Tips for Conducting a Preliminary Horizontal Merger Analysis

Practical Law Legal Update 3-570-5525 (Approx. 7 pages)

Tips for Conducting a Preliminary Horizontal Merger Analysis

by Practical Law Antitrust

Published on 10 Jun 2014 • USA (National/Federal)

This Legal Update sets out best practices for conducting an efficient preliminary antitrust analysis of a merger between competitors.

The Federal Trade Commission (FTC) and the Antitrust Division of the Department of Justice (DOJ) recently submitted to Congress their Hart-Scott-Rodino Annual Report (HSR Report) for fiscal year 2013 (October 1, 2012 through September 30, 2013) required under the HSR Act (see Legal Update, FTC and DOJ Release HSR Annual Report for Fiscal Year 2013). The HSR Report summarizes the agencies' merger control efforts and offers statistics on the number of:

HSR filings made (2,628, about a 7% decrease from fiscal year 2012).
Transactions reported under HSR (1,326 transactions, a 7.2% decrease from fiscal year 2012).
Transactions that resulted in a Second Request (47 transactions, or 3.7% of reported transactions, just a slight increase in percentage from fiscal year 2012) (see, Practice Note, Hart-Scott-Rodino: Overview: Request for Additional Information (Second Request)).

While many attorney hours are spent defending the 3.7% of transactions that receive a Second Request, antitrust counsel also spend substantial time on transactions that are investigated during the first 30 days of the HSR waiting period and cleared by the FTC and DOJ before the end of that period (see Merger Review Process Timeline for Investigated Transactions). In a deal between competitors, antitrust attorneys should undertake the following tasks early on in the deal process before a definitive agreement is signed, if possible, and certainly before an HSR filing is made:

Work with client executives and employees to gather key documents and other information.
Conduct a preliminary antitrust analysis.
Craft a merger defense.
Defend the merger to agency staff.

All of this takes time and the client's money. Clients in deals that are almost assured an antitrust investigation and Second Request, like US Airways and American Airlines or Comcast and Time Warner, expect deal delays and large legal fees. However, the antitrust agencies do not just investigate big deals. Attorneys should understand and communicate antitrust risks to clients early on in the acquisition process so that they can decide:

If and how to best defend the deal and make strategic decisions, like whether to hire an economist to aid in merger defense work (see Economic Tools Used for Evaluating Competitive Harm in Horizontal Mergers: How Economists Help in Evaluating Competitive Harm).
Whether to proceed with a transaction, as a client may choose not to enter into a deal that is likely to be blocked by the antitrust agencies or subject to certain unacceptable remedies (see Practice Note, Merger Remedies).
How to minimize antitrust risk and allocate risk between the parties in the merger agreement (see Antitrust Risk-shifting Toolkit).

(See Practice Note: Corporate Transactions and Merger Control: Overview: Preliminary Substantive Assessment.)

The smaller the deal, the less the client will want to spend on analyzing the deal for antitrust risks. This is particularly the case when the deal is too small to be reportable under the HSR Act (see Practice Note, Considerations and Strategies in Non-HSR Reportable Transactions). Therefore, counsel should act efficiently to analyze the antitrust risks a transaction presents without conducting a comprehensive (and expensive) antitrust review. This Update provides guidance on how to perform an efficient preliminary antitrust analysis.

Understand What the Agencies Are Looking For

To analyze whether a deal has antitrust issues, counsel must know which issues and facts are likely to cause concern to FTC and DOJ staff. Practical Law Antitrust has numerous resources to help attorneys understand how the antitrust agencies analyze horizontal mergers, including:

Practice Note, How Antitrust Agencies Analyze M&A, which:
- summarizes the 2010 Horizontal Merger Guidelines; and
- outlines the substantive principles observed by both US antitrust agencies in evaluating whether a transaction is likely to substantially lessen competition.
Article, Federal Merger Enforcement Actions: A Look at Recent Trends, which:
- reviews federal merger enforcement actions from 2010 through 2013;
- reveals insights on the FTC's and DOJ's approach to merger review; and
- highlights notable trends, like commonly reviewed theories of competitive harm and industries most often in the agencies' cross-hairs.
What's Market, Federal Merger Enforcement Actions database, which:
- tracks and summarizes the public outcomes in federal antitrust merger investigations, whether ending in a litigated case, consent decree, closed investigation, or abandoned deal;
- is searchable and allows counsel to tailor their searches by a number of variables, including industry, change in competitors (like mergers from three to two) and geographic market; and
- compares merger enforcement actions across those same variables so that counsel may quickly analyze, for example, theories of competitive harm used in particular industries or in markets with four or more competitors remaining.

Gather Information for a Preliminary Merger Analysis

To initially analyze a deal's effect on competition, counsel should gather information about the merging parties and their industry from both:

Publicly available sources, like the companies' own websites or relevant trade publications.
The merging parties.

