[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.
This post is authored by Eric Fruits, (Chief Economist, International Center for Law & Economics).]
While much of the world of competition policy has focused on mergers in the COVID-19 era. Some observers see mergers as one way of saving distressed but valuable firms. Others have called for a merger moratorium out of fear that more mergers will lead to increased concentration and market power. In the meantime, there has been a growing push for increased nationalization of a wide range of businesses and industries.
In most cases, the call for a government takeover is not a reaction to the public health and economic crises associated with coronavirus. Instead, COVID-19 is a convenient excuse to pursue long sought after policies.
Last year, well before the pandemic, New York mayor Bill de Blasio called for a government takeover of electrical grid operator ConEd because he was upset over blackouts during a heatwave. Earlier that year, he threatened to confiscate housing units from private landlords, “we will seize their buildings, and we will put them in the hands of a community nonprofit that will treat tenants with the respect they deserve.”
With that sort of track record, it should come as no surprise the mayor proposed a government takeover of key industries to address COVID-19: “This is a case for a nationalization, literally a nationalization, of crucial factories and industries that could produce the medical supplies to prepare this country for what we need.” Dana Brown, director of The Next System Project at The Democracy Collaborative, agrees, “We should nationalize what remains of the American vaccine industry now, thereby assuring that any coronavirus vaccines produced can be made as widely available and as inexpensive soon as possible.”
Dan Sullivan in the American Prospect suggests the U.S. should nationalize all the airlines. Some have gone so far as calling for nationalization of the U.S. oil industry.
On the one hand, it’s clear that de Blasio and Brown have no confidence in the price system to efficiently allocate resources. Alternatively, they may have overconfidence in the political/bureaucratic system to efficiently, and “equitably,” distribute resources. On the other hand, as Daniel Takash points out in an earlier post, both pharmaceuticals and oil are relatively unpopular industries with many Americans, in which case the threat of a government takeover has a big dose of populist score settling:
Yet last year a Gallup poll found that of 25 major industries, the pharmaceutical industry was the most unpopular–trailing behind fossil fuels, lawyers, and even the federal government.
In the early days of the pandemic, France’s finance minister Bruno Le Maire promised to protect “big French companies.” The minister identified a range of actions under consideration: “That can be done by recapitalization, that can be done by taking a stake, I can even use the term nationalization if necessary.” While he did not mention any specific companies, it’s been speculated Air France KLM may be a target.
The Italian government is expected to nationalize Alitalia soon. The airline has been in state administration since May 2017, and the Italian government will have 100% control of the airline by June. Last week, the German government took a 20% stake in Lufthansa, in what has been characterized as a “temporary partial nationalization.” In Canada, Prime Minister Justin Trudeau has been coy about speculation that the government might nationalize Air Canada.
Obviously, these takeovers have “bailout” written all over them, and bailouts have their own anticompetitive consequences that can be worse than those associated with mergers. For example, RyanAir announced it will contest the aid package for Lufthansa. RyanAir chief executive Michael O’Leary claims the aid will allow Lufthansa to “engage in below-cost selling” and make it harder for RyanAir and its rival low-cost carrier EasyJet to compete.
There is also a bit of a “national champion” aspect to the takeovers. Each of the potential targets are (or were) considered their nation’s flagship airline. World Bank economists Tanja Goodwin and Georgiana Pop highlight the risk of nationalization harming competition:
These [sic] should avoid rescuing firms that were already failing. … But governments should also refrain from engaging in production or service delivery in industries that can be served by the private sector. The role of SOEs [state owned enterprises] should be assessed in order to ensure that bailout packages are not exclusively and unnecessarily favoring a dominant SOE.
To be sure, COVID-19 related mergers could raise the specter of increased market power post-pandemic. But, this risk must be balanced against the risks posed by a merger moratorium. These include the risk of widespread bankruptcies (that’s another post) and/or the possibility of nationalization of firms and industries. Either option can reduce competition which can bring harm to consumers, employees, and suppliers.
[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.
This post is authored by Geoffrey A. Manne, (President, ICLE; Distinguished Fellow, Northwestern University Center on Law, Business, and Economics); and Dirk Auer, (Senior Fellow of Law & Economics, ICLE)]
Back in 2012, Covidien, a large health care products company and medical device manufacturer, purchased Newport Medical Instruments, a small ventilator developer and manufacturer. (Covidien itself was subsequently purchased by Medtronic in 2015).
Eight years later, in the midst of the coronavirus pandemic, the New York Times has just published an article revisiting the Covidien/Newport transaction, and questioning whether it might have contributed to the current shortage of ventilators.
The article speculates that Covidien’s purchase of Newport, and the subsequent discontinuation of Newport’s “Aura” ventilator — which was then being developed by Newport under a government contract — delayed US government efforts to procure mechanical ventilators until the second half of 2020 — too late to treat the first wave of COVID-19 patients:
And then things suddenly veered off course. A multibillion-dollar maker of medical devices bought the small California company that had been hired to design the new machines. The project ultimately produced zero ventilators.
That failure delayed the development of an affordable ventilator by at least half a decade, depriving hospitals, states and the federal government of the ability to stock up.
* * *
Today, with the coronavirus ravaging America’s health care system, the nation’s emergency-response stockpile is still waiting on its first shipment.
The article has generated considerable interest not so much for what it suggests about government procurement policies or for its relevance to the ventilator shortages associated with the current pandemic, but rather for its purported relevance to ongoing antitrust debates and the arguments put forward by “antitrust populists” and others that merger enforcement in the US is dramatically insufficient.
Only a single sentence in the article itself points to a possible antitrust story — and it does nothing more than report unsubstantiated speculation from unnamed “government officials” and rival companies:
Government officials and executives at rival ventilator companies said they suspected that Covidien had acquired Newport to prevent it from building a cheaper product that would undermine Covidien’s profits from its existing ventilator business.
Nevertheless, and right on cue, various antitrust scholars quickly framed the deal as a so-called “killer acquisition” (see also here and here):
THE ULTIMATE KILLER ACQUISITION Officials and executives at rival ventilator companies suspected that Covidien had acquired Newport to prevent it from building a cheaper product that would undermine Covidien’s profits from its existing ventilator business.https://t.co/m8gk2Clsr2
Unsurprisingly, politicians were also quick to jump on the bandwagon. David Cicilline, the powerful chairman of the House Antitrust Subcommittee, opined that:
Based on the reporting on this deal, all signs point to the conclusion that this was a killer acquisition. (1/5) https://t.co/iKWsvsqFH6
And FTC Commissioner Rebecca Kelly Slaughter quickly called for a retrospective review of the deal:
The public reporting on this acquisition raises important questions about the review of this deal. We should absolutely be looking back to figure out what happened.
These “hot takes” raise a crucial issue. The New York Times story opened the door to a welter of hasty conclusions offered to support the ongoing narrative that antitrust enforcement has failed us — in this case quite literally at the cost of human lives. But are any of these claims actually supportable?
Unfortunately, the competitive realities of the mechanical ventilator industry, as well as a more clear-eyed view of what was likely going on with the failed government contract at the heart of the story, simply do not support the “killer acquisition” story.
What is a “killer acquisition”…?
Let’s take a step back. Because monopoly profits are, by definition, higher than joint duopoly profits (all else equal), economists have long argued that incumbents may find it profitable to acquire smaller rivals in order to reduce competition and increase their profits. More specifically, incumbents may be tempted to acquire would-be entrants in order to prevent them from introducing innovations that might hurt the incumbent’s profits.
For this theory to have any purchase, however, a number of conditions must hold. Most importantly, as Colleen Cunningham, Florian Ederer, and Song Ma put it in an influential paper:
“killer acquisitions” can only occur when the entrepreneur’s project overlaps with the acquirer’s existing product…. [W]ithout any product market overlap, the acquirer never has a strictly positive incentive to acquire the entrepreneur… because, without overlap, acquiring the project does not give the acquirer any gains resulting from reduced competition, and the two bargaining entities have exactly the same value for the project.
Moreover, the authors add that:
Successfully developing a new product draws consumer demand and profits away equally from all existing products. An acquiring incumbent is hurt more by such cannibalization when he is a monopolist (i.e., the new product draws demand away only from his own existing product) than when he already faces many other existing competitors (i.e., cannibalization losses are spread over many firms). As a result, as the number of existing competitors increases, the replacement effect decreases and the acquirer’s development decisions become more similar to those of the entrepreneur.
Finally, the “killer acquisition” terminology is appropriate only when the incumbent chooses to discontinue its rival’s R&D project:
If incumbents face significant existing competition, acquired projects are not significantly more frequently discontinued than independent projects. Thus, more competition deters incumbents from acquiring and terminating the projects of potential future competitors, which leads to more competition in the future.
…And what isn’t a killer acquisition?
What is left out of this account of killer acquisitions is the age-old possibility that an acquirer purchases a rival precisely because it has superior know-how or a superior governance structure that enables it to realize greater return and more productivity than its target. In the case of a so-called killer acquisition, this means shutting down a negative ROI project and redeploying resources to other projects or other uses — including those that may not have any direct relation to the discontinued project.
