New Potential M&A Opportunities.

Three recent rejections of government merger challenges may present new opportunities for companies to pursue mergers or acquisitions of competitors in concentrated markets. While every case is fact specific, these cases may demonstrate a shift in antitrust enforcement, with courts permitting transactions that were challenged under the Horizontal Merger Guidelines. We provide below a short synopsis of these cases, and a list of lessons by which these cases can be applied in other industries.

FTC v. Arch Coal/Triton

The Federal Trade Commission (FTC) challenged Arch's acquisition of a competitor's two coal mines in Wyoming. Arch initially intended to purchase both of Triton's mines, which would have resulted in a doubling of Arch's market share and an extremely concentrated market. In the face of the potential FTC challenge, Arch found a buyer (Kiewit) to whom it would sell one of the two acquired mines. The FTC wanted the transaction evaluated, for purposes of the preliminary injunction, as Arch's acquisition of both mines, but the court evaluated the acquisition as Arch's acquisition of a single mine, with Kiewit's acquiring the other mine. Viewed as a onemine acquisition, the concentration levels barely exceeded the Merger Guidelines concentration thresholds of concern. In light of a weak concentration-based presumption of harm, the court held the FTC to a high burden of showing a theory of competitive harm (rather than relying on the presumption from the Merger Guidelines). Here, in light of the spin-off of one mine to Kiewit, Arch showed that its acquisition of the other mine would not reduce the number of competitors in the market as a result of the transaction. The court denied the FTC's request for a preliminary injunction on August 13, 2004, after a two week trial.

DOJ v. Oracle/PeopleSoft

The Department of Justice (DOJ) challenged Oracle's hostile acquisition of PeopleSoft. On September 10, 2004, the district court denied the government's request for a preliminary injunction, rejecting all aspects of the DOJ's case. The district court found that the government's claimed narrow market of high-end enterprise resource planning (ERP) software providers was not sustainable. The government's claimed market included only Oracle, PeopleSoft and SAP, so the government viewed the transaction as three competitors going to two. Oracle successfully demonstrated the existence of numerous other firms providing ERP solutions, and demonstrated that no clear distinction existed between high-end ERP and other ERP software providers that served primarily smaller customers. Therefore, the district court found the claimed "high end" ERP solutions and the other ERP providers competed in the same relevant product market. The court was dismissive of the DOJ's primary evidence, customer complaints, as anecdotal and not supported by rigorous analysis. The court wanted more statistical, econometric evidence, which the government did not offer. In addition, the court rejected the government's geographic market definition and found that ERP software providers competed in a world market. Because the government lost in its market definition, the case failed. Importantly, the court indicated that even in the government's alleged market, the government did not have a viable theory of harm. First, the court held that a coordinated effects theory did not apply because the products involved were highly differentiated products (software). Second the court rejected the Merger Guidelines' presumption regarding unilateral effects (which presumes a transaction combining two close competitors with a 35 percent combined market share is anticompetitive). The court found that unilateral effects are unlikely where, as here, there is a combination of two closely related firms (with combined shares exceeding 35 percent) as long as there is a third, similarly situated and similarly competitive firm.

DOJ v. Dairy Farmers of America (DFA)/Southern Belle

The DOJ also recently lost a post-closing challenge to a partial equity interest acquisition. DFA had acquired fifty percent interests in two dairies in Kentucky, which were major competitors of each other. The DOJ challenged the acquisition of the interest in the second dairy under Clayton Act Section 7, asserting that DFA's holding of major stakes in two competing dairies would increase the likelihood of anticompetitive milk pricing, either by facilitating coordination between the dairies, or changing their incentives to compete aggressively. During the pendency of the case, the organizational documents of the dairies were changed to make clear that DFA had no role in operating either dairy, and no access to competitively sensitive information from either dairy. Because DFA's [c] 2004 McDermott Will & Emery Page 2 interest was entirely passive in both dairies, the court granted summary judgment to DFA. This was a unique case given the nature of DFA's interests in the competing dairies.

Key Lessons Potentially Applicable to Other Industries

These cases establish some principles that may allow parties to succeed in completing transactions with competitors.

"Coordinated effects" theory cases will be harder for the FTC and DOJ to win One of the main theories that the government uses in challenging mergers is to argue that the reduction in the number of competitors will make it easier for the remaining competitors to coordinate on price or capacity. Most previous decisions had found that if the government was able to establish that the market in question was concentrated, the court would presume that coordinated effects were likely. However, in the Arch case, the judge did not give the FTC its usual favorable presumption based on the high concentration levels. Instead, the judge stated that even though concentration levels were high, the burden of proof was still fully on the FTC to show that the acquisition would result in coordinated effects. Therefore, in the future, courts may require the agencies to demonstrate past coordination or factors indicating coordination is likely, rather than relying on a market share / concentration presumption. Similarly, the Oracle decision also makes it more difficult for the government to establish coordinated effects in markets where the products are not homogenous. The judge in Oracle stated that coordination in differentiated product markets is not a viable theory. As a result, in the future, it will be difficult for the government to challenge mergers under a coordinated effects theory in industries, such as the software industry, where the competitors typically customize the product for each customer.

