Exam 2: The Regulatory Environment

Whose interests do you believe antitrust regulators represent? What trade-offs do antitrust regulators face in making decisions that impact the groups whose interests they represent? Be specific.

Federal securities and antitrust laws are the only laws affecting corporate takeovers. Other laws usually have little impact.

All of the following are true of the Hart-Scott-Rodino Antitrust Improvements Act except for

In an effort to gain approval of their proposed merger from the FTC, top executives from Exxon Corporation and Mobil Corporation argued that they needed to merge because of the increasingly competitive world oil market. Falling oil prices during much of the late 1990s put a squeeze on oil industry profits. Moreover, giant state-owned oil companies are posing a competitive threat because of their access to huge amounts of capital. To offset these factors, Exxon and Mobil argued that they had to combine to achieve substantial cost savings. Why were the Exxon and Mobil executives emphasizing efficiencies as a justification for this merger?

Speculate as to why the share prices of American and US Airways increased sharply on the day that the agreement with the Justice Department had been reached? Why did the share prices of other major airlines also increase?

Exxon and Mobil Merger—The Market Share Conundrum Following a review of the proposed $81 billion merger in late 1998, the FTC decided to challenge the Exxon–Mobil transaction on anticompetitive grounds. Options available to Exxon and Mobil were to challenge the FTC’s rulings in court, negotiate a settlement, or withdraw the merger plans. Before the merger, Exxon was the largest oil producer in the United States and Mobil was the next largest firm. The combined companies would create the world’s biggest oil company in terms of revenues. Top executives from Exxon Corporation and Mobil Corporation argued that they needed to implement their proposed merger because of the increasingly competitive world oil market. Falling oil prices during much of the late 1990s put a squeeze on oil industry profits. Moreover, giant state-owned oil companies are posing a competitive threat because of their access to huge amounts of capital. To offset these factors, Exxon and Mobil argued that they had to combine to achieve substantial cost savings. After a year-long review, antitrust officials at the FTC approved the Exxon–Mobil merger after the companies agreed to the largest divestiture in the history of the FTC. The divestiture involved the sale of 15% of their service station network, amounting to 2400 stations. This included about 1220 Mobil stations from Virginia to New Jersey and about 300 in Texas. In addition, about 520 Exxon stations from New York to Maine and about 360 in California were divested. Exxon also agreed to the divestiture of an Exxon refinery in Benecia, California. In entering into the consent decree, the FTC noted that there is considerably greater competition worldwide. This is particularly true in the market for exploration of new reserves. The greatest threat to competition seems to be in the refining and distribution of gasoline. -How do the divestitures address perceived anti-competitive problems?