Such “synergistic” mergers are also — like allegedly “killer” mergers — likely to involve acquirers and targets in the same industry and with technological overlap between their R&D projects; it is in precisely these situations that the acquirer is likely to have better knowledge than the target’s shareholders that the target is undervalued because of poor governance rather than exogenous, environmental factors.
In other words, whether an acquisition is harmful or not — as the epithet “killer” implies it is — depends on whether it is about reducing competition from a rival, on the one hand, or about increasing the acquirer’s competitiveness by putting resources to more productive use, on the other.
As argued below, it is highly unlikely that Covidien’s acquisition of Newport could be classified as a “killer acquisition.” There is thus nothing to suggest that the merger materially impaired competition in the mechanical ventilator market, or that it measurably affected the US’s efforts to fight COVID-19.
The market realities of the ventilator market and its implications for the “killer acquisition” story
1. The mechanical ventilator market is highly competitive
As explained above, “killer acquisitions” are less likely to occur in competitive markets. Yet the mechanical ventilator industry is extremely competitive.
Medical ventilators market competition is intense.
The conclusion that the mechanical ventilator industry is highly competitive is further supported by the fact that the five largest producers combined reportedly hold only 50% of the market. In other words, available evidence suggests that none of these firms has anything close to a monopoly position.
This intense competition, along with the small market shares of the merging firms, likely explains why the FTC declined to open an in-depth investigation into Covidien’s acquisition of Newport.
Similarly, following preliminary investigations, neither the FTC nor the European Commission saw the need for an in-depth look at the ventilator market when they reviewed Medtronic’s subsequent acquisition of Covidien (which closed in 2015). Although Medtronic did not produce any mechanical ventilators before the acquisition, authorities (particularly the European Commission) could nevertheless have analyzed that market if Covidien’s presumptive market share was particularly high. The fact that they declined to do so tends to suggest that the ventilator market was relatively unconcentrated.
2. The value of the merger was too small
A second strong reason to believe that Covidien’s purchase of Newport wasn’t a killer acquisition is the acquisition’s value of $103 million.
Indeed, if it was clear that Newport was about to revolutionize the ventilator market, then Covidien would likely have been made to pay significantly more than $103 million to acquire it.
As noted above, the crux of the “killer acquisition” theory is that incumbents can induce welfare-reducing acquisitions by offering to acquire their rivals for significantly more than the present value of their rivals’ expected profits. Because an incumbent undertaking a “killer” takeover expects to earn monopoly profits as a result of the transaction, it can offer a substantial premium and still profit from its investment. It is this basic asymmetry that drives the theory.
Indeed, as a recent article by Kevin Bryan and Erik Hovenkamp notes, an acquisition value out of line with current revenues may be an indicator of the significance of a pending acquisition in which enforcers may not actually know the value of the target’s underlying technology:
[Where] a court may lack the expertise to [assess the commercial significance of acquired technology]…, the transaction value… may provide a reasonable proxy. Intuitively, if the startup is a relatively small company with relatively few sales to its name, then a very high acquisition price may reasonably suggest that the startup technology has significant promise.
The strategy only works, however, if the target firm’s shareholders agree that share value properly reflects only “normal” expected profits, and not that the target is poised to revolutionize its market with a uniquely low-cost or high-quality product. Relatively low acquisition prices relative to market size, therefore, tend to reflect low (or normal) expected profits, and a low perceived likelihood of radical innovations occurring.
We can apply this reasoning to Covidien’s acquisition of Newport:
Precise and publicly available figures concerning the mechanical ventilator market are hard to come by. Nevertheless, one estimate finds that the global ventilator market was worth $2.715 billion in 2012. Another report suggests that the global market was worth $4.30 billion in 2018; still another that it was worth $4.58 billion in 2019.
As noted above, Covidien reported to the SEC that it paid $103 million to purchase Newport (a firm that produced only ventilators and apparently had no plans to branch out).
For context, at the time of the acquisition Covidien had annual sales of $11.8 billion overall, and $743 million in sales of its existing “Airways and Ventilation Products.”
If the ventilator market was indeed worth billions of dollars per year, then the comparatively small $108 million paid by Covidien — small even relative to Covidien’s own share of the market — suggests that, at the time of the acquisition, it was unlikely that Newport was poised to revolutionize the market for mechanical ventilators (for instance, by successfully bringing its Aura ventilator to market).
The New York Times article claimed that Newport’s ventilators would be sold (at least to the US government) for $3,000 — a substantial discount from the reportedly then-going rate of $10,000. If selling ventilators at this price seemed credible at the time, then Covidien — as well as Newport’s shareholders — knew that Newport was about to achieve tremendous cost savings, enabling it to offer ventilators not only to the the US government, but to purchasers around the world, at an irresistibly attractive — and profitable — price.
Ventilators at the time typically went for about $10,000 each, and getting the price down to $3,000 would be tough. But Newport’s executives bet they would be able to make up for any losses by selling the ventilators around the world.
“It would be very prestigious to be recognized as a supplier to the federal government,” said Richard Crawford, who was Newport’s head of research and development at the time. “We thought the international market would be strong, and there is where Newport would have a good profit on the product.”
If achievable, Newport thus stood to earn a substantial share of the profits in a multi-billion dollar industry.
Of course, it is necessary to apply a probability to these numbers: Newport’s ventilator was not yet on the market, and had not yet received FDA approval. Nevertheless, if the Times’ numbers seemed credible at the time, then Covidien would surely have had to offer significantly more than $108 million in order to induce Newport’s shareholders to part with their shares.
Given the low valuation, however, as well as the fact that Newport produced other ventilators — and continues to do so to this day, there is no escaping the fact that everyone involved seemed to view Newport’s Aura ventilator as nothing more than a moonshot with, at best, a low likelihood of success.
Curically, this same reasoning explains why it shouldn’t surprise anyone that the project was ultimately discontinued; recourse to a “killer acquisition” theory is hardly necessary.
3. Lessons from Covidien’s ventilator product decisions
The killer acquisition claims are further weakened by at least four other important pieces of information:
Covidien initially continued to develop Newport’s Aura ventilator, and continued to develop and sell Newport’s other ventilators.
There was little overlap between Covidien and Newport’s ventilators — or, at the very least, they were highly differentiated
Covidien appears to have discontinued production of its own portable ventilator in 2014
The Newport purchase was part of a billion dollar series of acquisitions seemingly aimed at expanding Covidien’s in-hospital (i.e., not-portable) device portfolio
Covidien continued to develop and sell Newport’s ventilators
For a start, while the Aura line was indeed discontinued by Covidien, the timeline is important. The acquisition of Newport by Covidien was announced in March 2012, approved by the FTC in April of the same year, and the deal was closed on May 1, 2012.
However, as the FDA’s 510(k) database makes clear, Newport submitted documents for FDA clearance of the Aura ventilator months after its acquisition by Covidien (June 29, 2012, to be precise). And the Aura received FDA 510(k) clearance on November 9, 2012 — many months after the merger.
It would have made little sense for Covidien to invest significant sums in order to obtain FDA clearance for a project that it planned to discontinue (the FDA routinely requires parties to actively cooperate with it, even after 510(k) applications are submitted).
Moreover, if Covidien really did plan to discreetly kill off the Aura ventilator, bungling the FDA clearance procedure would have been the perfect cover under which to do so. Yet that is not what it did.
Covidien continued to develop and sell Newport’s other ventilators
Second, and just as importantly, Covidien (and subsequently Medtronic) continued to sell Newport’s other ventilators. The Newport e360 and HT70 are still sold today. Covidien also continued to improve these products: it appears to have introduced an improved version of the Newport HT70 Plus ventilator in 2013.
If eliminating its competitor’s superior ventilators was the only goal of the merger, then why didn’t Covidien also eliminate these two products from its lineup, rather than continue to improve and sell them?
At least part of the answer, as will be seen below, is that there was almost no overlap between Covidien and Newport’s product lines.
There was little overlap between Covidien’s and Newport’s ventilators
Third — and perhaps the biggest flaw in the killer acquisition story — is that there appears to have been very little overlap between Covidien and Newport’s ventilators.
This decreases the likelihood that the merger was a killer acquisition. When two products are highly differentiated (or not substitutes at all), sales of the first are less likely to cannibalize sales of the other. As Florian Ederer and his co-authors put it:
Importantly, without any product market overlap, the acquirer never has a strictly positive incentive to acquire the entrepreneur, neither to “Acquire to Kill” nor to “Acquire to Continue.” This is because without overlap, acquiring the project does not give the acquirer any gains resulting from reduced competition, and the two bargaining entities have exactly the same value for the project.
A quick search of the FDA’s 510(k) database reveals that Covidien has three approved lines of ventilators: the Puritan Bennett 980, 840, and 540 (apparently essentially the same as the PB560, the plans to which Medtronic recently made freely available in order to facilitate production during the current crisis). The same database shows that these ventilators differ markedly from Newport’s ventilators (particularly the Aura).
