Exam 2: The Regulatory Environment

Case Study Short Essay Examination Questions 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. ^{BusinessWeek, 2000b} 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. ^{Murray, 2001} 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. Discussion Questions -What were the major obstacles between GE and the EU regulators? Why do you think these were obstacles? Do you think the EU regulators were justified in their position? Why/why not?

The Williams Act of 1968 consists of a series of amendments to the Securities Act of 1933,and it is intended to protect target firm shareholders from lighting fast takeovers in which they would not have enough time to adequately assess the value of an acquirer's offer.

Under federal law,states have the right to sue to block mergers they believe are anti-competitive,even if the FTC or SEC does not challenge them.

Which of the following are true about the Sherman Antitrust Act?

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

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.

The primary reason the Sarbanes-Oxly Act of 2002 was passed was to eliminate insider trading.

Case Study Short Essay Examination Questions Overcoming Regulatory Hurdles: Exelon Buys Constellation Energy Key Points: •Rising costs associated with more stringent environmental laws and the need to upgrade power grids are spurring consolidation in the fragmented U.S. electric utility industry. •However, acquiring utilities often is particularly challenging due to the complex regulatory approval process. ______________________________________________________________________________ Reflecting increased demands for clean power, an aging electric power grid and other infrastructure, and the rising cost of fuels to generate power, the highly fragmented U.S. electric utility industry has undergone significant consolidation in recent years. By achieving increased scale, electric utilities are hoping to lower operating costs and gain the financial strength to finance the necessary investments in infrastructure and alternative energy sources. Utilities also are increasingly confronted by a combination of regulated and non-regulated electricity markets. In most retail electricity markets in which electricity is sold directly to the end customer, rates that can be charged are regulated by local public utility commissions. While some utilities own their own generating capacity, others are dependent to varying degrees on purchasing electric power in the wholesale power market. A wholesale electricity market exists when competing HYPERLINK "http://en.wikipedia.org/wiki/Electricity_generation" \o "Electricity generation" generators offer their electricity output to HYPERLINK "http://en.wikipedia.org/wiki/Electricity_retailing" \o "Electricity retailing" retailers. Increasingly, large end-users can bypass retail electric utility companies to buy directly from wholesale power generators in a bid to access lower cost power by eliminating the middleman. Some states allow competition in their electricity markets while others do not. In competitive markets, power suppliers, including renewable and conventional oil and gas power generators, compete against each other to provide the best possible service at the lowest cost in order to attract and retain customers. In contrast, in monopoly-regulated states, power providers have no incentive to innovate or lower costs because ratepayers are captive to their monopoly-protected supplier. Some utilities are attempting to shift to a mix of regulated and non-regulated electricity markets. The latest illustration of this strategy is Exelon Corp's acquisition of Constellation Energy for $7.9 billion in April 2011. The deal creates the largest electric utility and power generator in the U.S. The combined firm will gain stakes in five nuclear reactors and become the largest U.S. electricity marketer. Exelon is currently the largest owner and operator of U.S. nuclear plants and owns electric utilities Commonwealth Edison in Chicago and Peco Energy in Pennsylvania. Constellation owns the utility Baltimore Gas & Electric. Most of its revenue comes from the retail sale of electricity in states that allow competition. The merger creates the number one competitive energy provider with one of the industry's cleanest and lowest cost power generation plant systems in the country. The combined company will keep the Exelon name and its headquarters in Chicago, as well as own more than 34 gigawatts of power generation. The company's power generation mix would be 55 percent nuclear, 24 percent natural gas, 6 percent hydro and renewable, and 7 percent oil, and 6 percent coal. Exelon will add 1.2 million electric customers in Constellation service areas. This deal is Exelon's largest transaction. Exelon has tried unsuccessfully three times to buy other electric power companies since 2003. Exelon was thwarted by regulators in efforts to buy independent power producer NRG Energy in 2009, Public Service Enterprise Group in 2006, and Illinois Power in 2003. Constellation has been the target of two failed bids by other suitors. A $14.8 billion sale of Constellation to NextEra Energy Inc., the largest U.S. wind-power generator and owner of Florida's largest utility, collapsed in 2005. Exelon announced on December 20, 2011 that it had received approval by the U.S. Justice Department to buy Constellation Energy Group Inc. The approval was contingent on Exelon selling three electricity generating plants in Maryland. The sale of the three power plants in the Baltimore area will significantly reduce the combined firm's market share in that region. The Justice Department believed that the combination, as originally proposed, would have lessened competition in the wholesale electricity market and increased prices for consumers in the Mid-Atlantic states (i.e., New York, Pennsylvania, and Maryland). Exelon and Constellation have also received regulatory approval from the Maryland and New York regulators as well as the Nuclear Regulatory Commission. : -How does the FTC define market share? In the electric utility market,to what extent does this methodology apply? To what extent does it not apply?

