Has the COVID-19 Pandemic Changed Economic Analysis in Merger Review?
The economic disruption caused by measures intended to halt the spread of COVID-19 has raised new questions for merger reviews as well. If the “new normal” for post-pandemic markets is still evolving, are the requirements for assessing competitive effects similarly in flux?
Managing Principal Rebecca Kirk Fair and Vice President Emily Cotton discussed their views on what has changed and what has not. Ms. Cotton and Ms. Kirk Fair have extensive experience analyzing competition, pricing, and outputs in connection with merger investigations in the US, Canada, and the EU in a range of industries, including technology, financial services, and pharmaceuticals.
How do you see the widespread economic disruption caused by the pandemic affecting the way we go about assessing competitive impacts of proposed mergers?
Ms. Kirk Fair: In general, I think we can say that the pandemic has changed many of the drivers of competition that underlie merger reviews, such as short-term customer needs, the distribution of services, product purchases, competitive conditions, and financial performance. It has certainly surfaced new challenges in using existing market share data, which may be changing quickly as companies either adapt to the new business conditions, fail to do so, or simply tread water.
Pandemic effects also heighten the inherent uncertainty involved in forecasting the potential competitive effects of a proposed merger or acquisition, at least until it becomes clearer whether the changes we’ve seen in markets and competition will become entrenched or will resolve as economies revive.
But evaluating the potential competitive effects of a proposed acquisition is complicated even more by the fact that a large number of businesses and services have been forced to shift online because of COVID-19. The digital economy had been growing by leaps and bounds even before, but the scramble to keep your doors open in the middle of a pandemic has only accelerated this competitive shift.
In several merger reviews that we were working on pre-pandemic, we had already begun to look at market shares in a different way so that we could account for the growth of online commerce, especially in the retail, media, and, of course, technology sectors. We expect that, going forward, the need will only grow for analysis of the implications of the digital economy for market definition, cost efficiencies, innovation, and near- and long-term competition.
In the face of these kinds of changes, are agencies requiring more data and information to complete their analysis?
Ms. Cotton: Generally, the second requests and voluntary requests I’ve seen are consistent with those served in prior years in terms of the number of years of data and the nature of the data requested. But now, there can be a slightly longer lag between requests and the opportunities to meet with the agencies.
Notably, however, even before the pandemic there had been requests for more comprehensive consideration for segmented analyses, non-price measures of competitive effects, nascent competition, and other broader questions. This seems to be tied less to the pandemic and more to the renewed interest in non-price effects of mergers that had been gaining momentum over the past few years. So we are not necessarily seeing more requests for the same kind of data, as such, but rather more requests for new and different kinds of data.
For example, the FTC [Federal Trade Commission] challenged Celgene’s acquisition by BMS [Bristol-Meyers Squibb] over concern it might harm consumers in the US market for oral treatments for psoriasis. While BMS and Celgene were not active competitors in this space, BMS had a pipeline product under development that was considered the most advanced oral treatment for moderate-to-severe psoriasis; the FTC believed it would be the likely next entrant and compete with Celgene’s Otezla. Ultimately, Celgene agreed to divest Otezla. This divestiture is considered the largest divestiture required to date in a merger enforcement matter.
“[A]gencies and parties may be left with less certainty around potential competitive effects from consolidation, and they may need to seek out alternatives.”
– Emily Cotton
Historically, attempts to use the failing firm defense have had little success. Now, however, a disconcertingly large number of businesses have been struggling with extraordinary and, in some cases, unprecedented hardships generated by the pandemic. Should these circumstances change our views on evaluating a failing firm defense?
Ms. Kirk Fair: The way we evaluate failing firm arguments has not changed, although pandemic conditions may make such analyses more challenging. The pandemic has forced many businesses to make fairly disruptive shifts in their business strategy, and it has accelerated the introduction of new distribution models and impacted the growth of new firms – sometimes for the better! All this has made it more challenging to decide whether and how to use historical market shares, past customer diversion ratios and overlap analyses, and previous pricing patterns to predict the potential competitive effects of a proposed merger.