In particular, Covidien manufactured primarily traditional, invasive ICU ventilators (except for the PB540, which is potentially a substitute for the Newport HT70), while Newport made much-more-portable ventilators, suitable for home use (notably the Aura, HT50 and HT70 lines).
Under normal circumstances, critical care and portable ventilators are not substitutes. As the WHO website explains, portable ventilators are:
[D]esigned to provide support to patients who do not require complex critical care ventilators.
A quick glance at Medtronic’s website neatly illustrates the stark differences between these two types of devices:
This is not to say that these devices do not have similar functionalities, or that they cannot become substitutes in the midst of a coronavirus pandemic. However, in normal times (as was the case when Covidien acquired Newport), hospitals likely did not view these devices as substitutes.
The conclusion that Covidien and Newport’s ventilator were not substitutes finds further support in documents and statements released at the time of the merger. For instance, Covidien’s CEO explained that:
This acquisition is consistent with Covidien’s strategy to expand into adjacencies and invest in product categories where it can develop a global competitive advantage.
Newport’s products and technology complement our current portfolio of respiratory solutions and will broaden our ventilation platform for patients around the world, particularly in emerging markets.
In short, the fact that almost all of Covidien and Newport’s products were not substitutes further undermines the killer acquisition story. It also tends to vindicate the FTC’s decision to rapidly terminate its investigation of the merger.
Covidien appears to have discontinued production of its own portable ventilator in 2014
Perhaps most tellingly: It appears that Covidien discontinued production of its own competing, portable ventilator, the Puritan Bennett 560, in 2014.
The product is reported on the company’s 2011, 2012 and 2013 annual reports:
Airway and Ventilation Products — airway, ventilator, breathing systems and inhalation therapy products. Key products include: the Puritan Bennett™ 840 line of ventilators; the Puritan Bennett™ 520 and 560 portable ventilator….
Surely if Covidien had intended to capture the portable ventilator market by killing off its competition it would have continued to actually sell its own, competing device. The fact that the only portable ventilators produced by Covidien by 2014 were those it acquired in the Newport deal strongly suggests that its objective in that deal was the acquisition and deployment of Newport’s viable and profitable technologies — not the abandonment of them. This, in turn, suggests that the Aura was not a viable and profitable technology.
(Admittedly we are unable to determine conclusively that either Covidien or Medtronic stopped producing the PB520/540/560 series of ventilators. But our research seems to indicate strongly that this is indeed the case).
Putting the Newport deal in context
Finally, although not dispositive, it seems important to put the Newport purchase into context. In the same year as it purchased Newport, Covidien paid more than a billion dollars to acquire five other companies, as well — all of them primarily producing in-hospital medical devices.
That 2012 spending spree came on the heels of a series of previous medical device company acquisitions, apparently totally some four billion dollars. Although not exclusively so, the acquisitions undertaken by Covidien seem to have been primarily targeted at operating room and in-hospital monitoring and treatment — making the putative focus on cornering the portable (home and emergency) ventilator market an extremely unlikely one.
By the time Covidien was purchased by Medtronic the deal easily cleared antitrust review because of the lack of overlap between the company’s products, with Covidien’s focusing predominantly on in-hospital, “diagnostic, surgical, and critical care” and Medtronic’s on post-acute care.
Newport misjudged the costs associated with its Aura project; Covidien was left to pick up the pieces
So why was the Aura ventilator discontinued?
Although it is almost impossible to know what motivated Covidien’s executives, the Aura ventilator project clearly suffered from many problems.
The Aura project was intended to meet the requirements of the US government’s BARDA program (under the auspices of the U.S. Department of Health and Human Services’ Biomedical Advanced Research and Development Authority). In short, the program sought to create a stockpile of next generation ventilators for emergency situations — including, notably, pandemics. The ventilator would thus have to be designed for events where
mass casualties may be expected, and when shortages of experienced health care providers with respiratory support training, and shortages of ventilators and accessory components may be expected.
The Aura ventilator would thus sit somewhere between Newport’s two other ventilators: the e360 which could be used in pediatric care (for newborns smaller than 5kg) but was not intended for home care use (or the extreme scenarios envisioned by the US government); and the more portable HT70 which could be used in home care environments, but not for newborns.
Unfortunately, the Aura failed to achieve this goal. The FDA’s 510(k) clearance decision clearly states that the Aura was not intended for newborns:
The AURA family of ventilators is applicable for infant, pediatric and adult patients greater than or equal to 5 kg (11 lbs.).
the company was unable to secure FDA approval for use in neonatal populations — a contract requirement.
And the US Government RFP confirms that this was indeed an important requirement:
The device must be able to provide the same standard of performance as current FDA pre-market cleared portable ventilators and shall have the following additional characteristics or features:
• Flexibility to accommodate a wide patient population range from neonate to adult.
Newport also seems to have been unable to deliver the ventilator at the low price it had initially forecasted — a common problem for small companies and/or companies that undertake large R&D programs. It also struggled to complete the project within the agreed-upon deadlines. As the Medtronic press release explains:
Covidien learned that Newport’s work on the ventilator design for the Government had significant gaps between what it had promised the Government and what it could deliver — both in terms of being able to achieve the cost of production specified in the contract and product features and performance. Covidien management questioned whether Newport’s ability to complete the project as agreed to in the contract was realistic.
As Jason Crawford, an engineer and tech industry commentator, put it:
Projects fail all the time. “Supplier risk” should be a standard checkbox on anyone’s contingency planning efforts. This is even more so when you deliberately push the price down to 30% of the market rate. Newport did not even necessarily expect to be profitable on the contract.
The above is mostly Covidien’s “side” of the story, of course. But other pieces of evidence lend some credibility to these claims:
Newport agreed to deliver its Aura ventilator at a per unit cost of less than $3000. But, even today, this seems extremely ambitious. For instance, the WHO has estimated that portable ventilators cost between $3,300 and $13,500. If Newport could profitably sell the Aura at such a low price, then there was little reason to discontinue it (readers will recall the development of the ventilator was mostly complete when Covidien put a halt to the project).
Covidien/Newport is not the only firm to have struggled to offer suitable ventilators at such a low price. Philips (which took Newport’s place after the government contract fell through) also failed to achieve this low price. Rather than the $2,000 price sought in the initial RFP, Philips ultimately agreed to produce the ventilators for $3,280. But it has not yet been able to produce a single ventilator under the government contract at that price.
Covidien has repeatedly been forced to recall some of its other ventilators ( here, here and here) — including the Newport HT70. And rival manufacturers have also faced these types of issues (for example, here and here).
Accordingly, Covidien may well have preferred to cut its losses on the already problem-prone Aura project, before similar issues rendered it even more costly.
In short, while it is impossible to prove that these development issues caused Covidien to pull the plug on the Aura project, it is certainly plausible that they did. This further supports the hypothesis that Covidien’s acquisition of Newport was not a killer acquisition.
Ending the Aura project might have been an efficient outcome
As suggested above, moreover, it is entirely possible that Covidien was better able to realize the poor prospects of Newport’s Aura project and also better organized to enable it to make the requisite decision to abandon the project.
Moreover, the relatively large share of revue and reputation that Newport — worth $103 million in 2012, versus Covidien’s $11.8 billion — would have realized from fulfilling a substantial US government project could well have induced it to overestimate the project’s viability and to undertake excessive risk in the (vain) hope of bringing the project to fruition.
While there is a tendency among antitrust scholars, enforcers, and practitioners to look for (and find…) antitrust-related rationales for mergers and other corporate conduct, it remains the case that most corporate control transactions (such as mergers) are driven by the acquiring firm’s expectation that it can manage more efficiently. As Henry G. Manne put it in his seminal article, Mergers and the Market for Corporate Control (1965):
Since, in a world of uncertainty, profitable transactions will be entered into more often by those whose information is relatively more reliable, it should not surprise us that mergers within the same industry have been a principal form of changing corporate control. Reliable information is often available to suppliers and customers as well. Thus many vertical mergers may be of the control takeover variety rather than of the “foreclosure of competitors” or scale-economies type.
Of course, the same information that renders an acquiring firm in the same line of business knowledgeable enough to operate a target more efficiently could also enable it to effect a “killer acquisition” strategy. But the important point is that a takeover by a firm with a competing product line, after which the purchased company’s product line is abandoned, is at least as consistent with a “market for corporate control” story as with a “killer acquisition” story.
“Killer acquisitions” can have a nefarious image, but killing off a rival’s product was probably not the main purpose of the transaction, Ederer said. He raised the possibility that Covidien decided to kill Newport’s innovation upon realising that the development of the devices would be expensive and unlikely to result in profits.
Concluding remarks
In conclusion, Covidien’s acquisition of Newport offers a cautionary tale about reckless journalism, “blackboard economics,” and government failure.
