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Mergers quaCompetition Regime

H.S. Chandhoke

Partner, Luthra & Luthra Law Offices

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Contents

1. Coverage

2. Mergers: Basic Concepts

3. Rationale for Merger Regulation

4. Types of Mergers

5. Motivation for Mergers

6. Adverse Effects of Mergers

7. Facts and Figures

8.Cross Border Mergers

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Contents

9. Mergers in India

10. Merger Control Provisions in India

11. A Balancing Act12. The Legal Framework

13. The Competition Act 2002

14. Decided Cases

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Coverage

The three core areas covered in theCompetition Law across the globe are:-

1. Anti-competitive agreements;

2. Abuse of Dominant Position; and3. Regulation of Combinations includingmergers.

The first two areas are prohibited ex post whilethe regulation of merger is generally ex-ante.

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Mergers: Basic Concepts

Merger - combination of two or moreenterprises whereby the assets and liabilities of

one are vested in the other, with the effect that

the former enterprise loses its identity.

Amalgamation combination of twocorporate entities where the assets and liabilities

of both are vested in a third entity, with theeffect that both former entities lose their

identities to form a new entity.

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Competition Act 2002Section 2(a)

Acquisition the acquiring, directly or

indirectly of shares, voting rights, assets orcontrol over management or assets, of another

enterprise.

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Section 2(h)

Enterprisemeans a person who is engaged in

any activity relating to production, storage,

supply, distribution, acquisition or control ofany goods, or the provision of services, or in

investment or securities, either directly or

indirectly, but does not include sovereignfunctions of the government.

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Basic concepts

Combinationincludes: Acquisition of control, shares, voting rights or

assets by an acquirer of an enterprise; [section5(a)]

Acquiring of control by a person of an enterprisewhere the person already has control over anotherenterprise engaged in production, distribution andtrading of similar or identical or substitutablegoods/services;

Merger or amalgamation between or amongstenterprises

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Rationale

The rationale for merger regulation is simple It is far better to prevent firms from gainingmarket power than to attempt to control market

power once it exists.

Effective merger policy requires a judgmentconcerning the impact of merger oncompetition before the merger has occurred.

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Rationale

The whole philosophy is based on an ancientEnglish Maxim: Prevention in better than cure.

It is better to prevent and prepare rather than to

repent andrepairNavjot Singh Sidhu

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Types of Mergers

Horizontal : between enterprises in the sameproduct market and at the same level of theproduction or distribution cycle.

Vertical: between enterprises that operate atdifferent levels of the production or distributioncycle.

Conglomerate: between enterprises operatingin different markets.

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Horizontal and Vertical Mergers

Raw MaterialProducer/Supplier



Manufacturer Manufacturer Manufacturer

Wholesaler Wholesaler Wholesaler

Retailer Retailer Retailer

Consumer Consumer Consumer

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Motivation for Mergers

To diversify the areas of activity and thereby toreduce business risks;

To achieve optimum size so as to reap thebenefits of economy of scale;

To reduce the duplicate expenses and thereby toimprove the profitability;

To serve the customer better;

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Motivation for Mergers

To have cohesiveness in control of the

organisation;

To grow without any gestation period;

Inorganic growth is believed to be much faster

compared to organic growth.

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Adverse Effects of Mergers

Mergers especially horizontal reduces thenumber of players and consequently thecompetition in the market;

Mergers amongst rivals is invariably unfriendlyto consumers;

Mergers often results in increased market shareand thereby leads to dominance which makes

the resultant enterprise complacent

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Adverse Effects of Mergers

and thereby brings inefficiency in theorganisation;

Mergers between healthy and unhealthy

enterprises reduces the tax liability and therebymakes the States exchequer poor;

Mergers often fail to create harmonisation inhuman relation.

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Facts & Figures on Mergers1

Worldwide mergers and acquisitions in thefirst quarter of 2005 exceeded $589 billion.

Combined with $670 billion in Q4 2004 thatamounts to over $1.2 trillion over 6 months.

1Source: Thomson Financial Services

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Facts & Figures on Mergers

Asian M&A in Q1 2005 amounted to $36billion (rise of 32.9% over Q1 2004) consistingof a total of 1,355 transactions (a decline of12.9% from Q1 2004).