The Legacy of GE's Aborted Attempt to Merge with Honeywell Many observers anticipated significant regulatory review because of the size of the transaction and the increase in concentration it would create in the markets served by the two firms. Most believed, however, that, after making some concessions to regulatory authorities, the transaction would be approved, due to its perceived benefits. Although the pundits were indeed correct in noting that it would receive close scrutiny, they were completely caught off guard by divergent approaches taken by the U.S. and EU antitrust authorities. U.S regulators ruled that the merger should be approved because of its potential benefits to customers. In marked contrast, EU regulators ruled against the transaction based on its perceived negative impact on competitors. Honeywell's avionics and engines unit would add significant strength to GE's jet engine business. The deal would add about 10 cents to GE's 2001 earnings and could eventually result in $1.5 billion in annual cost savings. The purchase also would enable GE to continue its shift away from manufacturing and into services, which already constituted 70 percent of its revenues in 2000. The best fit is clearly in the combination of the two firms' aerospace businesses. Revenues from these two businesses alone would total $22 billion, combining Honeywell's strength in jet engines and cockpit avionics with GE's substantial business in larger jet engines. As the largest supplier in the aerospace industry, GE could offer airplane manufacturers "one-stop shopping" for everything from engines to complex software systems by cross-selling each other's products to their biggest customers. Honeywell had been on the block for a number of months before the deal was consummated with GE. Its merger with Allied Signal had not been going well and contributed to deteriorating earnings and a much lower stock price. Honeywell's shares had declined in price by more than 40 percent since its acquisition of Allied Signal. While the euphoria surrounding the deal in late 2000 lingered into the early months of 2001, rumblings from the European regulators began to create an uneasy feeling among GE's and Honeywell's management. Mario Monti, the European competition commissioner at that time, expressed concern about possible "conglomerate effects" or the total influence a combined GE and Honeywell would wield in the aircraft industry. He was referring to GE's perceived ability to expand its influence in the aerospace industry through service initiatives. GE's services offerings help differentiate it from others at a time when the prices of many industrial parts are under pressure from increased competition, including low-cost manufacturers overseas. In a world in which manufactured products are becoming increasingly commodity-like, the true winners are those able to differentiate their product offering. GE and Honeywell's European competitors complained to the EU regulatory commission that GE's extensive services offering would give it entrée into many more points of contact among airplane manufacturers, from communications systems to the expanded line of spare parts GE would be able to supply. This so-called range effect or portfolio power is a relatively new legal doctrine that has not been tested in transactions of this size. On May 3, 2001, the U.S. Department of Justice approved the buyout after the companies agreed to sell Honeywell's helicopter engine unit and take other steps to protect competition. The U.S. regulatory authorities believed that the combined companies could sell more products to more customers and therefore could realize improved efficiencies, although it would not hold a dominant market share in any particular market. Thus, customers would benefit from GE's greater range of products and possibly lower prices, but they still could shop elsewhere if they chose. The U.S. regulators expressed little concern that bundling of products and services could hurt customers, since buyers can choose from among a relative handful of viable suppliers. To understand the European position, it is necessary to comprehend the nature of competition in the European Union. France, Germany, and Spain spent billions subsidizing their aerospace industry over the years. The GE–Honeywell deal has been attacked by their European rivals from Rolls-Royce and Lufthansa to French avionics manufacturer Thales. Although the European Union imported much of its antitrust law from the United States, the antitrust law doctrine evolved in fundamentally different ways. In Europe, the main goal of antitrust law is to guarantee that all companies be able to compete on an equal playing field. The implication is that the European Union is just as concerned about how a transaction affects rivals as it is consumers. Complaints from competitors are taken more seriously in Europe, whereas in the United States it is the impact on consumers that constitutes the litmus test. Europeans accepted the legal concept of "portfolio power," which argues that a firm may achieve an unfair advantage over its competitors by bundling goods and services. Also, in Europe, the European Commission's Merger Task Force can prevent a merger without taking a company to court. The EU authorities continued to balk at approving the transaction without major concessions from the participants—concessions that GE believed would render the deal unattractive. On June 15, 2001, GE submitted its final offer to the EU regulators in a last-ditch attempt to breathe life into the moribund deal. GE knew that if it walked away, it could continue as it had before the deal was struck, secure in the knowledge that its current portfolio of businesses offered substantial revenue growth or profit potential. Honeywell clearly would fuel such growth, but it made sense to GE's management and shareholders only if it would be allowed to realize potential synergies between the GE and Honeywell businesses. GE said it was willing to divest Honeywell units with annual revenue of $2.2 billion, including regional jet engines, air-turbine starters, and other aerospace products. Anything more would jeopardize the rationale for the deal. Specifically, GE was unwilling to agree not to bundle (i.e., sell a package of components and services at a single price) its products and services when selling to customers. Another stumbling block was the GE Capital Aviation Services unit, the airplane-financing arm of GE Capital. The EU Competition Commission argued that that this unit would use its influence as one of the world's largest purchasers of airplanes to pressure airplane manufacturers into using GE products. The commission seemed to ignore that GE had only an 8 percent share of the global airplane leasing market and would therefore seemingly lack the market power the commission believed it could exert. On July 4, 2001, the European Union vetoed the GE purchase of Honeywell, marking it the first time a proposed merger between two U.S. companies has been blocked solely by European regulators. Having received U.S. regulatory approval, GE could ignore the EU decision and proceed with the merger as long as it would be willing to forego sales in Europe. GE decided not to appeal the decision to the EU Court of First Instance (the second highest court in the European Union), knowing that it could take years to resolve the decision, and withdrew its offer to merge with Honeywell. On December 15, 2005, a European court upheld the European regulator's decision to block the transaction, although the ruling partly vindicated GE's position. The European Court of First Instance said regulators were in error in assuming without sufficient evidence that a combined GE–Honeywell could crush competition in several markets. However, the court demonstrated that regulators would have to provide data to support either their approval or rejection of mergers by ruling on July 18, 2006, that regulators erred in approving the combination of Sony BMG in 2004. In this instance, regulators failed to provide sufficient data to document their decision. These decisions affirm that the European Union needs strong economic justification to overrule cross-border deals. GE and Honeywell, in filing the suit, said that their appeal had been made to clarify European rules with an eye toward future deals, since they had no desire to resurrect the deal. In the wake of these court rulings and in an effort to avoid similar situations in other geographic regions, coordination among antitrust regulatory authorities in different countries has improved. For example, in mid-2010, the U.S. Federal Trade Commission reached a consent decree with scientific instrument manufacturer Agilent in approving its acquisition of Varian, in which Agilent agreed to divest certain overlapping product lines. While both firms were based in California, each has extensive foreign operations, which necessitated gaining the approval of multiple regulators. Throughout the investigation, FTC staff coordinated enforcement efforts with the staffs of regulators in the European Union, Australia, and Japan. The cooperation was conducted under the auspices of certain bilateral cooperation agreements, the OECD Recommendation on Cooperation among its members, and the European Union Best Practices on Cooperation in Merger Investigation protocol. -This is the first time that a foreign regulatory body has prevented a deal involving U.S. firms only from occurring. What do you think are the long-term implications, if any, of this precedent?

