On February 3, 2017, the U.S. Federal Trade Commission (FTC or Commission) released the findings of its “Merger Remedy Study” (the FTC Study) which examined the effectiveness of Commission-required remedies in transactions from 2006 to 2012.[1] The FTC Study—its first on merger remedies in over 16 years—provides an important window into the FTC’s current thinking about merger remedies that may help businesses plan and position transactions for FTC approval. Moreover, it also provides several key insights that potential divestiture buyers should consider during and after completion of the divestiture to ensure the remedy is successful.

The FTC Study concluded that the current process for designing remedies, as well as the remedies themselves, generally have accomplished what the Commission has sought—to replace the lost competition from the initial transaction. As a result, the FTC confirmed that it will continue to follow many of its practices and policies today.

• The FTC continues to have a strong preference for the divestiture of an ongoing business, though the FTC does not rule out that a divestiture of selected assets may be sufficient in certain circumstances.

• A potential divestiture buyer will be scrutinized carefully, including, in particular, its business plan, financing, and funding structure.

• The Commission confirmed that it still prefers upfront buyers in certain industries, shorter divestiture periods (e.g., four to six months) and monitors for certain transactions (e.g., those in technical markets or deals raising complex issues).

• Divestiture packages should include robust transition services packages that provide the proposed divestiture buyer with both the scope of services and the necessary length of time to ensure the divestiture buyer can be successful.

• Supply arrangements should seek to minimize the length of time a divestiture buyer relies on the parties, but should be flexible to provide extensions where the divestiture buyer needs additional supply.

• When a hold separate is necessary to ensure a successful divestiture, the hold separate manager should be authorized to respond to competitive circumstances and be able to position the business to compete for the long-term.

However, in addition to confirming a number of the FTC’s long-held key principles for merger remedies, the FTC Study emphasized a number of new considerations:

• The FTC expressed a preference that the parties proposing a divestiture remedy identify at least three potential “interested and approvable” divestiture buyers.

• The FTC likely will place greater emphasis on ensuring the proposed divestiture buyer has adequate time, access to employees, and sufficient information to conduct any necessary and appropriate due diligence.

• Given the importance of attracting and retaining customers and stepping into third-party relationships, the FTC likely will increase its focus on facilitating the transition to the divestiture buyer (e.g., by providing the divestiture buyer access to customers early in the process, by assigning customer contracts, by assisting with necessary approvals, etc.) to enable the divestiture buyer to compete.

• Similarly, the FTC likely will put an increased emphasis on transition services agreements that include the transition of back-office functions (e.g., information technology services) relating to the assets being divested. And, the FTC suggests that in certain cases where the divestiture buyer cannot provide such services itself or obtain such services from a third party, divestiture of such services by the parties may be necessary.

• Given the FTC found a general reluctance among divestiture buyers to raise concerns with FTC staff or monitors, the FTC Study emphasizes that frequent and open communication among the transaction parties, the proposed buyer, any existing monitor, and FTC staff is necessary at every stage of the process to ensure a successful divestiture, limit any post-divestiture issues, and address any such issues quickly.

• For pharmaceutical transactions, (a) the FTC continues to believe a Commission-approved monitor should be retained and (b) parties may face more pressure to divest “the easier to divest product, wherever possible,” (e.g., products produced by third-party manufacturers) as opposed to having a choice of which product to divest.

Background and Findings

The FTC Study kicked-off in January 2015 and was designed to consider the impact from, as well as update and expand on the FTC’s 1999 Divestiture Study.[2] The 1999 Divestiture Study led to several changes in the FTC’s divestiture process that continue today, including: (1) typically requiring an upfront Commission-approved buyer when parties divest less than an ongoing business unit; (2) typically providing six months or less after closing to find a divestiture buyer; and (3) an increased use of monitors.[3]

The 2017 FTC Study examined 89 consent decrees from 2006 to 2012 in a wide range of industries using one of three methods.[4] First, the FTC examined the effectiveness of 50 consent decrees using a case study method—interviewing parties and other industry participants, as well as studying 7 years’ worth of data.[5] Second, for 15 consent decrees in the supermarket, drug store, funeral home, and health care facility (e.g., dialysis clinics) industries, the FTC examined the effectiveness of the divestitures through divestiture buyer questionnaires.[6] Third, the FTC evaluated 24 pharmaceutical industry consent decrees using internal FTC information (such as compliance and monitor reports) and publicly available data.[7]