Reckless journalism because the New York Times clearly failed to do the appropriate due diligence for its story. Its journalists notably missed (or deliberately failed to mention) a number of critical pieces of information — such as the hugely important fact that most of Covidien’s and Newport’s products did not overlap, or the fact that there were numerous competitors in the highly competitive mechanical ventilator industry.
And yet, that did not stop the authors from publishing their extremely alarming story, effectively suggesting that a small medical device merger materially contributed to the loss of many American lives.
What is studied is a system which lives in the minds of economists but not on earth.
Numerouscommentators rushed to fit the story to their preconceived narratives, failing to undertake even a rudimentary examination of the underlying market conditions before they voiced their recriminations.
Two explanations for what happened in this infuriating story: merger was a 'killer acquisition' to destroy future competition, or shareholders didn't have the patience, preferring safer, quicker profits.
I’m so angry. We in the anti-monopoly movement have for years been calling to stop “killer acquisitions,” when a company buys a competitor just to eliminate it. This @nytimes report takes that term to a grotesque level. https://t.co/WsvKW1blf7
The only thing that Covidien and Newport’s merger ostensibly had in common with the killer acquisition theory was the fact that a large firm purchased a small rival, and that the one of the small firm’s products was discontinued. But this does not even begin to meet the stringent conditions that must be fulfilled for the theory to hold water. Unfortunately, critics appear to have completely ignored all contradicting evidence.
Finally, what the New York Times piece does offer is a chilling tale of government failure.
The inception of the US government’s BARDA program dates back to 2008 — twelve years before the COVID-19 pandemic hit the US.
The collapse of the Aura project is no excuse for the fact that, more than six years after the Newport contract fell through, the US government still has not obtained the necessary ventilators. Questions should also be raised about the government’s decision to effectively put all of its eggs in the same basket — twice. If anything, it is thus government failure that was the real culprit.
And yet the New York Times piece and the critics shouting “killer acquisition!” effectively give the US government’s abject failure here a free pass — all in the service of pursuing their preferred “killer story.”
[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.
This post is authored by Eric Fruits, (Chief Economist, International Center for Law & Economics).]
The Wall Street Journal reports congressional leaders have agreed to impose limits on stock buybacks and dividend payments for companies receiving aid under the COVID-19 disaster relief package.
Rather than a flat-out ban, the draft legislation forbids any company taking federal emergency loans or loan guarantees from repurchasing its own stock or paying shareholder dividends. The ban lasts for the term of the loans, plus one year after the aid had ended.
In theory, under a strict set of conditions, there is no difference between dividends and buybacks. Both approaches distribute cash from the corporation to shareholders. In practice, there are big differences between dividends and share repurchases.
Dividends are publicly visible actions and require authorization by the board of directors. Shareholders have expectations of regular, stable dividends. Buybacks generally lack such transparency. Firms have flexibility in choosing the timing and the amount of repurchases, subject to the details of their repurchase programs.
Cash dividends have no effect on the number of shares outstanding. In contrast, share repurchases reduce the number of shares outstanding. By reducing the number of shares outstanding, buybacks increase earnings per share, all other things being equal.
Over the past 15 years, buybacks have outpaced dividend payouts. The figure above, from Seeking Alpha, shows that while dividends have grown relatively smoothly over time, the aggregate value of buybacks are volatile and vary with the business cycle. In general, firms increase their repurchases relative to dividends when the economy booms and reduce them when the economy slows or shrinks.
This observation is consistent with a theory that buybacks are associated with periods of greater-than-expected financial performance. On the other hand, dividends are associated with expectations of long-term profitability. Dividends can decrease, but only when profits are expected to be “permanently” lower.
During the Great Recession, the figure above shows that dividends declined by about 10%, the amount of share repurchases plummeted by approximately 85%. The flexibility afforded by buybacks provided stability in dividends.
There is some logic to dividend and buyback limits imposed by the COVID-19 disaster relief package. If a firm has enough cash on hand to pay dividends or repurchase shares, then it doesn’t need cash assistance from the federal government. Similarly, if a firm is so desperate for cash that it needs a federal loan or loan guarantee, then it doesn’t have enough cash to provide a payout to shareholders. Surely managers understand this and sophisticated shareholders should too.
Because of this understanding, the dividend and buyback limits may be a non-binding constraint. It’s not a “good look” for a corporation to accept millions of dollars in federal aid, only to turn around and hand out those taxpayer dollars to the company’s shareholders. That’s a sure way to get an unflattering profile in the New York Times and an invitation to attend an uncomfortable hearing at the U.S. Capitol. Even if a distressed firm could repurchase its shares, it’s unlikely that it would.
The logic behind the plus-one-year ban on dividends and buybacks is less clear. The relief package is meant to get the U.S. economy back to normal as fast as possible. That means if a firm repays its financial assistance early, the company’s shareholders should be rewarded with a cash payout rather than waiting a year for some arbitrary clock to run out.
The ban on dividends and buybacks may lead to an unintended consequence of increased merger and acquisition activity. Vox reports an email to Goldman Sachs’ investment banking division says Goldman expects to see an increase in hostile takeovers and shareholder activism as the prices of public companies fall. Cash rich firms who are subject to the ban and cannot get that cash to their existing shareholders may be especially susceptible takeover targets.
Desperate times call for desperate measures and these are desperate times. Buyback backlash has been brewing for sometime and the COVID-19 relief package presents a perfect opportunity to ban buybacks. With the pressures businesses are under right now, it’s unlikely there’ll be many buybacks over the next few months. The concern should be over the unintended consequences facing firms once the economy recovers.
[TOTM: The following is part of a symposium by TOTM guests and authors on the 2020 Vertical Merger Guidelines. The entire series of posts is available here.
This post is authored byGeoffrey A. Manne (President & Founder, ICLE; Distinguished Fellow, Northwestern University Center on Law, Business, and Economics ); and Kristian Stout (Associate Director, ICLE).]
Although it is doubtless correct that the 1984 guidelines don’t reflect the latest economic knowledge, it is by no means clear that this has actually been a problem — or that a new set of guidelines wouldn’t create even greater problems. Indeed, as others have noted in this symposium, there is a great deal of ambiguity in the proposed guidelines that could lead either to uncertainty as to how the agencies will exercise their discretion, or, more troublingly, could lead courts to take seriously speculative theories of harm.
We can do little better in expressing our reservations that new guidelines are needed than did the current Chairman of the FTC, Joe Simons, writing on this very blog in a symposium on what became the 2010 Horizontal Merger Guidelines. In a post entitled, Revisions to the Merger Guidelines: Above All, Do No Harm, Simons writes:
My sense is that there is no need to revise the DOJ/FTC Horizontal Merger Guidelines, with one exception…. The current guidelines lay out the general framework quite well and any change in language relative to that framework are likely to create more confusion rather than less. Based on my own experience, the business community has had a good sense of how the agencies conduct merger analysis…. If, however, the current administration intends to materially change the way merger analysis is conducted at the agencies, then perhaps greater revision makes more sense. But even then, perhaps the best approach is to try out some of the contemplated changes (i.e. in actual investigations) and publicize them in speeches and the like before memorializing them in a document that is likely to have some substantial permanence to it.
Wise words. Unless, of course, “the current [FTC] intends to materially change the way [vertical] merger analysis is conducted.” But the draft guidelines don’t really appear to portend a substantial change, and in several ways they pretty accurately reflect agency practice.
What we want to draw attention to, however, is an implicit underpinning of the draft guidelines that we believe the agencies should clearly disavow (or at least explain more clearly the complexity surrounding): the extent and implications of the presumed functional equivalence of vertical integration by contract and by merger — the contract/merger equivalency assumption.
Vertical mergers and their discontents
The contract/merger equivalency assumption has been gaining traction with antitrust scholars, but it is perhaps most clearly represented in some of Steve Salop’s work. Salop generally believes that vertical merger enforcement should be heightened. Among his criticisms of current enforcement is his contention that efficiencies that can be realized by merger can often also be achieved by contract. As he discussed during his keynote presentation at last year’s FTC hearing on vertical mergers:
And, finally, the key policy issue is the issue is not about whether or not there are efficiencies; the issue is whether the efficiencies are merger-specific. As I pointed out before, Coase stressed that you can get vertical integration by contract. Very often, you can achieve the vertical efficiencies if they occur, but with contracts rather than having to merge.
And later, in the discussion following his talk:
If there is vertical integration by contract… it meant you could get all the efficiencies from vertical integration with a contract. You did not actually need the vertical integration.
Salop thus argues that because the existence of a “contract solution” to firm problems can often generate the same sorts of efficiencies as when firms opt to merge, enforcers and courts should generally adopt a presumption against vertical mergers relative to contracting:
Coase’s door swings both ways: Efficiencies often can be achieved by vertical contracts, without the potential anticompetitive harms from merger.
In that vertical restraints are characterized as “just” vertical integration “by contract,” then claimed efficiencies in problematical mergers might be achieved with non-merger contracts that do not raise the same anticompetitive concerns. (emphasis in original)
(Salop isn’t alone in drawing such a conclusion, of course; Carl Shapiro, for example, has made a similar point (as have others)).