The Legacy of GE's Aborted Attempt to Merge with Honeywell Many observers anticipated significant regulatory review because of the size of the transaction and the increase in concentration it would create in the markets served by the two firms. Most believed, however, that, after making some concessions to regulatory authorities, the transaction would be approved, due to its perceived benefits. Although the pundits were indeed correct in noting that it would receive close scrutiny, they were completely caught off guard by divergent approaches taken by the U.S. and EU antitrust authorities. U.S regulators ruled that the merger should be approved because of its potential benefits to customers. In marked contrast, EU regulators ruled against the transaction based on its perceived negative impact on competitors. Honeywell's avionics and engines unit would add significant strength to GE's jet engine business. The deal would add about 10 cents to GE's 2001 earnings and could eventually result in $1.5 billion in annual cost savings. The purchase also would enable GE to continue its shift away from manufacturing and into services, which already constituted 70 percent of its revenues in 2000. The best fit is clearly in the combination of the two firms' aerospace businesses. Revenues from these two businesses alone would total $22 billion, combining Honeywell's strength in jet engines and cockpit avionics with GE's substantial business in larger jet engines. As the largest supplier in the aerospace industry, GE could offer airplane manufacturers "one-stop shopping" for everything from engines to complex software systems by cross-selling each other's products to their biggest customers. Honeywell had been on the block for a number of months before the deal was consummated with GE. Its merger with Allied Signal had not been going well and contributed to deteriorating earnings and a much lower stock price. Honeywell's shares had declined in price by more than 40 percent since its acquisition of Allied Signal. While the euphoria surrounding the deal in late 2000 lingered into the early months of 2001, rumblings from the European regulators began to create an uneasy feeling among GE's and Honeywell's management. Mario Monti, the European competition commissioner at that time, expressed concern about possible "conglomerate effects" or the total influence a combined GE and Honeywell would wield in the aircraft industry. He was referring to GE's perceived ability to expand its influence in the aerospace industry through service initiatives. GE's services offerings help differentiate it from others at a time when the prices of many industrial parts are under pressure from increased competition, including low-cost manufacturers overseas. In a world in which manufactured products are becoming increasingly commodity-like, the true winners are those able to differentiate their product offering. GE and Honeywell's European competitors complained to the EU regulatory commission that GE's extensive services offering would give it entrée into many more points of contact among airplane manufacturers, from communications systems to the expanded line of spare parts GE would be able to supply. This so-called range effect or portfolio power is a relatively new legal doctrine that has not been tested in transactions of this size. On May 3, 2001, the U.S. Department of Justice approved the buyout after the companies agreed to sell Honeywell's helicopter engine unit and take other steps to protect competition. The U.S. regulatory authorities believed that the combined companies could sell more products to more customers and therefore could realize improved efficiencies, although it would not hold a dominant market share in any particular market. Thus, customers would benefit from GE's greater range of products and possibly lower prices, but they still could shop elsewhere if they chose. The U.S. regulators expressed little concern that bundling of products and services could hurt customers, since buyers can choose from among a relative handful of viable suppliers. To understand the European position, it is necessary to comprehend the nature of competition in the European Union. France, Germany, and Spain spent billions subsidizing their aerospace industry over the years. The GE–Honeywell deal has been attacked by their European rivals from Rolls-Royce and Lufthansa to French avionics manufacturer Thales. Although the European Union imported much of its antitrust law from the United States, the antitrust law doctrine evolved in fundamentally different ways. In Europe, the main goal of antitrust law is to guarantee that all companies be able to compete on an equal playing field. The implication is that the European Union is just as concerned about how a transaction affects rivals as it is