Rebstock: Mergers and Acquisitions Summit
5th Annual Mergers and Acquisitions Summit 2006
Paula Rebstock, Commission Chair, 6 March 2006
Good afternoon and thank you for inviting me to speak today at this 5th annual summit of Mergers and Acquisitions.
As you are aware the Commerce Commission’s involvement in mergers and acquisitions relates to administering the Commerce Act, and more specifically Part 3 of the Act, which prohibits mergers and acquisitions that would have the likely effect of substantially lessening competition within a market.
In a broader sense, the Commission has responsibility for deciding on merger and acquisition applications because the structure of markets is a critical factor in fostering competition. Competitive behaviour can only flourish when the structure of the market allows for it. The Commission’s role is to ensure that companies in New Zealand are not prevented from competing by concentrations of market power that can result from merger and acquisition activity.
Today I will begin with a report on general activity in the mergers and acquisitions area.
I will update you on some of the Commission’s recent cases and the issues they have raised, including a brief discussion of two-sided platform markets. The Commission has had some experience with these recently when dealing with mergers and acquisitions in the media sector.
To conclude, I’d like to reinforce how important it is for competition that the integrity of the Commission’s processes is maintained.
I will be happy to answer any questions at the end of my presentation.
Complexity of applications
While in 2004/2005 year we had 18 merger applications in total, in the six months to December alone, the Commission received 14 applications. While in past periods we normally considered three to four applications at once, over the last year we have been working on up to 13 applications at any one time.
Merger and acquisition activity is cyclical, and it is generally agreed that a slowdown in the economy results in businesses coming under pressure due to declining or stagnant market growth. The result is an increase in mergers and acquisitions in response to the need to consolidate.
So, despite a slight easing in this area over the last month, the Commission anticipates that the number of clearance applications will grow again in the near future through the predicted economic slowdown.
The Commission has also seen an increase in the complexity of applications made. A new statutory threshold for the assessment of mergers and acquisitions was introduced in 2001, and a new era of mergers and acquisitions began.
Although the legislative change was not necessarily a radical shift, it did move the goalposts from the test of dominance to a test of a substantial lessening of competition. It also introduced a focus on coordinated market power, in addition to unilateral market power.
Subsequently, the Commission published new merger and acquisition guidelines. We also now have some judicial insight into the way the legislation should be applied. And the publication of written reasons by the Commission gives applicants further guidance on factors they should bear in mind when considering an application.
Since 2001 there is greater understanding in the business community of what kinds of mergers and acquisitions are likely to be acceptable. This means that straightforward clearance applications are rarely received. Instead the Commission’s clearance workload consists largely of applications where there are complex issues to consider.
In forming a view on mergers and acquisitions the Commission must compare what the market would look like with and without the acquisition going ahead: the factual and counterfactual. Because analysis of future scenarios is necessarily hypothetical, making judgments about the future operation of markets is not an exact science.
As we deal with increasingly complex applications, the efforts we must make to gather and analyse that information is increasing. And we must apply the appropriate analytical frameworks to allow us to analyse how competition will change in response to a change in the structure in the market.
Even if we find that competition is likely to be lessened as the result of a merger or acquisition, substantial judgement is often required to determine if this lessening is likely to be substantial.
While in previous years we have averaged three declines a year, in 2005 the Commission declined four clearance applications, all of which raised complex issues and I’d like to discuss some of those issues now.
In September 2005, the Commission declined to grant clearance to Fletcher Concrete and Infrastructure to acquire the building products division of W Stevenson and Sons.
The Commission was not satisfied that the acquisition would not have, or would not be likely to have, the effect of substantially lessening competition in the national market for the manufacture or import and wholesale supply of cement.
Stevenson is New Zealand’s largest independent cement user and Fletcher is a supplier of cement. About 70% of all cement is used for making ready-mix concrete. The primary suppliers of cement in New Zealand, Fletcher and Holcim, both have large ready-mix operations and are affiliated, formally and informally, with other downstream players.
While the application for clearance did not involve any aggregation in the cement market, it did increase vertical integration between the upstream and downstream markets. In other words, had the acquisition gone ahead, those selling cement and those buying cement would have been part of the same company.
