or other order or prohibition preventing the consummation of the transaction shall be in effect

From a seller’s perspective, may wish to have a carve-out that prior to asserting condition, the asserting party must be in compliance with its best efforts obligations (e.g., to settle or litigate)

36

Antitrust & Acquisition Agreements ‘No Conflict/Absence of Litigation’ condition

Typically provides that no action is pending (or threatened) that seeks to delay or prevent consummation of the transaction

From a seller’s perspective, this could be too favorable as it would cover a challenge brought by a private party, or in non-U.S. jurisdictions, an appeal by a private party filed against an already approved transaction

For seller, watch for inconsistency between antitrust clearance conditions and generally worded conditions on “absence of litigation” or “no contravention of law”

37

Antitrust & Acquisition Agreements Regulatory Approval/Best Efforts Covenants

Agreement to cooperate and obtain regulatory approvals using Best efforts; or Reasonable best efforts; or Commercially reasonable best efforts

Filing Obligations and Timing HSR default is 10 business days Other jurisdictions may take significantly longer, so parties usually

agree on filing these “as promptly as practicable”

38

Antitrust & Acquisition Agreements Other provisions in best efforts covenants

Obligation to litigate in the event of a challenge May be imposed on buyer alone or on both parties Obligation may be to litigate through to a final, non-appealable

judgment, or something less If advising seller, need to be careful that decision by buyer to litigate

does not relieve it of any divestiture obligation (if there is one) Coordination on dealing with government agencies

Advance notice and review of communications and submissions (buyer will usually want more control over process)

Right to attend meetings/conferences with Governmental authorities

39

Antitrust & Acquisition Agreements Other provisions in best efforts covenants

Agreement not to take any action that will make antitrust approval more difficult

Agreement not to withdraw filings, extend waiting periods or enter into timing agreement without consent of other party (seller typically wants)

Agreement on timing of SR response (seller may want to impose a tight timeframe)

Agreement on exchanging information on settlement offers (very pro-seller)

40

Antitrust and Acquisition Agreements Risk-Shifting Provisions

Typical provisions No divestiture obligation “Hell or Highwater” provision, requiring seller to do whatever it takes to obtain

antitrust clearance Reverse breakup fee

Many other alternatives, depending on the circumstances: Divestiture obligations limited to certain product lines Divestitures limited by revenue cap Materiality cap on divestitures “Take or pay” obligation

Divestiture obligation alters buyer’s bargaining power vis-à-vis the enforcement agency and can raise “road map” problem Sometimes dealt with in a side-letter interpreting the acquisition agreement,

but this may not be possible in public deals due to SEC disclosure requirements

41

Antitrust and Acquisition Agreements Timing and Termination Issues

Drop-dead date Does it provide long enough for expected approvals? Firm termination date or extension (typically +120 days) in the event

of a Second Request or Phase II investigation? MAC clause: if business likely to deteriorate significantly during a

prolonged antitrust review, may need provisions to ensure MAC is not used to avoid any divestiture commitments or avoid payment of reverse breakup fees

42