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— Regulatory —
These are the best of times, these are the worst of times. With apologies to Charles Dickens, we might take some literary license with the beginning of his novel "A Tale of Two Cities" to describe the current M&A environment. The credit crunch and the worldwide recession help to define the worst of times, but -- under the right circumstances -- there are great opportunities for companies to engage in strategic acquisitions. Companies may face both a weakened competitor as a target and weakened bidding competition. In a recent white paper "The Clock is Ticking," the Boston Consulting Group argued that "the current lull presents a unique and potentially short-lived window of opportunity for companies with the firepower to do a deal to capture the strategic high ground." BCG also noted that its research showed transactions undertaken in bad times had a much higher chance of generating superior returns.
Strategic acquisitions, however, generally mean antitrust review, and the headlines about the renewed vigor of antitrust enforcement under the Obama administration have been blaring almost as loudly as those about the financial crisis. So doesn't that make it the worst of times? How does one acquire the struggling competitor in the face of new antitrust cops on the beat committed to vigorous antitrust enforcement? In a word, carefully. Although the first dozen words of Dickens' classic are well remembered, the next dozen are less so: "it was the age of wisdom, it was the age of foolishness." The strategic acquirer needs much of the former and cannot afford to fall prey to the latter, thinking that in these hard times when a competitor or target is struggling the antitrust enforcers will go easy on the transaction for the good of the economy -- they will not. In a recent speech, Carl Shapiro, the Department of Justice Antitrust Division's new chief economist, made this plain; he noted that some firms may act opportunistically, using "the current economic conditions as a pretext to secure approval of what would otherwise be judged an anticompetitive merger." He argued for a long-term view: "[r]ecessions are temporary, but mergers are forever." The economic crisis will also bring merger enforcement into the bankruptcy court. Experience tells us that a target's bankruptcy is not a free pass for a competitor to purchase a competitor. As Shapiro has observed: "Reorganization through bankruptcy does not mean the removal of a competitor from the market." On the other hand, it is also the case that bankruptcy judges are notoriously disinterested in antitrust -- they want money for the creditors -- which makes it a difficult forum for the agencies to play their hand. The antitrust agencies will, nonetheless, intervene when in their view it is necessary. The financial health of the target is not, however, irrelevant -- far from it. It is critical, though, to understand the difference between a "failing firm" and a "flailing firm" and how the antitrust laws account for the difference when evaluating a merger. The former is enshrined in antitrust doctrine and can rise to the level of a "defense" if the strict requirements of the doctrine are met. Put simply, the defense can be invoked when the target is not capable of reorganizing successfully in bankruptcy, there is no alternative purchaser posing less of a threat to competition and its competitive assets are likely to exit the industry. As Shapiro said in recent congressional testimony on the newspaper industry: "Strict requirements must be met for that defense to be invoked, and rightly so. For a free market economy to work to harness the power of competition, rivals must not be able to short-circuit the competitive process, to the detriment of consumers, unless the alternative is imminent exit, which would also involve a loss of competition. ... Unfortunately, this type of 'tough love' may come into play with increasing frequency during the current economic challenges, simply because we are likely to see an uptick in the number of mergers in which the acquiring firm asserts that the acquired firm (or division) is failing." If a company is "failing" in a practical real world sense, even though the strict elements of the defense cannot be met, or is simply struggling very badly -- one might say "flailing" -- it may well mean that its future competitiveness is in doubt. This is highly relevant to antitrust merger review, which is forward looking, even if it doesn't rise to the level of a complete defense. In other words, the antitrust authorities look at the past to help predict the future, and the target's historic market share, for instance, may not be a reliable indicator of its going forward competitiveness if it is bleeding badly with no meaningful prospects of returning to its former glory. Ultimately, though, the key to developing a successful antitrust strategy for a strategic acquisition of a struggling competitor is developing a powerful synergy or efficiencies case. In every strategic transaction, one needs to explain to the antitrust authorities the competitive rationale for the transaction; and it is, of course, never (repeat never) to raise prices, reduce output or eliminate a competitive thorn in the side. In this context, the agencies may well ask: If the target is so wounded or in imminent danger of failing, why does it make sense to spend the money to acquire it? Why wouldn't a rational competitor just sit on the sidelines, preserve its cash and relish in watching its competitor's demise? The answer, of course, is synergies: combining the hard (and some times soft) assets of the two companies will enable the combined entity to lower unit costs and ultimately increase output, generating greater profits than the acquirer could accomplish without the transaction. To come through antitrust review successfully, the strategic acquirer should do the careful work of developing the efficiencies that the deal will yield, and efficiencies that in antitrust parlance are merger-specific, verifiable, and of such a caliber to influence the market. Antitrust enforcers will generally only credit efficiencies that directly flow from the transaction at hand and that are unlikely to be accomplished in the absence of the transaction, or through any other less anticompetitive means. They also require clearly identifiable information and data to substantiate any claims of efficiencies. For instance, the likelihood and magnitude of each asserted efficiency, how and when each would be achieved (and any costs of doing so), how each would enhance the merged firm's ability and incentive to compete, and why each would be merger-specific. The agency will ultimately balance the magnitude of the transaction's efficiencies against the magnitude of the likely harm to competition absent the efficiencies. This makes it critically important that the parties demonstrate how their post-transaction behavior will be pro-competitive for the marketplace and outweigh any likely harm. Thus, in the near term companies should view these times, in
Dickens's words, as "the spring of hope" and not "the winter of
despair," with opportunities in the near term to acquire weakened
competitors, generating meaningful efficiencies and along the way
meaningful returns to their shareholders. Bob Schlossberg is a partner in the antitrust, competition and trade group in the Washington office of Freshfields Bruckhaus Deringer LLP. |
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