According to international cement distributors, Stevenson uses almost enough cement to make importing into New Zealand an economically viable option. International sources also informed the Commission that the remaining New Zealand independent cement users do not have sufficient demand to make bulk importation likely. As a result, the Commission considered that if Stevenson was removed from the market as a potential point of entry for a cement importer, then importing in bulk would become a remote option.
The Commission also considered that, if Fletchers did not acquire Stevenson, then Stevenson would probably be bought by another party, who would then be able to use the threat of importing cement to secure a favourable price from either Fletcher or another supplier. These lower prices would then be likely to flow on to other cement users.
The Commission was not satisfied that there was not be likely to be a substantial lessening of competition in the New Zealand cement market if the acquisition went ahead, and so the application was declined.
Within the last year, the Commission has considered a number of clearance applications involving bidding markets. These included two bus clearances: Red Bus and Leopard, and the current application of NZ Bus and Mana Coachlines.
In both of these applications the Commission considered the processes of bus companies submitting bids to Regional Councils for the rights to provide subsidised bus services.
The Commission has also conducted two clearance investigations involving tender processes and bids for the provision of pathology services to various District Health Boards. These applications were NZDG and Sonic and Wellington Pathology and Valley Diagnostics.
Bidding markets are different from conventional markets because, instead of competing daily, bidders compete only when contracts are renewed. They have then "cornered the market" for the length of the contract.
The Commission has tackled the analysis of these bidding markets by assessing the potential competitors for each tender round, and by analysing the change that may result at the conclusion of the process. For instance, whether the unsuccessful bidders are likely to exit the market.
I will now outline one of these cases in more detail.
In September 2005 the Commission declined the Application of Sonic Healthcare Limited and New Zealand Diagnostic Group Limited to form several joint venture companies. The Applicants are the two largest New Zealand providers of human pathology services, and the merger was to be effected in six District Health Board regions.
These proposals were particularly complex because they involved a transition from competition occurring in the market on a day-to-day basis, to a bidding system whereby a bulk-funded contract would be awarded to a single provider. In addition, the models proposed by the DHBs varied considerably, with two of the DHBs proposing a contract period of ten years.
The Commission has recognised the DHBs’ desire to reduce costs, eliminate duplication of testing, and remove operational inefficiencies. The Commission therefore understood the DHBs’ rationale for preferring a single provider funding model.
However, the Commission did challenge the assertion that joint ventures between the two largest private pathology providers in New Zealand were the only way to achieve these savings. The Commission considered that there are other options consistent with a single provider model, and these could potentially achieve even greater savings to the DHBs. These savings would derive, in part, from maintaining competition in the long-run.
The key deciding factors in this decision were the unlikelihood of fringe competitors being able to compete with the merged entity in future bidding rounds, and the shift from two vigorous competitors, to one merged venture.
The Commission considered that the change from two competitors to a single venture would remove the DHBs’ countervailing market power as the single purchaser. Instead of the DHB being able to play off the two parties against each other to get the best deal for health consumers, the joint venture could present a "take it or leave it" proposition, and the DHB would have no alternative provider to turn to.
The Commission is concerned that, to date, the DHBs have not consistently exercised the full extent of their power as the only buyer. We consider that the DHBs can preserve their countervailing power through the design of their bidding processes. The Commission hopes that DHBs will be more willing to exercise their countervailing power in future contract rounds in order to ensure competitive prices and quality for consumers in the long term, and provide incentives for innovation.
Given the significance of health markets to consumer welfare, the Commission will continue to closely analyse developments in this area, whether it is proposed mergers and acquisitions, or alleged anticompetitive behaviour. Health managers may not see themselves as business people, but they need to ensure that their consumers get the benefits of competition, as provided for by the Commerce Act.
Another highly publicised decision of the Commission was its determination to approve the application of Pyne Gould Guinness Limited and Wrightson Limited to merge. I understand that this case is the subject of a presentation tomorrow by James Mellsopp of Charles River Associates.
In considering the PGG/Wrightson application, the breadth of services provided to the farming community by both applicants ultimately required the Commission to define 12 markets, half of which were specific to particular varieties of seed and grain.
Market definition is not an exact science. When defining markets the Commission will take a pragmatic approach and seek to define the markets in a way which best highlights the potential competition effects of the merger or acquisition. This may result in the same markets being defined in different ways when different applications are considered, due to different fact circumstances.