The FTC Study concluded that the vast majority of reviewed merger remedies addressed the competitive concerns identified by the FTC with 70 percent of consent decrees considered a “success” and another 14 percent a “qualified success.” Although most of the FTC’s imposed remedies during the period were deemed successful, the FTC found a meaningful difference in the success rates of consent decrees in non-consummated mergers versus consummated mergers—only 25 percent of the consummated cases were successful, with 50 percent deemed “qualified successes” and about 25 percent as “failures.”[8] These results seem to bear out the existing enforcement view of the FTC—that “[i]t may be particularly difficult to restore the pre-merger state of competition if the merging parties have commingled, sold, or closed assets; integrated or dismissed employees; transferred customers to the merged entity; or shared confidential information.”[9]

The FTC Study also highlighted the FTC’s emphasis on a divestiture process that works well. Consent decrees where divestiture buyers expressed process concerns were much less likely to achieve quick competitive success: 78 percent of consent decrees with no expressed process concerns were likely to be successful versus 56 percent of those with process concerns. The FTC found process concerns typically fell into the following categories: (1) concerns with the divestiture asset package itself (i.e., divestitures of selected assets—even with an upfront buyer—posed more risk than that of an ongoing business unit); (2) concerns that buyers without financing flexibility (or without a willingness or ability to invest post-acquisition) led to less successful remedies; (3) concerns that an inadequate divestiture process typically stemmed from not enough due diligence, insufficient supply and/or transition services that made customer retention difficult, or other issues with the business during the hold separate period; and (4) concerns related to insufficient communication with the FTC during and after the divestiture.[10]

Key Considerations for Merger Remedies

The FTC Study made clear that while the Commission views its overall approach as working well it also suggested that changes should be made and identified a number of best practices that FTC staff recommends, some of which are new, and all of which are likely to play an important part of the remedy process going forward.

Defining the Asset Package. For years, the FTC has required the parties to a transaction must demonstrate that the scope of the asset package is adequate to maintain or restore competition in the affected markets. For divestitures of an ongoing business unit, parties should be able to explain how the business can be run to compete effectively and immediately. And, where parties would like to divest less than a complete ongoing business unit, the parties should be able to explain why such selected assets are sufficient and how the buyer can “fill the gap” between the divested assets and a full business. Given concerns expressed by market participants and divestiture buyers about the sufficiency of divestiture asset packages, the FTC’s presumption appears to be that divestiture of an entire ongoing business will be required. Parties should expect, and be prepared to respond to, a renewed focus by FTC on the need to divest entire business units and even more scrutiny when only selected assets are included in a divestiture package.

Identifying the Proposed Buyer. Although the divestiture package is critical, the FTC Study also highlighted the importance of the proposed divestiture buyer. In that regard, the FTC Study places increased emphasis on vetting of the potential buyer. To ensure those proposed buyers are able to compete not only in the short term, but also the long term, parties should expect the FTC to examine proposed divestiture buyer’s financing and funding structure. A proposed buyer should be prepared to present a comprehensive overview of its funding structure when discussing its proposal with the FTC. Proposed divestiture buyers should also expect to address how they plan to maintain or restore competition, what other assets or services they would need to do so, how they will obtain those additional assets or services, and to provide estimates of the time and cost to obtain these assets or services.[11]

Although not explicitly referenced by the FTC Study, the increased focus on a proposed buyer’s financing and funding structure may be due to recent experiences. First, in Hertz Global Holdings, Inc.’s acquisition of Dollar Thrifty Automotive Group, Inc., the divestiture buyer declared bankruptcy and the FTC allowed Hertz to re-acquire some auto rental locations so those locations could continue to operate.[12] Similarly, Haggen, the buyer of a number of the divested grocery stores in connection with Albertsons’ acquisition of Safeway Inc. also declared bankruptcy shortly after the divestiture was complete. In that matter, Albertsons was not only able to re-acquire some of the Haggen stores, but the FTC modified the settlement to permit Albertsons to re-hire employees.[13]

However, the most significant guidance from the FTC Study regarding potential divestitures is the recommendation that parties identify at least 3 potential buyers for FTC staff to review.[14] As a result, at the outset of the initial transaction, parties should consider if divestiture options are limited and factor in how the FTC may view such limited options in light of the FTC Study’s suggested practice.