consumers. Complaints from competitors are taken more seriously in Europe, whereas in the United States it is the impact on consumers that constitutes the litmus test. Europeans accepted the legal concept of "portfolio power," which argues that a firm may achieve an unfair advantage over its competitors by bundling goods and services. Also, in Europe, the European Commission's Merger Task Force can prevent a merger without taking a company to court. The EU authorities continued to balk at approving the transaction without major concessions from the participants—concessions that GE believed would render the deal unattractive. On June 15, 2001, GE submitted its final offer to the EU regulators in a last-ditch attempt to breathe life into the moribund deal. GE knew that if it walked away, it could continue as it had before the deal was struck, secure in the knowledge that its current portfolio of businesses offered substantial revenue growth or profit potential. Honeywell clearly would fuel such growth, but it made sense to GE's management and shareholders only if it would be allowed to realize potential synergies between the GE and Honeywell businesses. GE said it was willing to divest Honeywell units with annual revenue of $2.2 billion, including regional jet engines, air-turbine starters, and other aerospace products. Anything more would jeopardize the rationale for the deal. Specifically, GE was unwilling to agree not to bundle (i.e., sell a package of components and services at a single price) its products and services when selling to customers. Another stumbling block was the GE Capital Aviation Services unit, the airplane-financing arm of GE Capital. The EU Competition Commission argued that that this unit would use its influence as one of the world's largest purchasers of airplanes to pressure airplane manufacturers into using GE products. The commission seemed to ignore that GE had only an 8 percent share of the global airplane leasing market and would therefore seemingly lack the market power the commission believed it could exert. On July 4, 2001, the European Union vetoed the GE purchase of Honeywell, marking it the first time a proposed merger between two U.S. companies has been blocked solely by European regulators. Having received U.S. regulatory approval, GE could ignore the EU decision and proceed with the merger as long as it would be willing to forego sales in Europe. GE decided not to appeal the decision to the EU Court of First Instance (the second highest court in the European Union), knowing that it could take years to resolve the decision, and withdrew its offer to merge with Honeywell. On December 15, 2005, a European court upheld the European regulator's decision to block the transaction, although the ruling partly vindicated GE's position. The European Court of First Instance said regulators were in error in assuming without sufficient evidence that a combined GE–Honeywell could crush competition in several markets. However, the court demonstrated that regulators would have to provide data to support either their approval or rejection of mergers by ruling on July 18, 2006, that regulators erred in approving the combination of Sony BMG in 2004. In this instance, regulators failed to provide sufficient data to document their decision. These decisions affirm that the European Union needs strong economic justification to overrule cross-border deals. GE and Honeywell, in filing the suit, said that their appeal had been made to clarify European rules with an eye toward future deals, since they had no desire to resurrect the deal. In the wake of these court rulings and in an effort to avoid similar situations in other geographic regions, coordination among antitrust regulatory authorities in different countries has improved. For example, in mid-2010, the U.S. Federal Trade Commission reached a consent decree with scientific instrument manufacturer Agilent in approving its acquisition of Varian, in which Agilent agreed to divest certain overlapping product lines. While both firms were based in California, each has extensive foreign operations, which necessitated gaining the approval of multiple regulators. Throughout the investigation, FTC staff coordinated enforcement efforts with the staffs of regulators in the European Union, Australia, and Japan. The cooperation was conducted under the auspices of certain bilateral cooperation agreements, the OECD Recommendation on Cooperation among its members, and the European Union Best Practices on Cooperation in Merger Investigation protocol. -What are the important philosophical differences between U.S. and EU antitrust regulators? Explain the logic underlying these differences? To what extent are these differences influenced by political rather than economic considerations? Explain your answer.