Whenever an investor acquires 5% or more of public company,it must disclose its intentions,the identities of all investors,their occupation,sources of financing,and the purpose of the acquisition.

Acquisitions involving companies of a certain size cannot be completed until certain information is supplied to the federal government and until a specific waiting period has elapsed.

Alliances and joint ventures are likely to receive more intensive scrutiny by regulators because of their tendency to be more anti-competitive than M&As.

Antitakeover laws do not exist at the state level.

Whenever an investor accumulates 5% or more of a public company's stock,it must make a so-called 13(d)filing with the SEC.

In determining whether a proposed transaction is anti-competitive,U.S.regulators look at all of the following except for

Which other types of legislation can have a significant impact on a proposed transaction?

Case Study Short Essay Examination Questions FTC Prevents Staples from Acquiring Office Depot As the leading competitor in the office supplies superstore market, Staples' proposed $3.3 billion acquisition of Office Depot received close scrutiny from the FTC immediately after its announcement in September 1996. The acquisition would create a huge company with annual sales of $10.7 billion. Following the acquisition, only one competitor, OfficeMax with sales of $3.3 billion, would remain. Staples pointed out that the combined companies would comprise only about 5% of the total office supply market. However, the FTC considered the superstore market as a separate segment within the total office supply market. Using the narrow definition of "market," the FTC concluded that the combination of Staples and Office Depot would control more than three-quarters of the market and would substantially increase the pricing power of the combined firms. Despite Staples' willingness to divest 63 stores to Office Max in markets in which its concentration would be the greatest following the merger, the FTC could not be persuaded to approve the merger. Staples continued its insistence that there would be no harmful competitive effects from the proposed merger, because office supply prices would continue their long-term decline. Both Staples and Office Depot had a history of lowering prices for their customers because of the efficiencies associated with their "superstores." The companies argued that the merger would result in more than $4 billion in cost savings over 5 years that would be passed on to their customers. However, the FTC argued and the federal court concurred that the product prices offered by the combined firms still would be higher, as a result of reduced competition, than they would have been had the merger not taken place. The FTC relied on a study showing that Staples tended to charge higher prices in markets in which it did not have another superstore as a competitor. In early 1997, Staples withdrew its offer for Office Depot. : -Do you believe the FTC was being reasonable in not approving the merger even though? Staples agreed to divest 63 stores in markets where market concentration would be the greatest following the merger? Explain your answer.

Case Study Short Essay Examination Questions Justice Department Blocks Microsoft's Acquisition of Intuit In 1994, Bill Gates saw dominance of the personal financial software market as a means of becoming a central player in the global financial system. Critics argued that, by dominating the point of access (the individual personal computer) to online banking, Microsoft believed that it may be possible to receive a small share of the value of each of the billions of future personal banking transactions once online banking became the norm. With a similar goal in mind, Intuit was trying to have its widely used financial software package, Quicken, incorporated into the financial standards of the global banking system. In 1994, Intuit had acquired the National Payment Clearinghouse Inc., an electronic bill payments system integrator, to help the company develop a sophisticated payments system. By 1995, Intuit had sold more than 7 million copies of Quicken and had about 300,000 bank customers using Quicken to pay bills electronically. In contrast, efforts by Microsoft to penetrate the personal financial software market with its own product, Money, were lagging badly. Intuit's product, Quicken, had a commanding market share of 70% compared to Microsoft's 30%. In 1994 Microsoft made a $1.5 billion offer for Intuit. Eventually, it would increase its offer to $2 billion. To appease its critics, it offered to sell its Money product to Novell Corporation. Almost immediately, the Justice Department challenged the merger, citing its concern about the anticompetitive effects on the personal financial software market. Specifically, the Justice Department argued that, if consummated, the proposed transaction would add to the dominance of the number-one product Quicken, weaken the number two-product (Money), and substantially increase concentration and reduce competition in the personal finance/checkbook software market. Moreover, the DoJ argued that there would be few new entrants because competition with the new Quicken would be even more difficult and expensive. Microsoft and its supporters argued that government interference would cripple Microsoft's ability to innovate and limit its role in promoting standards that advance the whole software industry. Only a Microsoft-Intuit merger could create the critical mass needed to advance home banking. Despite these arguments, the regulators would not relent on their position. On May 20, 1995, Microsoft announced that it was discontinuing efforts to acquire Intuit to avoid expensive court battle with the Justice Department. : -Do you believe that the FTC might approve of Microsoft acquiring Intuit today? Why or why not?

States are not allowed to pass any laws that impose restrictions on interstate commerce or that conflict in any way with federal laws regulating interstate commerce.

Vertical mergers are likely to be challenged by antitrust regulators for all of the following reasons except for

In the U.S.,the Sherman Act makes illegal all contracts,combinations and conspiracies,which "unreasonably" restrain trade.The Act applies to all transactions and businesses engaging in both interstate and intrastate trade.