Mergers in rapidly developing, dynamic and innovation-led markets are increasingly coming under scrutiny from competition authorities.
Recent high-profile merger inquiries by the UK Competition and Markets Authority (CMA) – including Illumina/PacBio, Sabre/Farelogix, Tobii/Smartbox, TopCashback/Quidco and Experian/ClearScore (all of which were either prohibited or abandoned following an in-depth CMA investigation) – indicate that the CMA’s high degree of scrutiny in these markets is here to stay.
Indeed, the CMA’s annual plan for 2020-21 notes that it is 'determined to protect UK consumers from the harmful effects of mergers in fast-moving tech markets'. Earlier this year, Andrea Coscelli, the Chief Executive of the CMA, spoke about the importance of 'protecting potential competition and dynamic competition', pointing out that 'incumbents clearly take potential competitors seriously and, therefore, so should competition authorities'.
This is not just an issue for tech and digital deals. Companies looking to undertake transactions in other rapidly developing and dynamic sectors (such as healthcare and biotechnology) can expect competition authorities to take a sceptical approach. Recent examples in this space include Illumina/PacBio and Roche/Spark – see our earlier blog post on the key lessons from Roche/Spark.
Key lessons for deals in rapidly developing, dynamic or innovation-led sectors
The CMA has published an analysis describing the key lessons learnt from its review of Illumina’s proposed acquisition of Pacific Biosciences of California (PacBio).
The transaction, involving two suppliers of next-generation DNA sequencing systems, was abandoned by the parties after the CMA’s provisional findings indicated that it would likely block the deal at the end of its in-depth Phase 2 investigation.
This analysis – alongside the CMA’s approach in recent merger investigations – highlights a number of key issues that companies planning M&A activity in these sectors should be mindful of right from the early stages of deal planning:
The CMA will not shy away from intervening simply due to the inherent uncertainty in dynamic markets
While uncertainty is a feature of rapidly changing markets, this does not mean that the CMA will conclude that harm to competition or consumers is unlikely.
The CMA will conduct a forward-looking assessment and is bound only by a ‘balance of probabilities’ standard of proof in Phase 2 investigations (and an even lower standard in Phase 1 investigations).
As the CMA notes: 'The uncertainty often found in dynamic markets… should not mean that the CMA stands by and does nothing when a merger could give rise to harm to customers and competition more generally'.
As such, businesses need to think carefully upfront about how to manage the risk of an intrusive UK merger review.
The CMA will not only look at price but adopt a broader view of the relevant parameters of competition
Parties should expect a sharp focus on non-price factors, in particular innovation and quality.
In Illumina/PacBio, the CMA found that innovation was a 'crucial aspect' of competition in the market, with both parties’ common desire to be the preferred DNA sequencer for many projects acting as the driver for their innovation efforts.
Businesses will need to think creatively about how to gather robust evidence relating to non-price factors – particularly since the more traditional forms of quantitative evidence utilised in merger reviews often focus on price impacts.
Less focus on ‘static’ market shares – even small increments to market share may be sufficient to trigger competition concerns
This will be especially true in concentrated markets or where the acquirer is a clear market leader. As the CMA’s CEO, Andrea Coscelli, says 'historical or static data may not accurately reflect the changing market position' in dynamic sectors where companies are 'typically continuously evolving and releasing new products or services'.
The CMA will continue to rely heavily on internal documents
Internal documents continue to be a – if not the – vital source of evidence when conducting forward-looking assessments, with competition authorities often placing substantial weight on them at the expense of other pieces of evidence.
Indeed, the CMA noted that internal documents were particularly useful in Illumina/PacBio to assess likely competitive dynamics going forward due to the rapid pace of development in the industry – also noting that less weight had been placed on quantitative and economic evidence.
Other recent merger investigations – such as Google/Looker, JD Sports/Footasylum and Experian/Clearscore – confirm this trend. Businesses should therefore be particularly mindful, from the very early stages of deal planning, that competition authorities will likely require the production of substantial quantities of internal documents and place significant weight on their contents.
Although the CMA indicates that it is mindful of the need to avoid 'cherry-picking' documents, it can be challenging in practice to convince competition authorities to place limited weight on unhelpful internal documents where they consider those documents represent the company’s real views.
The CMA will scrutinise valuation models and deal rationale
The CMA will look closely at valuation models and deal rationale in order to gain 'insight into the acquirer’s expectations for the future trajectory of the target' as well as the acquirer’s intention in buying that target.
Where the transaction value greatly exceeds the target’s revenues, businesses can expect competition authorities to pore over their valuation models to understand where this value is coming from (and if it is linked to a reduction in competitive pressure or worse consumer outcomes).
This is illustrated by the CMA’s approach in PayPal/iZettle, in which the CMA considered whether PayPal’s $2.2bn valuation of iZettle was driven by a desire to eliminate an emerging rival.
Where deals are being investigated in parallel by multiple regulators, the CMA remains keen to coordinate and collaborate with other regulators.
In Illumina/PacBio, it exchanged relevant evidence with the US Federal Trade Commission (enabled via the use of confidentiality waivers) and maintained an open flow of information through regular calls and discussions of their respective evidence bases.
This will be of increasing importance post-Brexit as the CMA 'take[s] over jurisdiction for an increasing number of global mergers which are also being reviewed elsewhere'. The CMA is looking to cement its position as a thought leader on the international stage. Its recent prohibition of the Sabre/Farelogix transaction – which had been cleared in the US before the US District Court of Delaware – illustrates how the CMA will not simply follow the approach taken in other countries.
Businesses undertaking global M&A will therefore need to increasingly factor in a complex and lengthy UK merger review and consider how best to engage with the CMA to secure a positive outcome – parties should also be mindful that a CMA in-depth review is particularly long (with the Phase 2 review period being 24 weeks and the CMA often extending this by a further eight weeks for complex deals).
The CMA’s approach to assessing deals in rapidly developing, dynamic or innovation-led sectors means businesses should think carefully about how best to manage the risk of a UK merger review – and to factor in the time for a detailed upfront engagement with the CMA.
For more on antitrust risk in strategic deals in an era of heightened global antitrust intervention, see Strategic acquisitions, part of the 10th edition of our annual antitrust report of 10 key themes for the year ahead.