Mergers & Acquisitions Primer


Most large mergers and acquisitions are reviewed by the United States government prior to consummation. The two agencies reviewing these transactions are the Department of Justice ("DOJ") and the Federal Trade Commission ("FTC"). In order to provide a degree of predictability in those reviews, the agencies have promulgated a set of rules with regard to how the parties report their transactions to the government and how those transactions are evaluated. This note provides some background on both the premerger notification requirements and the guidelines for evaluating mergers.

Background

As a starting point, the government gains its authority to review mergers and acquisitions under Section 7 of the Clayton Act (15 U.S.C. § 18). Section 7 prohibits mergers and acquisitions that may substantially lessen competition or tend to create a monopoly. The government gains its authority to review mergers and acquisitions before the parties are allowed to consummate the transaction under Section 7A of the Clayton Act (15 U.S.C. § 18a), or the Hart-Scott-Rodino Antitrust Improvements Act of 1976 ("HSR"). The HSR Act prohibits parties from acquiring voting securities or assets without first filing notification and the appropriate waiting period expiring. The rules under the HSR Act provide for how the parties report the transactions. The government has promulgated a set of guidelines on how mergers are to be evaluated for potential anticompetitive effect. These rules are found in the Horizontal Merger Guidelines.

The purpose of the HSR Act is to give the government the opportunity take the action needed to protect competition (under Section 7) before the parties have merged their operations. It is much more difficult to unwind an anticompetitive merger once it is consummated than it is to stop the transaction before the parties have spent time and resources integrating their assets. The process also gives some certainty and predictability to a process that, prior to the HSR Act, could take years and cost millions.

Any party contemplating a larger merger or acquisition, must consider whether the transaction is reportable under the HSR Act and to what extent there may be a substantive problem under Section 7, as interpreted by the DOJ and the FTC under the Horizontal Merger Guidelines. To provide some insight into this process, we will first address the requirements of the HSR Act and then the Horizontal Merger Guidelines.

Hart-Scott-Rodino Antitrust Improvements Act

Premerger Notification

Not all transactions are subject to pre-consummation review by the agencies. Only transactions of a certain size involving parties of a certain size may trigger the reporting requirements. We say "may" because there are many exemptions which could eliminate the need for parties that otherwise meet the thresholds to file premerger notification. Generally speaking, however, if your transaction meets the size-of-person and the size-of-transaction tests, you should consult your attorneys. The rules are extremely complicated, and failure to file where there was a duty to do so can carry a fine of up to $11,000 per day the parties are out of compliance.

Generally (the actual rules are much more complicated), premerger notification is required if:

  1. either party to the proposed transaction has total annual net sales or total assets of at least $100 million and the other party has annual net sales or total assets of at least $10 million; and
  2. as a result of the impending merger, the acquiring party will hold more than $15 million of the acquired party's stock and/or assets. An acquisition of another party's voting securities of less than $15 million also require reporting if, as a result of the impending acquisition, the acquiring person will hold 50% or more of the voting securities of an issuer that has $25 million or more in annual net sales or total assets.

If the proposed transaction meets the HSR Act premerger notification thresholds, each party to the transaction must complete and file a Premerger Notification and Report Form. Additionally, the acquiring party must pay a $45,000 filing fee. Both parties to the transaction must file notification.

Hart-Scott-Rodino Antitrust Improvements Act

Antitrust Review of the HSR Filing

Once the forms are filed, the parties cannot consummate their transaction for a period of 30 days (15 days for cash tender offers). (Parties may request early termination of the waiting period -- if the government decides before the 30 day period is over that the transaction poses no threat to competition, the government will grant early termination allowing the parties to consummate.) During this period, a clearance process is used to allocate filings between the agencies based on particular product expertise and past industry knowledge. Depending on the product and industry, either the FTC or the DOJ review the filings to ascertain whether any proposed transaction presents substantial competitive concerns. The parties are prohibited during this time period from consummating the transaction unless the enforcement agencies grant early termination.