Timing of Divestiture. The FTC Study also suggested that a shorter divestiture window was critical to ensure that the divestiture buyer is able to quickly succeed and replace the lost competition from the initial transaction. As a result, the FTC Study confirmed that the Commission will continue to insist on upfront buyers in certain industries to protect against deterioration or wasting of divested assets in the interim period. It also suggested that in situations where an upfront buyer is not required, it is likely to require the divestiture be completed within four to six months.

Monitors. The FTC Study also confirmed that the FTC expects to continue its practice of imposing monitors in transactions in technical industries or that raise complex issues. And, because the FTC Study found that parties have been reluctant to raise issues with monitors, it is likely FTC staff is going to increase efforts to remind divestiture buyers that they should contact the monitor (or FTC staff) with any issues.

Due Diligence. The FTC Study found that buyers do not always have ample time and access for due diligence given that divestiture agreements are often done quickly towards the end of the antitrust review period and on a timeline for the merging parties.[15] This is complicated by the fact that the divestiture buyer will be a competitor in the future, which may affect the seller’s incentives. As a result, the FTC likely will place more emphasis on ensuring that the divestiture buyer has the information and access it needs to understand what it is acquiring and if what it is acquiring is sufficient to compete. Moreover, the FTC Study suggested that the FTC will discuss such issues not only with the divestiture buyer, but also customers and other industry participants to ensure any concerns can be addressed before approving of the divestiture.[16]

Transition Services. Similarly, FTC’s view that a divestiture is successful when the divestiture buyer replaces the competition lost, the FTC wants to ensure that there is a smooth transfer of customer and other third-party relationships. As a result, the FTC is more likely to take an active role to make sure parties properly assign customer contacts, assist in acquiring necessary consents and approvals, and provide the buyer with access to customers and third parties early on in the process.[17] The FTC also will look to ensure that transition services agreements last a sufficient period of time until the buyer can perform these services on its own.[18] Parties and divestiture buyers alike can expect more extensive questioning about “back-office” functions—how the proposed buyer will obtain these services, and whether the scope and length of any transition services the buyer will need from the parties provides adequate support.[19] And if they cannot be contracted for separately, it is possible that such services need to be included in the divestiture package.

Supply Arrangements. In some transactions, a supply arrangement where the seller provides the divestiture buyer with supply of a product (whether an input product or a final good) to enable the divestiture buyer to have sufficient product to be competitive in the marketplace may be necessary. While the divestiture buyer and the FTC both are likely to have concerns with prolonged entanglements where the divestiture buyer must rely on a competitor for product, such supply agreements can be essential to competing quickly and effectively. As a result, the FTC will carefully review the divestiture package and supply agreements to make sure they provide sufficient time and know-how to enable a buyer to manufacture the product on its own.[20] But, given the challenges a new entrant can face to establish its own supply chain, the FTC Study suggested that such supply agreements be flexible and provide for extensions, where necessary, to allow the divestiture buyer to compete long-term.

 Hold Separate Managers. In some instances, the FTC may require a “hold separate,” whereby the divesting party must hold the divestiture separately from the seller’s business and appoint a hold separate manager to run that business independent of the seller’s business. This is to ensure that competition continues in the interim period between divestiture and the closing of the main transaction. The FTC Study suggested that in some instances, hold separate managers did not act as swiftly or take sufficient action to respond to the competitive marketplace. As a result, the FTC Study suggested that hold separate managers should have more open and direct access to FTC staff, and that hold separate managers work with staff as early as possible to ensure that they are able to react to competitive conditions in the marketplace.

Communication. Finally, the FTC Study stressed the importance of open and frequent communication with FTC staff and a monitor, if appointed.[21] Accordingly, both parties and proposed divestiture buyers should expect more frequent communication with FTC staff throughout the process.