Assume that you are an antitrust regulator. How important is properly defining the market segment in which the acquirer and target companies compete in determining the potential increase in market power if the two firms are permitted to combine? Explain your answer.

What factors do U.S. antitrust regulators consider before challenging a merger or acquisition?

Regulators often consider market concentration when determining whether an M&A will drive up prices and reduce consumer choice and product/service quality. What is an acceptable level of concentration often is difficult to determine. Concentration may be an outgrowth of the high capital requirements of the industry. Attempts to limit concentration may actually work to the detriment of some consumers. ______________________________________________________________________________________ United States antitrust regulators have moved aggressively in recent years to block horizontal mergers (i.e., those involving direct or potential competitors) while being more lenient on vertical deals (i.e., those in which a firm buys a supplier or distributor). These actions foreshadowed the likely outcome of the deal proposed by telecommunications giant AT&T to acquire T-Mobile for $39 billion in cash in early 2011. Despite the unfavorable regulatory environment for horizontal deals, AT&T expressed confidence that it could get approval for the deal when it accepted a sizeable termination fee as part of the agreement if it did not complete the transaction by March 2012. However, the deal would never be completed, as U.S. antitrust regulators made it clear that a tie-up between number two, AT&T (behind Verizon), and number four, T-Mobile (behind Sprint), would not be permitted. On December 20, 2011, AT&T announced that it would cease its nine-month fight to acquire T-Mobile. AT&T was forced to pay T-Mobile’s parent, Deutsche Telekom, $3 billion in cash and a portion of its wireless spectrum (i.e., cellular airwaves) valued at as much as $1 billion. T-Mobile and AT&T did agree to enter into a seven-year roaming agreement that could cost AT&T another $1 billion. The announcement came shortly after AT&T had ceased efforts to fight the Justice Department’s lawsuit filed in August 2011 to block the merger. The Justice Department would not accept any combination of divestitures or other changes to the deal, arguing that the merger would raise prices to consumers and reduce both choice and service quality. Instead, the Justice Department opted to keep a “strong” fourth competitor rather than allow increased industry concentration. But T-Mobile’s long-term viability was in doubt. The firm’s parent, Deutsche Telekom, had made it clear that it wants to exit the mature U.S. market and that it has no intention of investing in a new high-speed network. T-Mobile is the only national carrier that does not currently have its own next-generation high-speed network. Because it is smaller and weaker than the other carriers, it does not have the cash or the marketing clout with handset vendors to offer exclusive, high-end smartphones to attract new customers. While competitors Verizon and AT&T gained new customers, T-Mobile lost 90,000 customers during 2011. In response to these developments, T-Mobile announced a merger with its smaller rival MetroPCS on October 3, 2012, creating the potential for a stronger competitor to Verizon and AT&T and solving regulators’ concerns about increased concentration. However, it creates another issue by reducing competition in the prepaid cell phone segment. MetroPCS’s low-cost, no-contract data plans and cheaper phones brought cellphones and mobile Internet to millions of Americans who could not afford major-carrier contracts. While T-Mobile announced the continuation of prepaid service, it has an incentive not to make it so attractive as to cause its own more profitable contract customers to shift to the prepaid service as their contracts expire. While T-Mobile also announced plans to develop a new high-speed network, it will be late to the game. Some industries are more prone to increasing concentration because of their high capital needs. Only the largest and most financially viable can support the capital outlays required to support national telecom networks. While the U.S. Justice Department has sent a clear signal that mergers in highly concentrated industries are likely to be disallowed, it is probable that the U.S. cellular industry will become increasingly concentrated despite disallowing the AT&T/T-Mobile merger due to the highly capital-intensive nature of the business. Justice Department Requires VeriFone Systems to Sell Assets before Approving Hypercom Acquisition • Asset sales commonly are used by regulators to thwart the potential build-up of market power resulting from a merger or acquisition. • In such situations, defining the appropriate market served by the merged firms is crucial to identifying current and potential competitors. ______________________________________________________________________________ In late 2011, VeriFone Systems (VeriFone) reached a settlement with the U.S. Justice Department to acquire competitor Hypercom Corp on the condition it sold Hypercom’s U.S. point-of-sale terminal business. Business use point-of-sale terminals are used by retailers to accept electronic payments such as credit and debit cards. The Justice Department had sued to block the $485 million deal on concerns that the combination would limit competition in the market for retail checkout terminals. The asset sale is intended to create a significant independent competitor in the U.S. The agreement stipulates that private equity firm Gores Group LLC will buy the terminals business. San Jose, California-based VeriFone is the second largest maker of electronic payment equipment in the U.S. and Hypercom, based in Scottsdale, Arizona, is number three. Together, the firms control more than 60 percent of the U.S. market for terminals used by retailers. Ingenico SA, based in France, is the largest maker of card-payment terminals. The Justice Department had blocked a previous attempt to sell Hypercom’s U.S. point-of-sale business to rival Ingenico, saying that it would have increased concentration and undermined competition. VeriFone will retain Hypercom’s point-of-sale equipment business outside the U.S. The acquisition will enable VeriFone to expand in the emerging market for payments made via mobile phones by giving it a larger international presence in retail stores and the opportunity to install more terminals capable of accepting mobile phone payments abroad. -What alternative actions could the government take to limit market power resulting from a business combination?