If the transaction appears to pose a threat to competition, the agencies may issue an additional request for information. The additional request is commonly referred to as the "Second Request." Issuance of a second request automatically extends the waiting period until 20 days (10 days for a cash tender offer) after the parties (in the case of a cash tender offer, the acquiring person) have substantially complied with the Second Request.

Horizontal Merger Guidelines

Review of a proposed merger is typically conducted under the framework set forth in the Horizontal Merger Guidelines jointly issued by the DOJ and the FTC in 1992. U.S. Dep't of Justice & Federal Trade Comm'n, Horizontal Merger Guidelines , reprinted in 4 Trade Reg. Rep. (CCH) ¶ 13,104 (the " Guidelines "). The Guidelines were most recently revised in April 1997 to clarify the analysis and consideration of efficiencies that may result from a proposed merger.

The analytical framework of the Guidelines involves the following:

  1. defining the relevant product market and geographic market and identifying the firms that compete in these relevant markets;
  2. measuring concentration in the relevant markets using the Herfindahl-Hirschmann Index ("HHI");
  3. assessing the ease of entry by new firms into the markets;
  4. assessing the likely competitive effects of the merger in light of the market concentration and other factors that characterize the markets; and
  5. considering any significant efficiencies resulting from the merger that could not be achieved by other means.

Product Market

Under the Guidelines , the final determination regarding whether products belong within the same market involves estimating the particular group of products that a monopolist could control in order to maximize profits by imposing a "small but significant and non-transitory" increase in price. If such a price increase would cause buyers to shift to other products so that the price increase would be unprofitable for the monopolist, the government expands the market to include the closest substitutes for the product and repeats the process until a group of products is identified for which the price increase would be profitable. The enforcement agencies will then add the next best substitutes and continue this process until there are no practicable substitutes to which the consumer may shift. At this point, the product market is defined.

When determining whether product substitutability exists, the agencies will consider the following: (1) evidence of whether the buyer's perceive the products as substitutes; (2) price movements in the products involved -- do they parallel each other or are they different; (3) similarities or differences in design and usage of the products; and (4) the seller's perception of the substitutability of the products.

Geographic Market

For each product market of each merging firm, the enforcement agencies must identify the geographic market(s) in which the firms sell. Generally, the agencies will attempt to identify the geographic market in which the hypothetical firm, the only present and future producer or seller of the relevant product, could impose a "small but significant non-transitory" price increase. If a buyer of the product could respond to this increase by purchasing outside of the immediate area, the geographic area is to narrow and the enforcement agencies will continue to expand the geographic market area by adding outside locations until it defines an area in which the hypothetical producer or seller could maximize profits by increasing the price.

When determining whether geographic substitutability exists, the agencies will consider the following: (1) shipment patterns of the merging firms and competitors; (2) evidence demonstrating that buyers have shifted from geographic area to another in response to a price increase; (3) differences or similarities to price movements within geographic areas; (4) transportation and distribution costs; and (5) excess capacity of firms outside the location of the merging firm.

Market Concentration

Once the product and geographic markets have been established, the individual market shares of the merging firms are examined. Market shares will be determined by using the HHI. Under the HHI, market concentration will equal the sum of the squares of the individual market shares of every firm in the market. For example, if there were only four firms in a particular market, each with 25% of the market, the HHI would be 2,500 (252 x 4). Any market with an HHI over 1,800 is considered highly concentrated by the enforcement agencies and viewed with some suspicion; between 1,800 and 1,000 the market is considered moderately concentrated; and below 1,000, the enforcement agencies consider such markets to be unconcentrated.

Mergers producing an increase in the HHI of more than 50 points in highly concentrated markets will raise significant antitrust concerns. A merger that increases the HHI by more than 100 points in highly concentrated markets is considered to create market power and is likely to be challenged by the enforcement agencies.

The HHI is used because it reflects, more importantly, the distribution of the market shares of the top firms and the composition of the market outside of the top firms. It will also give proportionately greater weight to the market shares of the larger firms in accordance with their relative importance in competitive interactions.

