Member Article

The competition review of local market mergers is often complex. This series of three articles breaks down that complexity into ten key questions.

Part 1

• What is a local market merger?
• What is the geographic market?
• How important is it to get the correct market definition?
• How is a local market analysis undertaken?

Part 2

• What is an isochrone analysis?
• Who are the customers of a business?
• Who are the competitors?

Part 3

• Is competition in the market sufficiently strong?
• What can be done to resolve any issues?
• What complications can arise?

This article looks at the three key questions within Part 3:

1. Is competition in the market sufficiently strong?

Having identified who are the competitors and the extent they are competing; it is necessary to determine whether the transaction may be expected to result in a substantial lessening of competition. A facet to this determination is whether, post-transaction, customers would still have sufficient choice. At its basic level this can be approached by determining how many competitors there will be post-transaction in the local market. Thus, if there were six pharmacies in a town and post-transaction two merge, then will the remaining four pharmacies and the merged purchaser/target pharmacies (so five in all) provide enough choice for customers. The answer to this question will depend in part on the product market definition. Does the result change if the transaction results not in five but four competitors, and what if there are three? As a reference, competition authorities are likely to investigate for potential serious issues if there are three or fewer competitors because of a transaction.

2. What can be done to resolve any issues?

If the transaction has already completed, divestment will almost certainly be the remedy required to resolve the finding that a substantial lessening of competition is expected because of the transaction. If the transaction has not completed, then the purchaser will need to resolve the issue before completing the transaction. This leads to two key issues. Is it the purchaser or buyer site that should be divested, and to whom can the site(s) be divested? Where each party has several stores, it may be that a mix of target and purchaser stores would remedy the issue. However, competition authorities may resist, arguing that the divestment stores should come either from the purchaser or the target. The purchaser’s business plan for the merged businesses and other elements will be relevant to the point. For example, if the purchaser plans to have all the target stores rebrand and to sell the divestment stores with the right to trade using the target brand name, then the competition authority may press the parties to have all the divestment stores be target stores. This might result in ‘crown jewel’ stores of the target being divested.

Because the nature and scale of divestments can have a material effect on the economics of the transaction, the determination of which stores are likely to need to be divested should be determined with a reasonably high degree of certainty prior to the transaction fundamentals being settled. A related point as regards transaction value net of divestments is to consider ahead of time the likely purchaser or purchasers of the divestment sites. It should be noted that the competition authority must approve of the purchaser. Typically, therefore, the divestment purchaser is already active on the product market (for example, it already owns several pharmacies) but not in the geographic area (market) of the divestment site. As the sale to the divestment purchaser must not itself create a competition concern, the choice of divestment purchaser might be limited, for example, in an already concentrated market.

3. What complications can arise?

For transactions that have not completed, where divestments of local businesses are required it should be noted that in legal terms the divestment seller might be the target business. Protocols and procedures will need to be put in place between the parties and their advisors to ensure maximum sale value within a relatively short period of time, while maintaining the competitive independence of the purchaser to the stores to be divested. The need for this ‘clean team’ vigilance is underlined by the competition authority invariably requiring the parties to engage a third-party sale trustee and probably a third-party monitoring trustee to have oversight of the divestment transaction and process.

In practice a combination of isochrone analysis and customer location analysis likely will not produce a clear single result. Instead, there will be different layers of results (e.g. one for a 20 minutes isochrone analysis and another for a 15 minutes isochrone analysis). Each layer might produce a different result in terms of number and location of divestment stores, with the consequence that identifying with clarity the scale of divestments and their economic impact on the transaction value is typically within an estimate range. Pre-notification discussions with the competition authority may be able to reduce this range.

Transactions involving many local markets, for example, the merger of two supermarket chains, can lead to very many local market overlaps. The volume of work involved means a competition authority cannot meet its usual timetable to undertake the work. This often results in assumptions being made by the authorities. For example, any local market where the number of competitors reduces to four or fewer is assumed to raise substantive concerns unless the contrary is proven. Parties can seek to ‘cut a deal’ with a competition authority by agreeing to divest all sites that fall within this negative assumption. This creates significant efficiency for the authority and the parties, although it does create a potential missed opportunity for the parties to try to retain some sites by arguing that the assumption does not apply in certain cases.

Given the scale of work involved for the parties and the competition authority, transactions involving local markets typically take more time and resources to complete than other transactions. These factors should be built-in to the parties’ timetable and expectations.