Orders in the Pharmaceutical Industry. Many of the best practices discussed above will apply to consent decrees in the pharmaceutical industry, but the FTC Study also highlighted several pharmaceutical industry-specific issues, including one in particular that parties should consider when structuring a deal. The FTC Study found that products already manufactured by a third party are often easier to divest than those manufactured by one of the merging parties,[22] and further noted that parties should divest such products “wherever possible.” While the FTC already considers the efficacy of any potential divestiture, the standard pharmaceutical antitrust analysis dictates that parties may divest either overlap product—it has not commonly been the case that staff would demand the divestiture of one product merely because it is manufactured by a third party. If this is the approach taken by the FTC going forward, parties may need to reconsider the deal value associated with certain products, with the expectation that they may be forced to divest the more successful overlap product merely because it is being manufactured by a third party.

Conclusion

While the FTC Study indicated that much of the FTC’s approach to merger remedies will continue, there likely will be changes in the FTC’s process. In particular, parties can expect more extensive scrutiny of proposed buyers, more time for potential divestiture buyers to conduct due diligence, greater focus on the sufficiency of transition services and supply arrangements, and increased communication with the divestiture buyer both during the divestiture process and after the divestiture is complete. Parties should take these points into consideration when initially contemplating a transaction where remedies may be required, to help limit any potential issues later in the process. Moreover, divestiture buyers should consider these reforms in determining what may be required for a successful divestiture acquisition.

ENDNOTES

[1] See U.S. Fed. Trade Comm., The FTC’s Merger Remedies 2006-2012: A Report of the Bureaus of Competition and Economics (Jan. 2017), https://www.ftc.gov/system/files/documents/reports/ftcs-merger-remedies-2006-2012-report-bureaus-competition-economics/p143100_ftc_merger_remedies_2006-2012.pdf (FTC Study). The FTC Study was conducted under Section 6(b) of the Federal Trade Commission Act, which allows the FTC to prepare special reports and obtain data and information from market participants. 15 U.S.C. 46(b). The Commission voted 3-0 to issue the FTC Study.

[2] See Staff of the Bureau of Competition of the Fed. Trade Comm., A Study of the Commission’s Divestiture Process (Aug. 1999),  https://www.ftc.gov/sites/default/files/attachments/merger-review/divestiture.pdf (“1999 Divestiture Study”). The 1999 study evaluated consent decrees from 1990 to 1994, relying primarily on market participant interviews. Unlike the 2017 FTC Study, the 1999 Divestiture Study examined only consent decrees involving divestitures.

[3] Fed. Trade Comm., Agency Information Collection Activities; Proposed Collection; Comment Request (Divestiture Remedy Study), 80 Fed. Reg. 2423 (Jan. 16, 2015).

[4] FTC Study at 4. The FTC Study considered both structural (e.g., divestitures) and behavioral relief (e.g., firewalls or licensing obligations).

[5] Id. at 9.

[6] Id. Because of the nature of these industries, it was not practical to interview individual customers and market participants.

[7] The FTC stated it used this methodology because these decrees required continued monitoring and data reports providing the FTC with in-house expertise. Id. at 9-10.

[8] Id. at 18-19.

[9] Id. at 18.

[10] Id. at 21-20.

[11] Id.

[12] FTC Press Release, FTC Seeks Public Comment on Franchise Services of North America’s Application to Sell Assets Related to Simply Wheelz to Hertz and Avis Budget Group (Apr. 17, 2014) https://www.ftc.gov/news-events/press-releases/2014/04/ftc-seeks-public-comment-franchise-services-north-americas.

[13] FTC Press Release, FTC Approves Application for Modification of Divestiture Agreement Between Albertsons and Haggen Holdings, LLC (Sept. 25, 2015) https://www.ftc.gov/news-events/press-releases/2015/09/ftc-approves-application-modification-divestiture-agreement.

[14] FTC Study at 32.

[15] Id. at 34.

[16] Id. at 34-35.

[17] Id. at 35.

[18] Id.

[19] Id. at 33.

[20] Id.

[21] Id. at 37.

[22] Id. at 36.

This post comes to us from Arnold & Porter Kaye Scholer LLP. It is based on the firm’s advisory, “FTC Merger Remedy Study: Key Takeaways,” dated February 8, 2017, and available here.