In our next post we explore the policy errors implicated by this contract/merger equivalency assumption. But here we want to consider whether it makes logical sense in the first place.
The logic of vertical integration is not commutative
It is true that, where contracts are observed, they are likely as (or more, actually) efficient than merger. But, by the same token, it is also true that where mergers are observed they are likely more efficient than contracts. Indeed, the entire reason for integration is efficiency relative to what could be done by contract — this is the essence of the so-called “make-or-buy” decision.
For example, a firm that decides to buy its own warehouse has determined that doing so is more efficient than renting warehouse space. Some of these efficiencies can be measured and quantified (e.g., carrying costs of ownership vs. the cost of rent), but many efficiencies cannot be easily measured or quantified (e.g., layout of the facility or site security). Under the contract/merger equivalency assumption, the benefits of owning a warehouse can be achieved “very often” by renting warehouse space. But the fact that many firms using warehouses own some space and rent some space indicates that the make-or-buy decision is often unique to each firm’s idiosyncratic situation. Moreover, the distinctions driving those differences will not always be readily apparent, and whether contracting or integrating is preferable in any given situation may not be inferred from the existence of one or the other elsewhere in the market — or even in the same firm!
There is no reason to presume in any given situation that the outcome from contracting would be the same as from merging, even where both are notionally feasible. The two are, quite simply, different bargaining environments, each with a different risk and cost allocation; accounting treatment; effect on employees, customers, and investors; tax consequence, etc. Even if the parties accomplished nominally “identical” outcomes, they would not, in fact, be identical.
Meanwhile, what if the reason for failure to contract, or the reason to prefer merger, has nothing to do with efficiency? What if there were no anticompetitive aim but there were a tax advantage? What if one of the parties just wanted a larger firm in order to satisfy the CEO’s ego? That these are not cognizable efficiencies under antitrust law is clear. But the adoption of a presumption of equivalence between contract and merger would — ironically — entail their incorporation into antitrust law just the same — by virtue of their effective prohibition under antitrust law.
In other words, if the assumption is that contract and merger are equally efficient unless proven otherwise, but the law adopts a suspicion (or, even worse, a presumption) that vertical mergers are anticompetitive which can be rebutted only with highly burdensome evidence of net efficiency gain, this effectively deputizes antitrust law to enforce a preconceived notion of “merger appropriateness” that does not necessarily turn on efficiencies. There may (or may not) be sensible policy reasons for adopting such a stance, but they aren’t antitrust reasons.
More fundamentally, however, while there are surely some situations in which contractual restraints might be able to achieve similar organizational and efficiency gains as a merger, the practical realities of achieving not just greater efficiency, but a whole host of non-efficiency-related, yet nonetheless valid, goals, are rarely equivalent between the two.
It may be that the parties don’t know what they don’t know to such an extent that a contract would be too costly because it would be too incomplete, for example. But incomplete contracts and ambiguous control and ownership rights aren’t (as much of) an issue on an ongoing basis after a merger.
As noted, there is no basis for assuming that the structure of a merger and a contract would be identical. In the same way, there is no basis for assuming that the knowledge transfer that would result from a merger would be the same as that which would result from a contract — and in ways that the parties could even specify or reliably calculate in advance. Knowing that the prospect for knowledge “synergies” would be higher with a merger than a contract might be sufficient to induce the merger outcome. But asked to provide evidence that the parties could not engage in the same conduct via contract, the parties would be unable to do so. The consequence, then, would be the loss of potential gains from closer integration.
At the same time, the cavalier assumption that parties would be able — legally — to enter into an analogous contract in lieu of a merger is problematic, given that it would likely be precisely the form of contract (foreclosing downstream or upstream access) that is alleged to create problems with the merger in the first place.
I want to reemphasize that there are also rules against vertical restraints in antitrust laws, and so to say that the firms could achieve the mergers outcome by using vertical restraints is kind of putting them in a circular motion where we are telling them you cannot merge because you could do it by contract, and then we say, but these contract terms are not acceptable.
Indeed, legal risk is one of the reasons why a merger might be preferable to a contract, and because the relevant markets here are oligopoly markets, the possibility of impermissible vertical restraints between large firms with significant market share is quite real.
More important, the assumptions underlying the contention that contracts and mergers are functionally equivalent legal devices fails to appreciate the importance of varied institutional environments. Consider that one reason some takeovers are hostile is because incumbent managers don’t want to merge, and often believe that they are running a company as well as it can be run — that a change of corporate control would not improve efficiency. The same presumptions may also underlie refusals to contract and, even more likely, may explain why, to the other firm, a contract would be ineffective.
But, while there is no way to contract without bilateral agreement, there is a corporate control mechanism to force a takeover. In this institutional environment a merger may be easier to realize than a contract (and that applies even to a consensual merger, of course, given the hostile outside option). In this case, again, the assumption that contract should be the relevant baseline and the preferred mechanism for coordination is misplaced — even if other firms in the industry are successfully accomplishing the same thing via contract, and even if a contract would be more “efficient” in the abstract.
Conclusion
Properly understood, the choice of whether to contract or merge derives from a host of complicated factors, many of which are difficult to observe and/or quantify. The contract/merger equivalency assumption — and the species of “least-restrictive alternative” reasoning that would demand onerous efficiency arguments to permit a merger when a contract was notionally possible — too readily glosses over these complications and unjustifiably embraces a relative hostility to vertical mergers at odds with both theory and evidence.
Rather, as has long been broadly recognized, there can be no legally relevant presumption drawn against a company when it chooses one method of vertical integration over another in the general case. The agencies should clarify in the draft guidelines that the mere possibility of integration via contract or the inability of merging parties to rigorously describe and quantify efficiencies does not condemn a proposed merger.
As has been rumored in the press for a few weeks, today Comcast announced it is considering making a renewed bid for a large chunk of Twenty-First Century Fox’s (Fox) assets. Fox is in the process of a significant reorganization, entailing primarily the sale of its international and non-television assets. Fox itself will continue, but with a focus on its US television business.
In December of last year, Fox agreed to sell these assets to Disney, in the process rejecting a bid from Comcast. Comcast’s initial bid was some 16% higher than Disney’s, although there were other differences in the proposed deals, as well.
In April of this year, Disney and Fox filed a proxy statement with the SEC explaining the basis for the board’s decision, including predominantly the assertion that the Comcast bid (NB: Comcast is identified as “Party B” in that document) presented greater regulatory (antitrust) risk.
As noted, today Comcast announced it is in “advanced stages” of preparing another unsolicited bid. This time,
Any offer for Fox would be all-cash and at a premium to the value of the current all-share offer from Disney. The structure and terms of any offer by Comcast, including with respect to both the spin-off of “New Fox” and the regulatory risk provisions and the related termination fee, would be at least as favorable to Fox shareholders as the Disney offer.
Because, as we now know (since the April proxy filing), Fox’s board rejected Comcast’s earlier offer largely on the basis of the board’s assessment of the antitrust risk it presented, and because that risk assessment (and the difference between an all-cash and all-share offer) would now be the primary distinguishing feature between Comcast’s and Disney’s bids, it is worth evaluating that conclusion as Fox and its shareholders consider Comcast’s new bid.
In short: There is no basis for ascribing a greater antitrust risk to Comcast’s purchase of Fox’s assets than to Disney’s.
Summary of the Proposed Deal
Post-merger, Fox will continue to own Fox News Channel, Fox Business Network, Fox Broadcasting Company, Fox Sports, Fox Television Stations Group, and sports cable networks FS1, FS2, Fox Deportes, and Big Ten Network.
The deal would transfer to Comcast (or Disney) the following:
Primarily, international assets, including Fox International (cable channels in Latin America, the EU, and Asia), Star India (the largest cable and broadcast network in India), and Fox’s 39% interest in Sky (Europe’s largest pay TV service).
Fox’s film properties, including 20th Century Fox, Fox Searchlight, and Fox Animation. These would bring along with them studios in Sydney and Los Angeles, but would not include the Fox Los Angeles backlot. Like the rest of the US film industry, the majority of Fox’s film revenue is earned overseas.
FX cable channels, National Geographic cable channels (of which Fox currently owns 75%), and twenty-two regional sports networks (RSNs). In terms of relative demand for the two cable networks, FX is a popular basic cable channel, but fairly far down the list of most-watched channels, while National Geographic doesn’t even crack the top 50. Among the RSNs, only one geographic overlap exists with Comcast’s current RSNs, and most of the Fox RSNs (at least 14 of the 22) are not in areas where Comcast has a substantial service presence.
The deal would also entail a shift in the companies’ ownership interests in Hulu. Hulu is currently owned in equal 30% shares by Disney, Comcast, and Fox, with the remaining, non-voting 10% owned by Time Warner. Either Comcast or Disney would hold a controlling 60% share of Hulu following the deal with Fox.
