This article was published in the Competition, Life Sciences, and Mergers & Acquisitions sections of Law360 on October 7, 2015. © Copyright 2015, Portfolio Media, Inc., publisher of Law360. It is republished here with permission.
The Federal Trade Commission suffered a rare loss when, on Sept. 24, the U.S. District Court for the Northern District of Ohio denied its request for a preliminary injunction, despite having accepted the FTC’s “actual potential entrant” theory.1 In connection with its review of the FTC’s challenge to Steris Corporation’s $1.9 billion acquisition of Synergy Health PLC, the court held that the FTC had failed to meet its burden of proof of showing that, absent the planned deal, the potential competitor would have entered the U.S. market. These decisions could be harbingers of the agencies’ greater willingness to aggressively challenge transactions involving potential competitors, or of the courts’ unquestioning acceptance of the actual potential entrant theory, or simply an interesting result limited to the facts of the case. It is most likely the latter. Regardless, companies considering acquisitions of potential competitors should do what they can to mitigate their antitrust risk.
Background
Steris and Synergy are the second- and third-largest product sterilization companies in the world. Sterigenics International Inc. is the largest. Sterilization is an important step in the manufacture of many healthcare products, as it eliminates bacteria and other microorganisms living on products and is required by the U.S. Food and Drug Administration.
Steris is one of two U.S. providers of gamma sterilization services, while Synergy operates more than three dozen contract sterilization facilities, including numerous gamma sterilization facilities outside of the United States. According to the FTC, currently, Synergy is only a small U.S. contract radiation player because it offers only e-beam sterilization services, but it is “an actual potential entrant” with its novel X-ray sterilization business, which would substantially increase its competitive significance. “Synergy’s entry with contract x-ray services would reduce concentration substantially in each relevant market and result in other procompetitive effects.”2
FTC v. Steris
The FTC claimed that, but for the proposed acquisition, Synergy was likely to enter the U.S. market by establishing an X-ray sterilization facility that would compete with Steris and Sterigenics, “within a reasonable time frame.”3 Citing a treatise, the FTC delineated the elements it contends it needs to prove to demonstrate that the acquisition of an actual potential competitor violates section 7 of the Clayton Act:4
1. The relevant market is highly concentrated;
2. The competitor “probably” would have entered the market;
3. Its entry would have had pro-competitive effects; and
4. There are few other firms that can enter effectively.5
Steris and Synergy opposed the injunction by arguing that, under the antitrust laws, a merger should be upheld so long as there is not a reduction in “pre-existing substantial competition.”6 They further argued that the actual potential entrant doctrine is disfavored by the courts and has rarely been adopted.
Following a preliminary injunction hearing, the Ohio court issued an order, stating “[s]ince the FTC has endorsed the ‘actual potential entrant’ theory in filing this Complaint, the Court will accept it for purposes of its decision.”7 The court did not question the theory because it recognized that the administrative law judge would apply it when weighing the merits of the FTC’s merger challenge. [cite] The court further directed the parties “to address the following question: But for the merger, is it probable that Synergy would have entered the U.S. market by building one or more x-ray sterilization facilities in the U.S. in a reasonable period of time?”8
Based on the evidence presented at a three-day hearing and the parties’ post-hearing written submissions, the court held that the FTC failed to meet its burden of proving that Synergy would have entered the U.S. contract sterilization market by building one or more X-ray facilities in the U.S. within a reasonable period of time.9
First, the evidence presented showed that Synergy’s customers in the United States had limited interest in contracting for X-ray sterilization services and would not commit financially to the technology. One reason for the lukewarm interest was that any cost savings that could be obtained by moving a product to X-ray sterilization was low compared to the costs and regulatory hurdles of making that switch.10
Second, Synergy’s own documents showed that the investment in U.S. X-ray facilities would consume more than its annual budget for investment projects and that the metrics in the business model did not meet Synergy’s internal standards. As a result, the court concluded that it was unlikely that Synergy was going to move forward with and receive approval from its corporate board for the investment and expansion into the U.S. market regardless of the planned merger.11
Finally, the court focused on the timing of Synergy’s decisions and statements. Rather than infer that Synergy would have entered the U.S. market within a reasonable time because it decided to drop its X-ray technology project after the FTC launched its investigation, the court found Synergy’s X-ray sterilization efforts post-merger announcement was evidence of the fact that it was not the merger that triggered Synergy’s abandonment of the technology. For example, during its 2014 earnings call Synergy said, “[w]e are pleased to announce that we have signed an agreement with IBA for X-ray technology to be deployed in the United States, supplemented by our in-house knowledge and expertise.”12 Because Synergy continued to work on its X-ray sterilization project and made this statement after the announcement of the merger, the court viewed this statement as clear evidence “that no one at Synergy viewed the proposed merger with Steris as an impediment to its U.S. x-ray strategy.”13 The court also interpreted this timing as indicative that Synergy abandoned its development of x-ray facilities in the United States for legitimate business reasons, because “[i]f the merger with Steris was going to prevent Synergy from entering the U.S. market, Synergy would have stopped working on the U.S. x-ray project as soon as the merger was announced in mid-October 2014.”14
On Oct. 1, the FTC issued a statement that it would not appeal the Steris court’s decision denying its requested preliminary injunction.15 In light of the court’s detailed review of the FTC’s and parties’ evidence following a substantial hearing, including judgments regarding the credibility of the witnesses, it is highly unlikely that any appeal of that decision would have been reversed. Although there has been no statement regarding whether the FTC will continue its challenge, the Steris/Synergy merger and the district court’s ruling do not bar a different outcome on the merits. However, the designated administrative law judge will likely have a difficult time reaching a different conclusion regarding the evidence addressed by the district court’s injunction decision.