Counsel can begin this preliminary assessment with information that is already accessible, particularly information that is already in counsel's files including information:

In a due diligence data room.
Provided in response to an information request where the transaction is reportable under the HSR Act (see Standard Document, HSR Form: Information Request (Non-Associate Transactions)).

Practical Law Antitrust's Preliminary Analysis of Merging Parties' Overlap Checklist identifies those publicly available or otherwise easily accessible documents that counsel should review to help determine:

The parties' overlapping products and services.
Revenues associated with the overlapping products and services.
Competitors and their overlapping revenues.
Market shares.
Herfindahl-Hirschman Index (HHI) values (see Practice Note, How to conduct an HHI analysis).

If the easily accessible information raises red flags of an antitrust issue, counsel should consider obtaining additional information from the client to further assess the competitive significance of the deal. For a sample memorandum counsel can send a client (whether buyer or seller) to gather information needed to complete a preliminary antitrust risk assessment of a proposed transaction in a manufacturing industry, see Standard Document, Antitrust Merger Analysis Information Request: Manufacturing.

Most documents gathered for the purpose of this preliminary analysis will have already been created. Counsel should mark any documents created while performing the overlap analysis as privileged and confidential. This privilege designation helps ensure a privileged document is not furnished to the antitrust agencies as part of an HSR filing or during a merger investigation (see Practice Note, Corporate Transactions and Merger Control: Overview: Privilege Considerations).

Conduct a Preliminary Antitrust Analysis

The preliminary overlap analysis focuses on the combined businesses of the buyer and the target company and is performed at a fairly high level in an effort to keep costs down while quickly determining if a more in-depth antitrust assessment is needed, which is both time-consuming and potentially expensive.

The initial substantive assessment should take into account any:

Competitive overlaps or potential overlaps in the parties' business activities.
Reasons for the transaction.
Customer and competitor reactions, including whether they are likely to complain and on what grounds.
Previous government enforcement actions affecting the same markets and particularly those involving the buyer or target (see What's Market, Federal Merger Enforcement Actions database).
Possible product and geographic market definitions based on market share data available from the parties, analysts or consulting services (see Practice Note, Analyzing a Relevant Market in Horizontal Mergers).
Internal documents and public sources that point toward the anticipated impact of the transaction.

Counsel should also consider the factors that the FTC and DOJ use to determine whether a deal may lead to anticompetitive effects, including, among other things:

Market shares and concentration levels (see Practice Note, How Antitrust Agencies Analyze M&A: Market Shares and Concentration).
The closeness of the parties' overlapping products or services, including:
- whether there are other close substitutes or alternatives to the parties' overlapping products or services (see Article, Federal Merger Enforcement Actions: A Look at Recent Trends: Loss of Next-best Choice); and
- how often customers switch between the two parties' products when one of them institutes a price increase (see Practice Note, Economic Tools for Evaluating Competitive Harm in Horizontal Mergers: Diversion Ratio).
Whether the target company is a maverick, meaning a company that is a price cutter or innovator and puts pressure on other competitors to lower prices or increase innovation efforts (see Article, Federal Merger Enforcement Actions: A Look at Recent Trends: Loss of a Maverick).
Barriers to entry and recent entrants into and exits from the market (see Practice Note, How Antitrust Agencies Analyze M&A: Entry Analysis).

For a checklist on assessing a horizontal deal's competitive risks, see Clearing a Horizontal Merger Checklist.

Advise the Client on Actions to Take and Risks Involved

Practical Law Antitrust's Practice Note, Corporate Transactions and Merger Control: Overview explains how the results of a preliminary merger analysis inform the strategic antitrust approach for the transaction. The analysis will usually result in one of the following outcomes:

No material competition issues exist, and an HSR filing, if required, likely will not prompt any inquiries from the agencies (see Practice Note, Corporate Transactions and Merger Control: Overview: Category A: No Material Issues, Unlikely to Prompt Antitrust Inquiries).
There is some likelihood that a reviewing agency will want further information, but the parties should be able to promptly produce information about competitive matters sufficient to persuade the agency to close its investigation within the initial 30-day waiting period (see Practice Note, Corporate Transactions and Merger Control: Overview: Category B: Further Information Requests Likely, but Agencies Likely to Close Investigation Within 30 Days).
The transaction appears to combine significant competitors in relatively concentrated markets, and it is more likely than not that the reviewing agency will conduct a detailed review (see Practice Note, Corporate Transactions and Merger Control: Overview: Category C: Potential Antitrust Issues, Second Request Likely).

In all cases, counsel should advise the client that the outcome of a merger review process can be unpredictable and depends on the availability of credible and persuasive evidence of competitive market dynamics.

Tips for Conducting a Preliminary Horizontal Merger Analysis | Practical Law