The Commission will often adopt a conservative approach to market definition where the boundaries of the market are unclear. A conservative approach means defining a market in a way which causes the effect of the merger or acquisition, in market share terms, to be greater. This will commonly, but not always, cause a narrower market definition to be adopted in preference to a wider one.
Four of the more contentious markets in the PGG/Wrightson case were:
- the saleyard facilities market;
- the livestock trading market;
- the rural supplies market; and
- the brassica seed market (consisting of swede, turnip, rape and kale seeds).
In the saleyard facilities market, the Commission determined that the merger would be unlikely to have a material effect on the level of saleyard-on-saleyard competition, and that any market power held in any of the South Island saleyards would not materially increase as a result of the merger.
At issue were a limited number of saleyards in which Wrightson and PGG each held a 50% share. Whilst the merger would essentially aggregate that share into a single entity, any incentives to refuse third party access to the facilities would be unchanged.
The second and related market was that for livestock trading. In this market the key considerations were the presence of a number of other, albeit smaller, independent stock and station agents; low barriers to entry and expansion; and the presence of meat company agents acquiring prime and store stock through field agents.
The Commission determined that in respect of the rural supplies market a number of independent resellers would provide a degree of competition, combined with more general retail stores which may compete on particular product lines. The Commission also considered the increasing ability for ‘off-site’ purchases through the internet and the relatively low barriers to entry.
The brassica market was, on its face, a highly concentrated one. However, a number of competition factors combined to lessen our concerns about the impact on competition of a merger.
The Commission found that, in the brassica market, the merged entity would only face a limited degree of competition from existing suppliers. Indeed, in respect of some varieties of brassica seed such as swede, there are no other New Zealand suppliers.
However, in the course of the investigation the Commission found a supplier that could relatively easily supply into the New Zealand market, having done extensive testing of their seeds here. The Commission also considered that, despite not being a direct substitute in every case, there was a degree of competition provided from other supplementary livestock feed options, including silage and grain.
The PGG / Wrightson merger presented complexities not only through the necessity to understand the science of individual products and their role in the competitive market, but also through the sheer volume and scope of the information considered in defining 12 markets and assessing competition within each.
While this application was of great interest to the rural community in particular, few observers would have realised the extent of the Commission’s analysis, and the range of issues it covered. One of the things that makes merger work both challenging and stimulating is the need to come to terms with vastly different areas of specialisation. I think it is safe to say that we have staff members who now know more about brassica seed and the market for swedes than they ever imagined when they joined the Commission!
Now I would like to discuss two-sided platform markets. As an economist, I find the theoretical analysis of these markets fascinating, but the Commission has more practical reasons to contemplate their workings.
In the past 12 months the Commission has considered a number of media acquisitions in relation to Fairfax New Zealand Limited, CanWest Radioworks Limited and Sky Networks Television Limited. All of these applications involved aspects of two-sided platform markets.
Two-sided platform markets are markets that involve a link between two otherwise unrelated activities through interaction on a common ‘platform’.
A commonly cited example is print media, where advertisers and readers interact on the same platform, namely the newspaper itself. Newspapers require both advertisers and readers to exist. They generally derive their revenue primarily from advertising dollars, but their number of readers is the crucial factor in attracting that advertising revenue.
Another example of a two-sided platform market is an internet auction, which requires both buyers and sellers in order to work.
The application of two-sided market platform ideas to merger analysis, or competition policy generally, is still in its infancy but may necessitate a slightly different approach in some markets.
For instance, it may be possible for a merger or acquisition to result in no obvious price effect on one side of a platform, but still cause a substantial lessening in competition on the other side of the platform.
A merger between two radio stations, for example, would not result in a price being charged to listeners but may, particularly if there are few other competitors, result in increased radio advertising rates.
Two-sided platform markets are unique in that they often carry an in-built mechanism for preserving competition. For instance a degradation in the quality of news provided in a community newspaper, or an increase in the price for readers, would have a corresponding effect on its circulation and ultimately on the value to advertisers.
Where appropriate, the Commission will further explore a two-sided platform approach to analysing markets and mergers in the future.
An interesting "recent" development in this area is the announcement this morning that Fairfax New Zealand has reached a conditional agreement to acquire Trade Me for $700 million.
In the past, the Commission has defined separate print and online media markets but acknowledged they are complementary. In the recent Fairfax/Times Media Group acquisition, the Commission, while defining a distinct print media advertising market, acknowledged that the extent to which it faced competition from online advertising was increasing.