What Will Be the Aftermath of the Steris Decision?
The concept of potential competition as part of merger analysis is not new. Section 7 bars acquisitions that may substantially lessen competition, and, as a result, its application is inherently forward-looking. In addition, the 2010 Horizontal Merger Guidelines define “horizontal mergers” as including “mergers and acquisitions involving actual or potential competitors.16 The guidelines further note that, in evaluating evidence of direct competition, the agencies will “consider whether the merging firms have been, or likely will become absent the merger, substantial head-to-head competitors.”17
Although the Steris decisions are interesting reading for those who follow the work of the antitrust enforcement agencies, it is unlikely that the court’s rulings will affect the viability of the future competition theory. Because the court accepted, without question, the FTC’s theory, there was no discussion of the underlying principles or the strengths and weaknesses of the theory and, therefore, the case is of no or extremely limited precedential value.
On the other hand, the court’s careful review of the facts and circumstances provides some useful insights. Some of the more practical elements of the case include a possible judicial roadmap for the review of mergers involving a potential market entrant and the absence of evidence of the acquiring company’s involvement in Synergy’s decision to end its X-ray technology project transactions.
Roadmap for Mergers Involving a Potential Entrant
There is little clarity or history regarding when potential competition is meaningful or sufficiently likely to play a factor in the ultimate analysis or trigger the special antitrust issues raised in connection with due diligence and preclosing integration in transactions with competitors. As demonstrated by the Steris court’s analysis, among the factors that should be considered are the following:
-
whether the potential competitor has entered into commitments with customers or vendors18
-
whether the potential competitor has a corporate practice of policy for approval or commitment to a strategy or entry into a new market and how close the firm is to satisfying the elements of that policy19
-
the existence of other potential competitors and how their progress compares with the potential competitor that is a party to the contemplated transaction20
-
whether significant barriers remain to the entry of the potential competitor, including the nature, status, cost and complexities of any regulatory requirements21
-
the likely timing of entry if matters progress as they were progressing before serious consideration of the transaction at issue22
-
whether the potential competitor continued to work towards its entry goals even after entering into a potential merger agreement23
-
relatedly, whether the other party to the transaction over-stepped its bounds and played a part in any decision to end the efforts to enter the market,24 and
-
the speed at which the market is evolving, including related technology, and where the potential competitor stands in the evolution process.25
Chief among the tools used to assess these factors are the parties’ public statements and internal documents regarding or reflecting all potential competition. If the parties intend to argue that plans for market entry have either been dropped or delayed and their internal documents do not reflect that decision, the risk is high that the applicable agency will not accept the parties’ argument. The agencies will view skeptically any effort to document that decision after the parties have begun serious consideration of the contemplated transaction. Accordingly, the parties should muster any preexisting evidence to back up the logic of the decision or the reasons underlying the decision, as well as any nonparty evidence. Additionally, evidence of other independent potential competitors could be key. Other equally well-positioned or likely potential competitors would eliminate much of the risk of a merger with another possible competitor.
Independence or Integrity of Potential Competitor’s Decision
Parties and advisers anxious to push transactions forward are often resistant to putting in place proper preclosing antitrust protocols when one of the two parties involved is only a potential competitor, as compared to an actual competitor. For example, where the buyer or target company is only a potential competitor, advisers often argue that diligence can be exchanged freely without restrictions on access to customer-specific competitively sensitive information.