South Korea ranked first in terms of transaction

value while China ranked first in terms ofnumber of transactions.

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Facts & Figures on Mergers

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Facts & Figures on Mergers - India

Late 1980s35 mergers. 1997 552 mergers.

2002 - $ 6.5 billion.

2003 - $ 3.7 billion. (Business & Economy Magazine) The value of mergers in India more than

doubled to $9.32 billion in 2004, from $4.4

billion in 2003. (Bloomberg Feb 2005)

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Facts & Figures on Mergers - India

The first quarter of 2005 itself has seen M&Asto the tune of over $3 billion. (Thomson Financial)

According to PWC study which appeared in

Financial Express of August 17, 2005, Indiarecorded second highest growth rate in M&Aactivities in the first half of 2005, second only to

Japan.

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Facts & Figures on Mergers Asia(ex Japan)

Q1 2005 Figures

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Cross Border Mergers1

Worldwide Cross Border M&As represent alarge portion of the total M&As amounting

to $296 billion in 2003, of which Indiasparticipation amounted to $949 million (83out of 4562 deals).

World Investment Report 2004

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Cross Border Mergers

The motivating factors for cross borderM&As are:

Quickest way to grow

Acquire tangible and intangible assets

Restructure existing operations

Exploit synergies Obtain strategic advantages

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Cross Border Mergers

However, the overwhelming majority of the crossborder M&As involve foreign firms acquiring Indiancompanies. In cases where such acquisitions involveno increase in economic efficiencies or production

capacities, it raises the concern that such M&Assimply shift ownership from domestic to foreignhands.

Domestic consolidation of enterprises would helpIndian enterprises achieve a better bargaining positionand reverse the trend.

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Mergers in India

From 1991 to date, mergers are not regulatedfrom a competition perspective. The AsianDevelopment Outlook 2005 mentions theimpact of M&As in India. It indicates forexample Coca Cola re-entered the Indianmarket in 1993 by acquiring Parle. Today it has50% market share of the soda industry. Pepsi

gained a major market presence by acquiringDuke in 1988, and now has 48% market shareof the soda industry.

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Mergers in India

HLL has succeeded in enhancing its market sharethrough a process of Mergers /Acquisitions

Product 1992-93 1997-98

Ice Cream 0.00 74.06

Sauces,ketchups,jams 0.00 63.54

Dental hygiene products 11.20 41.56

Soaps 19.66 26.01

Synthetic detergents 33.12 46.72Vanaspati 0.85 13.90

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Merger Control Provisions in India

Pre 1991: Only the MRTP Act, 1969 and theCompanies Act, 1956 had merger controlprovisions.

Post 1991: The Companies Act, 1956; SEBI(Takeover) Guidelines, 1997; and the

Competition Act, 2002 now form the backboneof merger control provisions in India.

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A Balancing Act

Despite foreseeable advantages, mergers canhave an adverse impact on public and consumerinterest in terms of higher costs, increasedpolitical influence of merged entity and reduced

efficiency owing to diversification into unrelatedbusinesses.

In dealing with mergers, Competition Law has

to balance between encouraging competitionand at the same time promoting economicefficiency.

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The Legal Framework

1.The Companies Act, 1956Sections 390 - 396A, 108A, 17, 319 and 42.

2. SEBI (Substantial Acquisition of Shares andTakeovers) Regulation, 1997

3. The Competition Act, 2002

Sections 5 and 6 deal with Combination andRegulation ofCombination respectively.

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Threshold Limits

Where a merger proposal comes within thepurview of the threshold limits stated underSection 5, notification thereof may be made

to the CCI.

The Act encompasses a voluntary pre-

notification requirement for mergers above acertain threshold limit.

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Acquisition, Acquisition of Controlor Merger or Amalgamation

By a PersonThe Resultant Entity musthave:

(i) in India, assets valued at

more than Rs.1000 crores orturnover of more that Rs.3000 crores; or

(ii) in India or outside India,assets valued at more than

US$ 500 million or turnoverof more than US$ 1.5 billion.