Entry Analysis

Under the Guidelines , a merger is unlikely to create or enhance market power if entry into the relevant market is relatively easy. To ascertain whether entry into the market is "easy," the enforcement agencies will analyze the timeliness, likelihood, and sufficiency of entry.

   Timeliness . Under the Guidelines , entry into a market is timely only when it can be achieved within two years from the initial planning to significant market impact on price.

   Likelihood . Entry into the market is likely under the Guidelines only if the new entrant would be profitable under premerger prices. This premerger standard is used because following a merger, a firm with enhanced market share could temporarily reduce its prices to discourage other entrants, or if there were new entrants into the market, make it more difficult for the new firm to achieve market share. Thus, if the potential entrant is able to acquire market share and profits within the two-year period, entry is likely.

   Sufficiency of Entry . Entry is considered sufficient under the Guidelines where the potential entrant possesses adequate knowledge of the market and financial resources to deter or counteract any supra competitive pricing by a merged firm.

Competitive Effects

Market definitions and the evaluation of market shares and concentration provide the starting framework for analyzing the competitive impact of a proposed merger. Under the Guidelines , the enforcement agencies will examine whether a lessening of competition through either "coordinated interaction" or "unilateral effects" exists. While the 1984 Guidelines were principally concerned with collusive price-fixing, the 1992 Guidelines were expanded to include coordinated interaction between competing firms. This coordinated interaction incorporates parallel or matching conduct by competitors. Coordinated behavior can include tacit or express collusion.

The agencies will also determine whether competition is lessened due to unilateral effects such as a firm unilaterally altering its behavior following an acquisition by elevating price and suppressing output. This examination will include an analysis of product differentiation and production capacity.

Significant Efficiencies

If a merger does not pose a serious threat to competition, it is unlikely to be challenged. If a substantial threat is present, however, the enforcement agencies may exercise prosecutorial discretion in determining whether net efficiencies (e.g. , cost reductions and/or product enhancements) outweigh the competitive risks. Examples of efficiencies may include the ability of two previously ineffective (e.g., high cost) competitors to become one effective (e.g., low cost) competitor, the reduction in marginal cost that may lessen the merged firm's incentive to elevate price, or efficiencies that may result in benefits such as new or improved products.

The Guidelines recognize certain claimed efficiencies as credible. These include achieving economies of scale, better integration of production facilities, plant specialization, lower transportation costs and similar efficiencies relating to manufacturing, servicing, or distribution operations of the merging firms. Reductions in selling, administrative and overhead expenses may also be considered by the enforcement agencies as credible cost reduction effects of a merger.

Enforcement Procedures and Relief

DOJ

Pursuant to Section 15 of the Clayton Act (15 U.S.C. § 25), DOJ may challenge proposed mergers by seeking an injunction in federal court. In the case of a merger that has been consummated, the DOJ will typically request relief in the form of a total or partial divestiture of assets or other behavioral relief.

FTC

The FTC typically challenges proposed mergers by seeking a preliminary injunction in federal district court pursuant to Section 13(b) of the FTC Act (15 U.S.C. § 53(b)). Under Section 13(b), a district court may grant a temporary restraining order or preliminary injunction to prevent consummation of the proposed merger pending the issuance of an administrative complaint by the FTC and completion of FTC administrative proceedings. The court is required to dissolve the order or injunction if the FTC does not issue it administrative complaint within the period specified by the court (not to exceed 20 days).

The FTC is also authorized to adjudicate the legality of mergers and other challenged Clayton Act violations under Section 11 of the Clayton Act (15 U.S.C. § 21). Administrative merger enforcement begins when the FTC issues and serves a complaint on the parties. Where a merger is found to violate Section 7 of the Clayton Act, the FTC is empowered to issue "cease and desist" orders. The FTC may also order the divestiture of assets acquired in violation of Section 7, as well as behavioral relief.