Similarly, parties often want to “jump the gun” — begin integration of the firms or to become involved in or influence each other’s businesses too early in the transaction process. In the Steris case, if Steris had involved itself in Synergy’s push for customer commitments, analysis of their effort to enter the market, or decision to invest in or continue the X-ray technology project, the outcome of the preliminary injunction motion very likely would have been different. Transaction parties must permit each other to operate independently and in the best interest of each’s business. At a minimum, they should not interfere with customer or vendor relationships, strategic decisions, the ordinary course of their businesses, or decisions related to plans to compete against each other or in the future.
The Steris court’s ready acceptance of the “actual potential entrant” theory may or may not bolster the agencies’ willingness to challenge transactions involving potential competitors. Such companies, like direct competitors, should limit the exchange of competitively sensitive information to only that which is reasonably necessary to consummate the transaction and should not exchange the following:
-
customer-specific or product-specific pricing
-
customer-specific or product-specific margins
-
terms of specific significant vendor arrangements.
Instead, this type of competitively sensitive data should only be disclosed in aggregated, summary or historical form, such that the receiving party is unable to reverse engineer the information to influence its future pricing, sales or purchasing activities.
Moreover, the Steris decision demonstrates the importance of conducting a thorough antitrust analysis of all aspects of a merger or acquisition from every possible angle, including likely future competition. The agencies will focus not just on how the market looks today, but how the market could look tomorrow and beyond. A review of internal business planning documents, as well as interviews of key client personnel most familiar with the market, equipment, intellectual property and other factors necessary for success in the market, and strategic options under consideration at all levels of the business remains important. And, in cases involving potential competition, more important than ever.
Endnotes
1 FTC v. Steris Corp., 1:15-cv-1080, 2015 U.S. Dist. LEXIS 128470 (N.D. Ohio Sept. 24, 2015)
2 FTC Complaint, FTC v. Steris Corp., No. 1:15-cv-01080-DAP, at 6 ¶11 (N.D. Ohio filed May 29, 2015), available at https://www.ftc.gov/system/files/documents/cases/150529sterissynergytro.pdf.
3 Post Hearing Brief for FTC, Steris, No. 1:15-cv-01080-DAP, at 2 (N.D. Ohio filed Aug. 28, 2015), available at https://www.ftc.gov/system/files/documents/cases/150828posthearingbrief.pdf.
4 The FTC’s complaint relies not only on section 7, but also on section 5 of the FTC Act. As the FTC has made clear, it intends to rely on section 5 in matters where the challenged conduct is “likely to cause[] harm to competition”. Donald S. Clark, Sec’y, FTC, Statement of Enforcement Principles Regarding “Unfair Methods of Competition” Under Section 5 of the FTC Act (Aug. 13, 2015), available at https://www.ftc.gov/system/files/documents/public_statements/
735201/150813section5enforcement.pdf.
5 Brief for FTC, Steris, No. 1:15-cv-01080-DAP, at 6 (N.D. Ohio filed June 4, 2015), available at https://www.ftc.gov/system/files/documents/cases/150504ecfmemo.pdf.
6 See Int’l Shoe Co. v. FTC, 280 U.S. 291, 298 (1930).
7 Scheduling Order, Steris, No. 1:15-cv-01080-DAP (N.D. Ohio filed Aug. 20, 2015) available at https://www.ftc.gov/system/files/documents/cases/150820ecfschedulingorder.pdf.
8 Id.
9 Steris Corp., 2015 U.S. Dist. LEXIS 128470.
10 Id. at 43-53.
11 Id. at 53-56.
12 Id. at 59.
13 Id.
14 Id. at 60.
15 See The Commission Office of Public Affairs statement (Oct. 1, 2015), available at https://www.ftc.gov/system/files/documents/cases/151001sterisstmt.pdf.
16 See U.S. Dep’t of Justice & the Fed. Trade Comm’n, Horizontal Merger Guidelines, at § 1 (Aug. 19, 2010), available at http://ftc.gov/os/2010/08/100819hmg.pdf.
17 Id. at § 2.1.4 (emphasis added).
18 Steris Corp., 2015 U.S. Dist. LEXIS 128470 at *44-49.
19 Id. at *56-57.
20 Id. at *14-16.
21 Id. at *47-48.
22 Id. at *61-63.
23 Id. at *62.
24 Id. at *43, 61.
25 Id. at *63.