Analysis of the Antitrust Risk of a Comcast/Fox Merger
According to the joint proxy statement, Fox’s board discounted Comcast’s original $34.36/share offer — but not the $28.00/share offer from Disney — because of “the level of regulatory issues posed and the proposed risk allocation arrangements.” Significantly on this basis, the Fox board determined Disney’s offer to be superior.
The claim that a merger with Comcast poses sufficiently greater antitrust risk than a purchase by Disney to warrant its rejection out of hand is unsupportable, however. From an antitrust perspective, it is even plausible that a Comcast acquisition of the Fox assets would be on more-solid ground than would be a Disney acquisition.
Vertical Mergers Generally Present Less Antitrust Risk
A merger between Comcast and Fox would be predominantly vertical, while a merger between Disney and Fox, in contrast, would be primarily horizontal. Generally speaking, it is easier to get antitrust approval for vertical mergers than it is for horizontal mergers. As Bruce Hoffman, Director of the FTC’s Bureau of Competition, noted earlier this year:
[V]ertical merger enforcement is still a small part of our merger workload….
There is a strong theoretical basis for horizontal enforcement because economic models predict at least nominal potential for anticompetitive effects due to elimination of horizontal competition between substitutes.
Where horizontal mergers reduce competition on their face — though that reduction could be minimal or more than offset by benefits — vertical mergers do not…. [T]here are plenty of theories of anticompetitive harm from vertical mergers. But the problem is that those theories don’t generally predict harm from vertical mergers; they simply show that harm is possible under certain conditions.
On its face, and consistent with the last quarter century of merger enforcement by the DOJ and FTC, the Comcast acquisition would be less likely to trigger antitrust scrutiny, and the Disney acquisition raises more straightforward antitrust issues.
This is true even in light of the fact that the DOJ decided to challenge the AT&T-Time Warner (AT&T/TWX) merger.
The AT&T/TWX merger is a single data point in a long history of successful vertical mergers that attracted little scrutiny, and no litigation, by antitrust enforcers (although several have been approved subject to consent orders).
Just because the DOJ challenged that one merger does not mean that antitrust enforcers generally, nor even the DOJ in particular, have suddenly become more hostile to vertical mergers.
Of particular importance to the conclusion that the AT&T/TWX merger challenge is of minimal relevance to predicting the DOJ’s reception in this case, the theory of harm argued by the DOJ in that case is far from well-accepted, while the potential theory that could underpin a challenge to a Disney/Fox merger is. As Bruce Hoffman further remarks:
I am skeptical of arguments that vertical mergers cause harm due to an increased bargaining skill; this is likely not an anticompetitive effect because it does not flow from a reduction in competition. I would contrast that to the elimination of competition in a horizontal merger that leads to an increase in bargaining leverage that could raise price or reduce output.
The Relatively Lower Risk of a Vertical Merger Challenge Hasn’t Changed Following the DOJ’s AT&T/Time Warner Challenge
Judge Leon is expected to rule on the AT&T/TWX merger in a matter of weeks. The theory underpinning the DOJ’s challenge is problematic (to say the least), and the case it presented was decidedly weak. But no litigated legal outcome is ever certain, and the court could, of course, rule against the merger nevertheless.
Yet even if the court does rule against the AT&T/TWX merger, this hardly suggests that a Comcast/Fox deal would create a greater antitrust risk than would a Disney/Fox merger.
A single successful challenge to a vertical merger — what would be, in fact, the first successful vertical merger challenge in four decades — doesn’t mean that the courts are becoming hostile to vertical mergers any more than the DOJ’s challenge means that vertical mergers suddenly entail heightened enforcement risk. Rather, it would simply mean that that, given the specific facts of the case, the DOJ was able to make out its prima facie case, and that the defendants were unable to rebut it.
A ruling for the DOJ in the AT&T/TWX merger challenge would be rooted in a highly fact-specific analysis that could have no direct bearing on future cases.
In the AT&T/TWX case, the court’s decision will turn on its assessment of the DOJ’s argument that the merged firm could raise subscriber prices by a few pennies per subscriber. But as AT&T’s attorney aptly pointed out at trial (echoing the testimony of AT&T’s economist, Dennis Carlton):
The government’s modeled price increase is so negligible that, given the inherent uncertainty in that predictive exercise, it is not meaningfully distinguishable from zero.
Even minor deviations from the facts or the assumptions used in the AT&T/TWX case could completely upend the analysis — and there are important differences between the AT&T/TWX merger and a Comcast/Fox merger. True, both would be largely vertical mergers that would bring together programming and distribution assets in the home video market. But the foreclosure effects touted by the DOJ in the AT&T/TWX merger are seemingly either substantially smaller or entirely non-existent in the proposed Comcast/Fox merger.
Most importantly, the content at issue in AT&T/TWX is at least arguably (and, in fact, argued by the DOJ) “must have” programming — Time Warner’s premium HBO channels and its CNN news programming, in particular, were central to the DOJ’s foreclosure argument. By contrast, the programming that Comcast would pick up as a result of the proposed merger with Fox — FX (a popular, but non-essential, basic cable channel) and National Geographic channels (which attract a tiny fraction of cable viewing) — would be extremely unlikely to merit that designation.
Moreover, the DOJ made much of the fact that AT&T, through DirectTV, has a national distribution footprint. As a result, its analysis was dependent upon the company’s potential ability to attract new subscribers decamping from competing providers from whom it withholds access to Time Warner content in every market in the country. Comcast, on the other hand, provides cable service in only about 35% of the country. This significantly limits its ability to credibly threaten competitors because its ability to recoup lost licensing fees by picking up new subscribers is so much more limited.
And while some RSNs may offer some highly prized live sports programming, the mismatch between Comcast’s footprint and the FOX RSNs (only about 8 of the 22 Fox RSNs are in Comcast service areas) severely limits any ability or incentive the company would have to leverage that content for higher fees. Again, to the extent that RSN programming is not “must-have,” and to the extent there is not overlap between the RSN’s geographic area and Comcast’s service area, the situation is manifestly not the same as the one at issue in the AT&T/TWX merger.
In sum, a ruling in favor of the DOJ in the AT&T/TWX case would be far from decisive in predicting how the agency and the courts would assess any potential concerns arising from Comcast’s ownership of Fox’s assets.
A Comcast/Fox Deal May Entail Lower Antitrust Risk than a Disney/Fox Merger
As discussed below, concerns about antitrust enforcement risk from a Comcast/Fox merger are likely overstated. Perhaps more importantly, however, to the extent these concerns are legitimate, they apply at least as much to a Disney/Fox merger. There is, at minimum, no basis for assuming a Comcast deal would present any greater regulatory risk.
The Antitrust Risk of a Comcast/Fox Merger Is Likely Overstated
The primary theory upon which antitrust enforcers could conceivably base a Comcast/Fox merger challenge would be a vertical foreclosure theory. Importantly, such a challenge would have to be based on the incremental effect of adding the Fox assets to Comcast, and not on the basis of its existing assets. Thus, for example, antitrust enforcers would not be able to base a merger challenge on the possibility that Comcast could leverage NBC content it currently owns to extract higher fees from competitors. Rather, only if the combination of NBC programming with additional content from Fox could create a new antitrust risk would a case be tenable.
Enforcers would be unlikely to view the addition of FX and National Geographic to the portfolio of programming content Comcast currently owns as sufficient to raise concerns that the merger would give Comcast anticompetitive bargaining power or the ability to foreclose access to its content.
Although even less likely, enforcers could be concerned with the (horizontal) addition of 20th Century Fox filmed entertainment to Universal’s existing film production and distribution. But the theatrical film market is undeniably competitive, with the largest studio by revenue (Disney) last year holding only 22% of the market. The combination of 20th Century Fox with Universal would still result in a market share only around 25% based on 2017 revenues (and, depending on the year, not even result in the industry’s largest share).
There is also little reason to think that a Comcast controlling interest in Hulu would attract problematic antitrust attention. Comcast has already demonstrated an interest in diversifying its revenue across cable subscriptions and licensing, broadband subscriptions, and licensing to OVDs, as evidenced by its recent deal to offer Netflix as part of its Xfinity packages. Hulu likely presents just one more avenue for pursuing this same diversification strategy. And Universal has a history (see, e.g., this, this, and this) of very broad licensing across cable providers, cable networks, OVDs, and the like.
In the case of Hulu, moreover, the fact that Comcast is vertically integrated in broadband as well as cable service likely reduces the anticompetitive risk because more-attractive OVD content has the potential to increase demand for Comcast’s broadband service. Broadband offers larger margins (and is growing more rapidly) than cable, and it’s quite possible that any loss in Comcast’s cable subscriber revenue from Hulu’s success would be more than offset by gains in its content licensing and broadband subscription revenue. The same, of course, goes for Comcast’s incentives to license content to OVD competitors like Netflix: Comcast plausibly gains broadband subscription revenue from heightened consumer demand for Netflix, and this at least partially offsets any possible harm to Hulu from Netflix’s success.