The Commission intends to consider these issues further in assessing the competitive impact of this proposed acquisition.
Telecom, Counties Power
The final matter I will address today is the importance the Commission places on the integrity of its processes.
Last October, Telecom submitted an application seeking clearance to acquire management rights to 7MHz of radio spectrum in the 3.5GHz band from Counties Power Limited.
Shortly before the Commission was due to make a determination on the matter, and just after the Commission had written to Telecom expressing concerns about the proposed acquisition, Telecom withdrew its application for clearance and proceeded to acquire the rights without Commerce Commission clearance.
The Commission then opened an investigation into whether the transaction had breached s47 of the Act, which prohibits acquisitions that have the likely effect of substantially lessening competition. This investigation is ongoing.
As it considered the actions of the companies, the Commission became concerned that communications from the parties and their lawyers may have breached section 103 of the Commerce Act.
Section 103(2) establishes that it is a criminal offence to attempt to deceive or knowingly mislead the Commission in relation to any matter before it. A second investigation was opened on this matter.
The statements the Commission considered may have been misleading related to the timing of the transaction. Those statements were important, as they gave the Commission the incorrect impression that it was not able to apply to the Courts for an injunction to stop the acquisition.
The Commission has recently completed an investigation into this matter and considers there is an arguable case that parties attempted to deceive or knowingly mislead the Commission.
After taking into account all of the factors that are relevant to a decision on whether to prosecute, the Commission considered that the appropriate course in this case was to issue a warning regarding the conduct.
Last week, a written warning was issued by the Commission to Telecom, and to certain lawyers involved in the transaction.
Telecom is one of the largest companies in New Zealand and deals with the Commission on a regular basis. Given the stature of Telecom, and that of Counties Power, the Commission was surprised and extremely disappointed to find that the transaction was plagued by a series of miscommunications, which contributed to the Commission being misled.
The Commission expects that the business community will take note of the warning issued in this instance, and understand that criminal prosecution is an option for those who attempt to mislead the Commission.
I have spoken today about the complexity of clearance applications coming to the Commission, and the approaches the Commission takes to market definition, bidding markets and two sided platforms.
The specific examples I have considered (Fletcher Concrete and Stevensons, PGG and Wrightson, and the Sonic and New Zealand Diagnostic Group joint venture) illustrate the diversity of markets being examined, and the importance to consumers of merger and acquisition decisions.
There are things the Commission can do to ensure it has good quality information on which to base its decisions.
We can ask that adequate information is provided by applicants, and we will be updating our merger and acquisition application form this year to help streamline the process and facilitate high quality applications.
We can ensure our own information gathering and analysis are of a high standard, and continue to develop our thinking on issues such as two-sided platforms. The intellectual rigor the Commission brings to bear in its analysis continues to be the best guarantee of sound decision making.
And the Commission can publish written reasons for its decisions, so that the market may better understand the Commission’s reasoning. It is worth noting that while the publishing of written reasons is not required by law and is undertaken by few overseas competition agencies, the Commission is committed to providing full written reasons because of the transparency and certainty this brings to the marketplace.
In addition to its own efforts, the Commission also relies on applicants to help facilitate sound decision making. Incorrect, incomplete or misleading information can compromise the Commission’s processes, and prevent it from effectively performing its role. It is therefore vitally important that all interactions with the Commission are conducted in a straightforward and fulsome manner.
New Zealand’s small economy raises a number of significant issues when considering a merger or acquisition application. First, markets often have very few firms of reasonable size and are therefore relatively concentrated. Secondly, firms are generally small on a world scale.
There is inherent tension in small economy industries between the potential for market power based on concentration and sub-optimal firm size. This tension is likely to mean that small economies will need to pay relatively greater attention to specific efficiency considerations. It can also mean that concentrated markets can facilitate unilateral or coordinated market power.
The vast majority of mergers are economically beneficial, and the consequences of declining applications are particularly significant in a small economy like New Zealand’s.
The Commission does take into account New Zealand’s market conditions when applying the substantial lessening of competition test, and making merger and acquisition decisions. We are aware that much is at stake for businesses and consumers in merger and acquisition decisions, and we will continue to ensure that they can depend on integrity and soundness of those decisions.