By a GroupThe Resultant Entity musthave:

(i) in India, assets valued at

more than Rs.4000 crores orturnover of more than Rs.12,000 crores; or

(ii) in India or outside India,assets valued at more than

US$ 2 billion or turnover ofmore that US$ 6 billion.

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Group

Group means two or more enterprises which,directly or indirectly, are in a position to:

(i) exercise twenty-six per cent, or more ofthe voting right in the other enterprise;

or(ii) appoint more than fifty percent, of the

members of the board of directors in theother enterprise; or

(iii) control the management or affairs of theother enterprise.

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Control

Control includes controlling the affairs or

management by

One or more enterprises, either jointly orsingly, over another enterprise or group;

One or more groups, either jointly or singly,

over another group or enterprise.

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Section 6

Any combination entered into which causesor is likely to cause an appreciable adverseeffect on competition within the relevant

market[section 2(t)] in India shall be void. A person entering into a combination may

give notice to the CCI disclosing details of

the combination within 7 days of (a) approvalof the merger by the boards of

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Section 6

the enterprises, or (b) execution of anyagreement for acquisition referred to in 5(a)or acquiring of control.

Exception Section 6 does not apply toshare subscription or financing facility or anyacquisition by a PFI, FII, bank or venture

capital fund pursuant to any covenant of aloan agreement or investment agreement.

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Notification Requirements

Pre-notification is compulsory in US and EU. In India, pre-notification is only voluntary.

Considering the current phase of growth andconsolidation of industry, it was decided againstincorporating a compulsory notificationrequirement.

Post- merger notification runs the risk of having

to unscramble the merger which usually entailshigh social cost.

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Inquiry: Section 20

The CCI may inquire into whether a combinationis likely to cause an appreciable adverse effect oncompetition based on its own knowledge or on

information provided to it. However, the CCI cannot initiate an inquiry into

any combination after the expiry of one year since

that combination has taken effect. CCI shall inquire in cases where notice is given

under section 6(2).

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Factors to be examined: Section 20

In order to determine whether a combination wouldhave the effect of or is likely to have an appreciableadverse effect on competition, the CCI shall havedue regard to the following factors:

a) actual and potential level of competitionthrough imports in the market;

b) extent of barriers to entry in the market;

c) level of combination in the market;

d) degree of countervailing power in the market;

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Factors (cont.)

e) likelihood that the combination would resultin the parties to the combination being ableto significantly and sustainably increase

prices or profit margins;f) extent of effective competition likely to

sustain in a market;

g) extent to which substitutes are available orare likely to be available in the market;

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Factors (cont.)

h) market share, in the relevant market, of thepersons or enterprises in a combination,individually and as a combination;

i) likelihood that the combination would resultin the removal of a vigorous and effectivecompetitor in the market;

j) nature and extent of vertical integration in the

market;

k) possibility of falling business;

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Factors(cont.)

l) nature and extent of innovation;m) relative advantage, by way of the

contribution to the economic development

by any combination having or likely to haveappreciable adverse effect on competition;

n) whether the benefits of the combination

outweigh the adverse impact of thecombination, if any.

Procedure for Investigation:

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Procedure for Investigation:Section 29

Where the CCI opines that a combination islikely to have an appreciable adverse effect

on competition, it shall call upon the partiesto respond within 30 days showing cause asto why an investigation should not be

conducted;

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Procedure (cont.)

After receiving the responses, if the CCI is ofthe prima facie opinion that the combinationis likely to have an appreciable adverse effect

on competition it shall direct within 7 daysthat the details of such combination bepublished within 10 working days of such

direction, in the manner prescribed;

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Procedure (cont.)

Objections to the combination are invitedfrom the public within 15 days from the dateof publication;

Within 15 days of receiving comments, theCCI may call for additional information fromthe parties to the combination, which is to befurnished within 15 days.

After the receipt of all information, the CCImust come to a decision within a period of 45days.