At the same time, especially relative to Netflix’s vast library of original programming (an expected $8 billion worth in 2018 alone) and content licensed from other sources, the additional content Comcast would gain from a merger with Fox is not likely to appreciably increase its bargaining leverage or its ability to foreclose Netflix’s access to its content.
Finally, Comcast’s ownership of Fox’s RSNs could, as noted, raise antitrust enforcers’ eyebrows. Enforcers could be concerned that Comcast would condition competitors’ access to RSN programming on higher licensing fees or prioritization of its NBC Sports channels.
While this is indeed a potential risk, it is hardly a foregone conclusion that it would draw an enforcement action. Among other things, NBC is far from the market leader, and improving its competitive position relative to ESPN could be viewed as a benefit of the deal. In any case, potential problems arising from ownership of the RSNs could easily be dealt with through divestiture or behavioral conditions; they are extremely unlikely to lead to an outright merger challenge.
The Antitrust Risk of a Disney Deal May Be Greater than Expected
While a Comcast/Fox deal doesn’t entail no antitrust enforcement risk, it certainly doesn’t entail sufficient risk to deem the deal dead on arrival. Moreover, it may entail less antitrust enforcement risk than would a Disney/Fox tie-up.
Yet, curiously, the joint proxy statement doesn’t mention any antitrust risk from the Disney deal at all and seems to suggest that the Fox board applied no risk discount in evaluating Disney’s bid.
Disney — already the market leader in the filmed entertainment industry — would acquire an even larger share of box office proceeds (and associated licensing revenues) through acquisition of Fox’s film properties. Perhaps even more important, the deal would bring the movie rights to almost all of the Marvel Universe within Disney’s ambit.
While, as suggested above, even that combination probably wouldn’t trigger any sort of market power presumption, it would certainly create an entity with a larger share of the market and stronger control of the industry’s most valuable franchises than would a Comcast/Fox deal.
Another relatively larger complication for a Disney/Fox merger arises from the prospect of combining Fox’s RSNs with ESPN. Whatever ability or incentive either company would have to engage in anticompetitive conduct surrounding sports programming, that risk would seem to be more significant for undisputed market leader, Disney. At the same time, although still powerful, demand for ESPN on cable has been flagging. Disney could well see the ability to bundle ESPN with regional sports content as a way to prop up subscription revenues for ESPN — a practice, in fact, that it has employed successfully in the past.
Disney is the world’s largest licensor, earning almost $57 billion in 2016 from licensing properties like Star Wars and Marvel Comics. Universal is in a distant 7th place, with 2016 licensing revenue of about $6 billion. Adding Fox’s (admittedly relatively small) licensing business would enhance Disney’s substantial lead (even the number two global licensor, Meredith, earned less than half of Disney’s licensing revenue in 2016). Again, this is unlikely to be a significant concern for antitrust enforcers, but it is notable that, to the extent it might be an issue, it is one that applies to Disney and not Comcast.
Conclusion
Although I hope to address these issues in greater detail in the future, for now the preliminary assessment is clear: There is no legitimate basis for ascribing a greater antitrust risk to a Comcast/Fox deal than to a Disney/Fox deal.
establish, among other things, a procedure for the automatic withdrawal of an HSR filing upon the submission of a filing to the U.S. Securities and Exchange Commission announcing that the notified transaction has been terminated.
The proposed rulemaking appears to be a solution in search of a problem. The Federal Register notice states that the proposed rules are necessary to prevent the FTC and DOJ from “expend[ing] scarce resources on hypothetical transactions.” Yet, I have not to date been presented with evidence that any of the over 68,000 transactions notified under the HSR rules have required Commission resources to be allocated to a truly hypothetical transaction. Indeed, it would be surprising to see firms incurring the costs and devoting the time and effort associated with antitrust review in the absence of a good faith intent to proceed with their transaction.
The proposed rules, if adopted, could increase the costs of corporate takeovers and thus distort the market for corporate control. Some companies that had complied with or were attempting to comply with a Second Request, for example, could be forced to restart their antitrust review, leading to significant delays and added expenses. The proposed rules could also create incentives for firms to structure their transactions less efficiently and discourage the use of tender offers. Finally, the proposed new rules will disproportionately burden U.S. public companies; the Federal Register notice acknowledges that the new rules will not apply to tender offers for many non-public and foreign companies.
Given these concerns, I hope that interested parties will avail themselves of the opportunity to submit public comments so that the Commission can make an informed decision at the conclusion of this process.
Apparently none of the other commissioners shared his concerns. But they remain valid. Most importantly, the amendments were adopted without a shred of evidence to suggest they were needed or would be helpful in any way. As Josh says in his dissent:
It has long been accepted as a principle of good governance that federal agencies should issue new regulations only if their benefits exceed their costs….However, I have not seen evidence that any of the over 68,000 transactions that have been notified under the HSR Rules has resulted in the allocation of resources to a truly hypothetical transaction.
In the absence of evidence that the automatic withdrawal rule would remedy a problem that exists under the current HSR regime, and thus benefit the public, I believe we should refrain from creating new regulations.
For what it’s worth. the single comment received by the Commission on the proposed rule supported Josh’s views:
Although the rule may prevent such inefficiency in the future, it would also require companies to incur substantial costs in premerger negotiations and resource allocation while waiting for FTC approval during the HSR period. Currently, firms can avoid such costs by temporarily withdrawing offers or agreements until they are assured of FTC approval. Under the proposed rule, however, doing so would automatically withdraw a company’s HSR filing, subjecting it to another HSR filing and filing fee.
Presumably the absence of other comments means the business community isn’t too concerned about the amendments. But that doesn’t mean they should have been adopted without any evidence to support the claim that they were needed. I commend Josh for sticking to his principles and going down swinging.
Although it probably flew under almost everyone’s radar, last week Josh issued his first Concurring Statement as an FTC Commissioner. The statement came in response to a seemingly arcane Notice of Proposed Rulemaking relating to Hart-Scott-Rodino Premerger Notification Rules:
The proposed rules also establish a procedure for the automatic withdrawal of an HSR filing when filings are made with the U.S. Securities and Exchange Commission (SEC) announcing that a transaction has been terminated.
The proposed rulemaking itself isn’t enormously significant, but Josh’s statement lays down a marker that indicates (as anyone could have predicted) that he intends to do everything he can to improve the agency and its process.
The rule, as suggested above, would automatically withdraw an HSR filing whenever transacting parties filed certain notices with the SEC announcing the termination of a deal. You may recall that the Hertz/Dollar Thrifty deal had been in the works for at least five years when it finally closed. When Hertz withdrew its tender offer in October 2011, it did not withdraw its HSR filing. As reported at the time, Hertz withdrew its bid over difficulty securing FTC approval, which had plagued other offers for Thrifty:
In a sign of frustration, Mr. Thompson said that the company had spent some $30 million over the last few years dealing with the barrage of takeover offers.
Obviously, given the difficulty of securing FTC approval and the costs imposed by the uncertainty it created, there was real benefit to Hertz (and perhaps Thrifty, for that matter) from receiving a decision from the FTC without meanwhile tying up the company’s resources, restraining its decision- and deal-making abilities, complicating negotiations and weakening its credit by maintaining a stalled-but-pending merger. So the deal was withdrawn, but the HSR filing was not.
In August 2012 the parties re-initiated the merger following ongoing consultations by Hertz with the FTC, and, in November 2012 — a full year after the deal was withdrawn (and a year and a half after the HSR filing) — the FTC approved the deal.
But, understandably, FTC staff don’t want to be wasting resources reviewing hypothetical transactions, and so, following on the heels of the Hertz/Dollar Thrifty deal, wrote the proposed rule to ensure that it never happens again.
Except it didn’t happen in Hertz because, after all, the deal was eventually made. According to Josh, in fact, the situation intended to be avoided by the rule has never arisen:
The proposed rulemaking appears to be a solution in search of a problem. The Federal Register notice states that the proposed rules are necessary to prevent the FTC and DOJ from “expend[ing] scarce resources on hypothetical transactions.” Yet, I have not to date been presented with evidence that any of the over 68,000 transactions notified under the HSR rules have required Commission resources to be allocated to a truly hypothetical transaction. Indeed, it would be surprising to see firms incurring the costs and devoting the time and effort associated with antitrust review in the absence of a good faith intent to proceed with their transaction.
This isn’t to say (and Josh doesn’t say) that the proposed rule is a bad idea, just that, given the apparently negligible benefits of the rule, the costs could easily outweigh the benefits.
Which is why Josh’s Statement is important. What Josh is asking for is not that the rule be scrapped, but simply that, before adopting the rule, the FTC weigh its costs and benefits. And as Josh points out, there could indeed be some costs:
The proposed rules, if adopted, could increase the costs of corporate takeovers and thus distort the market for corporate control. Some companies that had complied with or were attempting to comply with a Second Request, for example, could be forced to restart their antitrust review, leading to significant delays and added expenses. The proposed rules could also create incentives for firms to structure their transactions less efficiently and discourage the use of tender offers. Finally, the proposed new rules will disproportionately burden U.S. public companies; the Federal Register notice acknowledges that the new rules will not apply to tender offers for many non-public and foreign companies.