But global regulators have affirmed that the pandemic has not changed the criteria they use to evaluate whether a firm qualifies as failing. In fact, early on in the pandemic, the FTC hailed back to the previous financial crisis of 2008 to make it clear that “‘emergency’ exceptions to the antitrust laws are not needed” in times of market-wide or economy-wide distress.1 So parties must still present evidence related to the financial obligations, cash flow, assets, and liabilities of the allegedly failing firm, as well as other facts relevant to the target’s performance and their efforts to find alternatives.
Similarly, in the UK, the CMA [Competition and Markets Authority] also had not, at least as of the spring of 2021, accepted arguments related to financial distress caused by the COVID-19 pandemic in its competitive assessment of proposed mergers. The issue was raised in a string of merger petitions, such as Sabre/Farelogix, JD Sports Fashion/Footasylum, Circle Health Holdings Limited/BMI Healthcare Limited, and Viagogo/StubHub.
For example, in reviewing the Viagogo/StubHub merger, which was referred to Phase II in mid-2020, the CMA made it clear that it would continue to make its decisions based on long-term structural effects. The Authority explained that, while the pandemic has certainly had a significant impact on the live events industry for now, both of these online ticket resellers would still remain important competitors when the industry recovers. In particular, the CMA concluded that the two platform businesses compete closely against each other in the UK’s secondary ticketing market, with a combined share of more than 90%.
To preserve this competition, in February 2021 the CMA announced that it was requiring Viagogo to divest StubHub’s business outside of North America. This would have the effect of creating a StubHub international business independent from the merged business, while allowing Viagogo to keep StubHub’s US and Canadian operations.
But is it truly “business as usual” in the wake of the pandemic?
Ms. Kirk Fair: Not exactly. In fact, attempts to use the failing firm defense have been more noticeable during the pandemic, and it may continue to be part of the increasing flow of merger filings as long as cash flow and profitability concerns can be shown to put a firm’s ability to meet its financial obligations or to reorganize under bankruptcy at risk.
In particular, if the financial challenges we’ve experienced over the past year and a half last beyond the pandemic, we will need to see to what degree, if any, options to restructure debt, overhaul balance sheets, or reorganize become unavailable. Ultimately, in such circumstances, the argument could potentially be made that acquisition by a financially stronger competitor would be necessary to keep the firm’s assets operational.
“[The pandemic] has made it more challenging to decide whether and how to use historical market shares, past customer diversion ratios and overlap analyses, and previous pricing patterns to predict the potential competitive effects of a proposed merger.”
– Rebecca Kirk Fair
For example, if demand both during and after the pandemic contracts in some industries, it is possible that the number of firms that can operate at their efficient scale in the market may go down following the crisis; in this case, allowing firms to merge may be an efficient way of managing an adjustment to a less competitive equilibrium. So it’s certainly within the realm of possibility that a merger may rescue both parties, not just the target.
Of course, the parties would also have to show that the acquisition target has made good faith efforts to find “reasonable alternatives,” such as other potential buyers. Historically, this has been a high hurdle to clear. It remains to be seen whether the effects of the pandemic will also shrink the pool of potential buyers.
How can we deal with the new levels of uncertainty introduced by the pandemic?
Ms. Cotton: Determining whether the pandemic is or is not causing long-lasting contraction in demand will require an industry-by-industry assessment, and in some cases a company-by-company one. Where the effects appear to be long-lasting or structural, the prior level of competition may be impossible to maintain, and consideration of financial constraints or ongoing changes in demand may, as Rebecca mentioned, confront not only the target but also the buyer.
In fact, these kinds of traditional measures may be even less useful given that the pandemic has left many more firms in weaker financial positions. Businesses in a weakened competitive position may make suboptimal capital investments, may invest less in R&D, and may put a damper on longer-run strategic initiatives. In some instances, financial pressure may push prices up and output down.
In such circumstances, historical competitive positions may have little predictive power for future performance. In that case, agencies and parties may be left with less certainty around potential competitive effects from consolidation, and they may need to seek out alternatives. Here, consideration of internal forecasts, industry reports, public statements from market participants (including competitors, providers of complementary goods and services, and customers), and market research may provide better insight into future competitive conditions and the longevity of shifts in demand. ■
- Ian Conner, “Antitrust review at the FTC: staying the course during uncertain times,” Federal Trade Commission, Apr. 6, 2020, https://www.ftc.gov/news-events/blogs/competition-matters/2020/04/antitrust-review-ftc-staying-course-during-uncertain.