"Unilateral effects" theory has been narrowed substantially

The second theory that the government uses to challenge horizontal mergers is the unilateral effects theory, in which the government alleges that the new merged company will be able to raise prices unilaterally because of its large market share. The Merger Guidelines, which the government uses as a guide in analyzing mergers, presume unilateral anticompetitive effects in a market where a participant has 35 percent post-merger share and the merging firms are each others' closest competitors. The judge in Oracle suggested that the government must show that the combined company would have a "monopoly or dominant position" before it could prevail in a unilateral effects case. Because there were three strong competitors (Oracle, PeopleSoft and SAP) even in the market the government alleged, the court rejected the government's unilateral effects argument because SAP was a close competitor (even if not the "closest" competitor). After Oracle, if there is another close competitor, unilateral effects are unlikely even if the Guidelines thresholds are met.

Statistical evidence is more important than anecdotal evidence

Strong opposition from customers to a proposed merger and "bad documents", once a possible death sentence for a deal, will not necessarily stop a transaction. Courts will look beyond mere "opposition" by customers and "bad documents" to see if they are supported by underlying data. The judge in Oracle discounted customer testimony because the customers did not support their concerns with any "serious analysis." The judge said that the key is not what the customer would like or prefer, but what alternatives the customer has in the event of an anticompetitive price increase by Oracle. The Arch court also discounted the significance of anecdotal customer complaints. In addition, the court ignored the Oracle "bad documents" on product market definition and gave much more weight to the economic evidence.

Arch found a buyer for one of the two mines it was acquiring, and the court analyzed Arch's acquisition in light of that self-help divestiture (while the FTC wanted to ignore it for purposes of the preliminary injunction). Therefore, even if the government does not view a proposed remedy as being a viable "fix", the court will require the government to prove why the proposed remedy does not resolve the competitive issues of the transaction. [c] 2004 McDermott Will & Emery Page 3

Fringe competitors/entry are important

Even in highly concentrated markets, entry by other competitors is a critical defense that merging parties can utilize. "Fringe competitors" with ability to expand can have importance far in excess of their current market share. In Arch, the judge gave great weight to smaller competitors, far beyond their current production and small market shares. Similarly, in Oracle, the judge found that potential entry by other competitors, such as Microsoft, would prevent Oracle from being able to raise prices. The Oracle decision is particularly important for companies in the high-tech industries because entry by "fringe competitors" or the emergence of new technologies can be a very successful defense.

Narrow markets are difficult for the government to prove

Courts are skeptical of results-oriented carving of markets. In the future, the government may have a more difficult time defining narrow markets based on the size of the customer or based on quality/price differentials. In Arch, the judge did not accept the FTC's narrow market definition for premium coal, despite strong customer statements and generally accepted industry practice that such premium coal is a relevant market. In Oracle, the judge rejected the government's claimed high end ERP market. In high-tech industries, it may be particularly difficult for the government to establish narrow product markets because of the dynamic and evolving nature of these products. Moreover, high market shares in the U.S. for software competitors may not be as a significant antitrust issue in the future because of the court's rejection of the DOJ's attempt to define the geographic market as the U.S.

Economists are very important

Effective use of an economist is critical in defining the relevant market and explaining competitive effects. In both cases, the court gave substantial weight to the economists' testimony and was critical of the government's economic witnesses. In Oracle, the judge was critical of the government's economists reliance on qualitative data and the failure to have performed econometric studies. Both cases demonstrate the importance of retaining top economists when contemplating a transaction that raises antitrust issues.

Efficiencies are unlikely to save transactions

Unless they are large and well-supported by meaningful studies and analysis, efficiencies are unlikely to save a problematic transaction. The courts in both Arch and Oracle found that the claimed efficiencies would not save the transaction if the government had been able to meet its burden of showing a likelihood of a substantial lessening of competition. Even so, having an efficiencies story is still very helpful in convincing the regulators a transaction has procompetitive purpose.

Judicial skepticism of non-mainstream theories

The DFA case shows that courts may be skeptical of cases brought under novel theories of anticompetitive harm. In DFA, the theory involved alleged changes to competitive incentives of competing entities based on common ownership by a third party. The passive nature of the ownership interest in both dairies resulted in the dismissal of the case. It is not clear whether this decision will restrain the FTC and DOJ from investigating or challenging partial equity interest situations where a firm directly takes a passive minority interest in its competitor.

Please call a member of McDermott Will & Emery LLP's Antitrust and Competition practice group if you would like to discuss how these cases can be used to grow your company or the implications of these cases for future transactions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Mr Jon B. Dubrow

McDermott Will & Emery

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