The Sarbanes-Oxley Act has been very controversial. Discuss the arguments for and against the Act. Which side do you find more convincing and why?

Anthem-Well Point Merger Hits Regulatory Snag In mid-2004, a California insurance regulator refused to approve Anthem Inc’s (“Anthem”) $20 billion acquisition of WellPoint Health NetWorks Incorporated (“WellPoint”). If allowed, the proposed merger would result in the nation’s largest health insurer, with 28 million members. After months of regulatory review, the deal had already received approval from 10 state regulators, the Justice Department, and 97% of the shares outstanding of both firms. Nonetheless, California Insurance Commissioner, John Garamendi, denounced the proposed transaction as unreasonably enriching the corporate officers of the firms without improving the availability or quality of healthcare. Earlier the same day, Lucinda Ehnes, Director of the Department of Managed Healthcare in California approved the transaction. The Managed Healthcare Agency has regulatory authority over Blue Cross of California, a managed healthcare company that is by far the largest and most important WellPoint operation in the state. Mr. Garamendi’s department has regulatory authority over about 4% of WellPoint’s California business through its BC Life & Health Insurance Company subsidiary (“BC”). Interestingly, Ms. Ehnes is an appointee of California’s Republican governor, Arnold Schwarzenegger, while Mr. Garamendi, a Democrat, is an elected official who had previously run unsuccessfully for governor. Moreover, two week’s earlier he announced that he will be a candidate for lieutenant governor in 2006. Mr. Garamendi had asked Anthem to invest in California’s low income communities an amount equal to the executive compensation payable to WellPoint executives due to termination clauses in their contracts. Estimates of the executive compensation ranged as high as $600 million. Anthem immediately sued John Garamendi, seeking to overrule his opposition to the transaction. In the lawsuit, Anthem argued that Garamendi acted outside the scope of his authority by basing his decision on personal beliefs about healthcare policy and executive compensation rather than on the criteria set forth in California state law. Anthem argued that the executive compensation payable for termination if WellPoint changed ownership was part of the affected executives’ employment contracts negotiated well in advance of the onset of Anthem’s negotiations to acquire WellPoint. The California insurance regulator finally dropped his objections when the companies agreed to pay $600 million to help cover the cost of treating California’s uninsured residents. Following similar concessions in Georgia, Anthem was finally able to complete the transaction on December 1, 2004. Closing occurred almost one year after the transaction had been announced. -To what extent should regulators use their powers to promote social policy?

How did the delay in filing the Justice Department lawsuit impact the economic viability of American Airlines?

All of the following are true of antitrust lawsuits except for

U.S. antitrust regulators in determining if a proposed business combination is likely to be anti-competitive consider only domestic competitors or foreign competitors with domestic operations.

All of the following are true of the Williams Act except for

State antitrust laws are usually quite similar to federal laws.

Negotiated agreements between the buyer and seller rarely have a provision enabling the parties to back out, if the proposed transaction is challenged by the FTC or SEC.

Antitrust laws exist to prevent individual corporations from assuming too much market power such that they can limit their output and raise prices without concern for how their competitors might react.