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Orders: Section 31

The Commission has to pass final order within90 working days (subject to certain exception)from the date of publication, failing which the

Merger is deemed to have been approved;

The Commission is vested with a power to

approve the Merger, or approve withmodifications, or to reject the merger;

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Orders

In case the modification suggested is agreedto by the parties, the merger is approved and

in case modifications are not agreed to, theMerger is refused and the agreement will bedeclared void;

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Orders modifying the Merger

Divestment

Requiring access to essential inputs/facilities

Dismantling exclusive distribution agreements

Removing no-competition clauses

Imposing price caps or other restraints onprices

Refrain from conduct inhibiting entry

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Penalty: Section 44

If any party to a combination makes a falsestatement or omits to state any material

particular, such person is liable for a penaltybetween Rs. 50 lakhs and one crore.

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Usage

Even though the factors and procedurecontained in Competition law seemcomprehensive, experience has shownauthorities very rarely block proposed mergers.

The European Commission has prohibited 19proposed mergers out of a total of 2827 notified

(0.65%) between 1990 and July 2005.

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Usage

The Competition Commission of the UK sincebeing set up in 2003 has found adversecompetition effects in only 5 cases and

prohibited only 3. The US Federal Trade Commission and

Department of Justice combined challengedonly 36 out of 1014 mergers notified in 2003leading to 12 consent orders and 16 abandonedtransactions.

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Decided Cases

FTC v. Staples Inc.[970 F.Supp. 1066 (DDC 1997)]

In 1997, the two largest office superstore chains in

US, Office Depot and Staples Inc. announced their

agreement to merge. The Federal TradeCommission (FTC) opposed the merger on the

grounds that it was likely to harm competition and

lead to higher prices in the market for the sale of

consumable office supplies sold through office

superstores.

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FTC v Staples Inc.(cont.) The FTC argued that voluminous evidence

structural, documentary and statistical supported the conclusion that the proposedmerger would raise prices for office supplies.

The relevant market in this case was held to beofficesuperstores and that the merged entities

would have a dominant market share between45% - 100% in many geographic markets.

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FTC v Staples Inc. (cont.)

Office superstores were held to be different fromother office supply retailers in terms of appearance,size, format, the number and variety of itemsoffered, and the type of customers targeted.

In the absence of a merger, the separate entitieswere competitors and would have targeted eachothers market and kept prices low.

The efficiencies argued for were held not to besufficient to offset price increase.

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Cases

GE-Honeywell[Case No. COMP/M.2220] On October 22, 2000 a merger was announced

between two American based companiesGeneral Electric and Honeywell.

GE makes, sells, and services large aircraftengines. Honeywell makes small aircraft engines,avionics components, and non-avionics

components, such as environmental controlsystems, wheels and brakes, and auxiliary powerunits.

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GE-Honeywell

This was case of a conglomerate merger, where theonly substantial horizontal overlap occurred in thesupply of military helicopter engines and in repairand overhaul services for certain Honeywell aircraft

engines.

However each party was a leader in its

respective market. At $42 billion it was thelargest industrial merger in history.

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GE-Honeywell

The USDOJ cleared the proposed merger onthe condition that GE divest Honeywellshelicopter engine business and to license a newcompetitor to maintain and repair certainHoneywell engines.

Due to the size of GE and HoneywellsEuropean sales, the merger had to be approved

by the European Commission (EC) as well.

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GE-Honeywell

The EC found that GE had a dominant positionin the aircrafts engine market while Honeywellhad a dominant position in the avionics andnon-avionics sectors.

These products being complementary to eachother, the EC held that the merger would allow

the new entity to bundle their products, giving itan advantage over competitors.

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GE-Honeywell

This advantage would lead to the exit of rivalsand ultimately the elimination of competition

altogether. The EC thus blocked the merger.

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Selected Reading

Antitrust Law Developments, American Bar Association(ABA), 5th ed., ABA Section of Antitrust Law.

Gellhorn, Ernest, Kovacic, William E., and Calkins,Stephen, Antitrust Law and Economics in a nut shell,

2004, West Publishing Co., MN. Goetz, Charles J., McChesney, Fred S., Antitrust

Law: Interpretation and Implementation, 2002, MathewBender & Co, Lexis Nexis, NJ.

Whish, Richard, Competition Law, 5th ed, 2003,Butterworths.

Documents

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