Given these concerns, I hope that interested parties will avail themselves of the opportunity to submit public comments so that the Commission can make an informed decision at the conclusion of this process.
What is surprising is not that Josh suggested that there might be unanticipated costs to such a rule, nor that cost-benefit analysis be applied. Rather, what’s surprising is that the rest of the Commission didn’t sign on. Why is that surprising? Well, because cost-benefit analysis is not only sensible, it’s consistent with the Obama Administration’s stated regulatory approach. Executive Order 13563 requires that:
Each agency must, among other things: (1) propose or adopt a regulation only upon a reasoned determination that its benefits justify its costs (recognizing that some benefits and costs are difficult to quantify) . . . In applying these principles, each agency is directed to use the best available techniques to quantify anticipated present and future benefits and costs as accurately as possible.
The FCC, FTC and many other regulatory agencies aren’t required to do cost-benefit analysis at all. Because these are “independent agencies”—creatures of Congress rather than part of the Executive Branch (like the Department of Justice)—only Congress can impose cost-benefit analysis on agencies. A bipartisan bill, the Independent Agency Regulatory Analysis Act (S. 3486), would have allowed the President to impose the same kind of cost-benefit analysis on independent regulatory agencies as on Executive Branch agencies, including review by the Office of Information and Regulatory Affairs (OIRA) for “significant” rulemakings (those with $100 million or more in economic impact, that adversely affect sectors of the economy in a material way, or that create “serious inconsistency” with other agencies’ actions). . . . yet the bill has apparently died . . . .
Legislation or not, it is the Commission’s responsibility to ensure that the rules it enacts will actually be beneficial (it is a consumer protection agency, after all). The staff, presumably, did a perfectly fine job writing the rule they were asked to write. Josh’s point is simply that it isn’t clear the rule should be adopted because it isn’t clear that the benefits of doing so would outweigh the costs.
It may have happened before, but I can’t recall an FTC Commissioner laying down the cost-benefit-analysis gauntlet and publicly calling for consistent cost-benefit review at the Commission, even of seemingly innocuous (but often not actually innocuous), technical rules.
This is exactly the sort of thing that those of us who extolled Josh’s appointment hoped for, and I’m delighted to see him pushing this kind of approach right out of the gate. No doubt he rocked some boats and took some heat for it. Good. That means he’s on the right track.
Professor Bainbridge properly gives candidate Gingrich the treatment Professor Ribstein dished out to Professor Krugman on private equity
Jury deliberates in $1B antitrust lawsuit against Microsoft (USA Today)
Clock stops on EU review of Google-Motorola acquisition (BNA)
Analyst argues that killing the AT&T-T-Mobile transaction will pose risks for investors as the former searches for others ways to meet its spectrum needs and the other would have trouble remaining “independently viable and competitive” (Bloomberg)
Henry Manne first theorized the market for corporate control, but the man who first put the concept into action was Louis E. Wolfson. I blogged briefly about Wolfson when he died in 2008. Now you can read more about him in Alan M. Weinberger, What’s in a Name?– The Tale of Louis Wolfson’s Affirmed, 39 Hofstra L. Rev. 645 (2011) (not on SSRN). Here’s the abstract:
Why would someone choose to name a thoroughbred racehorse “Affirmed” after his conviction for federal securities laws violations had been affirmed on appeal? This inquiry is the basis for exploring the enigmatic life and spectacular career of Louis E. Wolfson, owner and breeder of the last winner of horse racing’s Triple Crown.
Perhaps best known as the central figure in the scandal that resulted in the forced resignation of Supreme Court Justice Abe Fortas, Wolfson left a sizable footprint on corporate legal history. He has been described as the original corporate raider, the inventor of the market for corporate control through the hostile tender offer, and the founder of the first modern conglomerate. Principal cases involving Wolfson appear in virtually all Corporations and Securities Regulation casebooks. Long the subject of academic study, commentary, and controversy, these decisions continue to be cited as authority for the partial indemnification of officers and directors, and the proposition that controlling persons expose themselves to criminal liability for effecting a distribution of unregistered shares through a broker.
The NYT discusses a controversy at UCLA (mainly, it seems, involving objections by Lynn Stout) to the $10 million gift it just announced from Lowell Milken, Michael’s brother. Lowell was accused many years ago in connection with his brother’s securities violations and escaped prosecution because of his brother’s plea deal. Steve Bainbridge comments in response to the NYT story, discussing this ancient history:
Some of us who were active in the field at the time–as I was–remember the story a bit differently. In our view, the government used threats to go after Lowell as one of the ways on which they coerced Michael into taking a plea deal.
I have more perspective in my paper, Imagining Wall Street. There I note that Oliver Stone’s film Wall Street
may have helped create an environment that became increasingly unfriendly to takeovers. In the year following the film’s release, Drexel and Milken were prosecuted, eventually culminating in the fining and jailing of Milken along with many others in the takeover game, and the demise of Drexel Burnham. Milken pleaded guilty and was sentenced to ten years in jail.68 [United States v. Milken, No. (S) 89Cr.41(KMW), 1990 WL 264699 (S.D.N.Y. Nov. 21, 1990)] * * * It is hard to say how much of that attitude was based on actual events reported in the media, and how much on the fiction Wall Street helped create. Milken was prosecuted not for insider trading, but rather for technical violations of the Williams Act—that is, using Boesky to accumulate non-disclosed positions in target shares.69 [Id. at 4]
In short, there is a big question whether Lowell’s history is such as to taint UCLA by his gift.
But I am not unsympathetic with the idea that law schools are supposed to be teaching their students that ethics trumps money, and so should be careful about whom they take money from, and more generally the company they keep. Indeed, for that reason I wrote critically last year about Bill Lerach’s foray into law teaching.
The real question here is where you draw the line and who decides. Is the decision to turn down a gift based on ethics or politics? More to the point, would the same people who oppose the Milken gift also object to an association with Lerach?
And how do you balance those considerations against the institution’s needs? Interestingly, Professor Stout has written extensively about the need to take the interests of all constituencies into account in corporate decision-making. Where would UCLA’s students stand in the decision Professor Stout favors to reject the Milken gift?
Steve Bainbridge is offering his new book, Directors as Auctioneers: A Concise Guide to Revlon-Land, as a Kindle eBook. Here’s his discussion of the book and of his decision to go the e-book route. I’ve bought it already and presumably will have it when I turn my Kindle on.
Steve’s reasoning is plausible: he gets more money than for law review articles, controls the marketing and price, and keeps all the proceeds instead of just royalties. He doesn’t get any quality signal, but at his career stage doesn’t need another one. His Revlon book offers him an opportunity to “update, expand, and augment older work on Revlon and offer up a new and improved analysis in a different package” that provides analysis relevant to some recent Delaware decisions.
I would add that the format provides a marginal incentive that could produce scholarship that might not otherwise get produced. This is what markets are supposed to do.
Needless to say, I’m interested in how this works out for Steve. Given rapid developments in publishing, I expect that this is just the first stage of an interesting evolutionary process.
Jason Zweig wrote Saturday in the WSJ about how companies are hoarding their cash. Microsoft, Cisco, Google, Apple and J & J “added $15 billion in cash and marketable securities to their balance sheets. Microsoft alone packed away roughly $9 billion, or $100 million a day. All told, the companies in the Standard & Poor’s 500-stock index are sitting on more than $960 billion in cash, a record.” The proportion of earnings paid as dividends is at the lowest level since 1936.
What are they planning to do with the money? Well, MS paid almost precisely all of its additional cash, $8.5 billion, for Skype. Zweig asks, “[w]as that torrent of cash burning a hole in Microsoft’s pocket?”
The hoarding may be because firms don’t see opportunities in an uncertain, highly taxed and increasingly regulated economy. But whatever the reason, Zweig is right in saying, following Benjamin Graham, that if they don’t have good uses for the cash they should give it back to the shareholders. Zweig notes that Graham proposed that investors insist on payouts of inappropriately hoarded cash and set formal dividend policies, with leading companies paying out two-thirds of their earnings.
But managers generally have the final say over dividend policies. So what to do? Well, as Henry Manne proposed long ago, takeovers can solve this problem. More specifically, the kind of takeovers that turn publicly held corporations into private-equity managed uncorporations. As I’ve pointed out in numerous articles (e.g.) and in my Rise of the Uncorporation, the uncorporation replaces often-ineffective corporate-type disciplines like fiduciary duties and shareholder voting with financial discipline centered on debt and distributions, which restricts the amount of cash managers have to play with.
The uncorporation is not for all firms. But, alas, it may be for an increasing number of firms, even former growth firms, this economy has beached.
Meanwhile it would be nice to find away to create the kinds of growing firms that do have opportunities and might actually be able to use the corporate form.
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