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Commercial Awareness: The Sainsbury's/Asda Merger vs Competition Law

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About The Author

Connor Griffith (Consulting Editor)

Connor is a law graduate from the University of Nottingham with a particular interest in intellectual property and corporate law. He is currently a trainee solicitor at a large national firm, sitting in the Real Estate department. Outside the law, he enjoys stand-up comedy and moaning about Brexit.

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©Elliott Brown

We're in the money, come on, my honey. Let's lend it, spend it, send it rolling along!

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An area of the law which often attracts the attention of starry-eyed aspiring solicitors is that of Mergers & Acquisitions (M&A). Promising hard work for large financial rewards and contact with a catalogue of international companies, it is little wonder that this area of work is an aspiration for many law students.

Indeed, it is a sector that has recently boomed as companies try to become the strongest competitor in the market. In the UK, in particular, many companies are finding they must acquire or merge with rival companies just to remain competitive: the impact of foreign companies entering the market, the increase in online shopping and the economy growing at its slowest rate in five years has caused havoc for many once-thriving businesses.

However, an increase in mergers raises concerns about the formation of an oligopoly: a market controlled by only a few dominant firms. A example of this is the UK groceries market, which is currently dominated by the ‘Big Four’ supermarkets: Tesco, Sainsbury’s, Asda, and Morrisons. However, if the proposed merger of J Sainsbury plc and Asda Stores Ltd were to be permitted, a ‘Big Two’ would be created whereby 58% of the groceries market is controlled by Tesco and the merged Sainsbury’s/Asda company.

The role of tackling such concerns falls upon competition law; it operates as a watchdog, preventing companies from becoming so dominant that they lose their incentive to continue innovating or behaving in the interests of consumers. Competition law ensures the make-up of the market is such that companies compete with one another by keeping prices low and ensuring the public are consistently offered new and exciting goods or services.

As an introduction to M&A and the balance it must strike with competition law, this article considers the proposed Sainsbury’s/Asda merger and dives into exactly how a merger between two companies is subjected to extensive checks before an approval may (or may not) be given.

Case Study: The Sainsbury’s and Asda Merger

On 28 April 2018, it was announced that Sainsbury’s and Asda – the UK's second and third largest grocers in terms of market share, respectively – were in advanced merger talks. Their goal: to form a company more powerful than the current market leader, Tesco.

The deal – intended to be an all-share deal – will see Walmart (Asda’s parent company) transferring all the shares in Asda Stores Ltd to J Sainsbury plc in return for £2.975bn in cash and a 42% stake in the merged company (though Walmart will receive no more than 29.9% of the voting rights).

The two companies will continue to operate as separate brands. However, they will together form the UK’s largest supermarket group with an expected 31% of the grocery market and annual sales of about £50bn. This would bring them above Tesco’s 27% market share, while also granting them sufficient size to cut costs in a way that would enhance their ability to compete with the rapidly growing German discounters Aldi and Lidl. Indeed, the chief executives of Sainsbury’s and Asda have already asserted that the merger will allow them to make (controversial) price cuts of 10% for everyday items so as to benefit the consumer.

Given the size of the proposed merger, it was inevitable that there would be competition law implications. Indeed, within hours of the joint announcement, the Competition and Markets Authority (CMA) stated the merger is ‘likely to be subject to review’.

It is worth noting that the CMA approved Tesco’s £3.7bn acquisition of food wholesaler Booker in 2017 without imposing any conditions, finding that the retail and wholesale sectors would remain ‘highly competitive’ despite Tesco’s pre-existing dominant position in the market. However, it would be unwise to rely on this as precedent for the Sainsbury’s/Asda merger: while the former is a vertical agreement (between two companies at different stages of production process, namely a distributor and a wholesaler), the latter is a horizontal agreement (between direct competitors at the same stage of production, namely two retailers).

Generally, horizontal mergers are considered greater threats to competition because they involve the direct elimination of competition between two previous competitors: the merged company being given the opportunity to increase its market share, geographical spread and consumer base. For example, in the Sainsbury’s/Asda merger, Sainsbury’s has typically operated in the South and its consumers are more likely to belong to the ‘professional’ social class, whereas Asda operates more in the North and sells more often to the ‘working’ social class. If this merger were to proceed, the merged company would therefore operate heavily in both the North and South, and would sell to all types of consumers.

As a result, instead of competing with one another – thereby lowering prices and increasing product variety – the merged company would be able to take a more relaxed approach by splitting jurisdictions and limiting the choices for consumers.

An Overview of Competition Law

The UK's competition rules operate under four main headings, over which the CMA the UK's principal competition law enforcement authority possesses extensive powers:

  1. Anti-competitive Agreements and Cartels: Chapter I of the Competition Act 1998 (CA 1998)
  2. Abuse of Market Power: Chapter II of the CA 1998
  3. Market Investigations: Enterprise Act 2002 (EA 2002)
  4. Merger Controls: EA 2002.

In addition, if there is a threat to competition between Member States of the EU, the relevant EU law will apply (for example, Article 101 and Article 102 of the the Treaty on the Functioning of the European Union mirror Chapter I and Chapter II of the CA 1998and the European Commission will replace the CMA as the primary enforcement body.

The relevant legislation to the Sainsbury’s/Asda merger are the merger controls set out in the EA 2002, as amended by the Enterprise and Regulatory Reform Act 2013. These rules apply to enterprises, which are defined in Section 129 of the EA 2002 as ‘the activities, or part of the activities, of a business’.

If the CMA chooses to investigate a proposed or existing merger, it will normally do so in two phases:

  1. Phase 1: An investigation that decides whether to refer the merger to an inquiry group for a detailed inspection of its potential impact on competition.
  2. Phase 2: Occurring only after a reference under Phase 1, a panel of independent experts is appointed to make a decision whether the merger should be permitted unconditionally, permitted with conditions, or prohibited unconditionally.

Phase 1

Phase 1 begins once the CMA becomes aware of the merger, either after the merging parties submit a Merger Notice or the CMA's attention is otherwise directed towards the proposed agreement. The CMA must then – within 40 working days of it becoming aware of the parties' plans – establish whether the merger qualifies for investigation.

For this to be the case, Section 23 of the EA 2002 requires that there is a ‘relevant merger situation’, whereby two or more enterprises cease to be distinct by – per Section 26(1) of the EA 2002 – coming under common ownership or common control. If this is established, it must then be shown that the relevant merger situation satisfies one of the following tests:

  1. The Turnover Test: The turnover (generated by sales to customers in the UK) of the business to be acquired exceeds £70m; or
  2. The Share of Supply Test: The merger creates an enlarged business supplying or purchasing 25% or more of the goods or services of any description in the UK, or in a substantial part of the UK.

Finally, if the CMA wishes to make a reference to the inquiry group, the merger in question must either be in contemplation at the time of reference or have taken place not more than four months before the reference.

If these conditions are met, a case officer will be appointed. They will put further questions to the merging parties, requiring details of their main customers, competitors and suppliers. In addition, the case officer will invite comments from third parties in order to find out as much relevant information about the merger as possible. Using this information, a case review meeting will be held to discuss the merger. The decision whether or not the merger will be referred to the inquiry group for Phase 2 proceedings is made in a final separate meeting.

Crucial to this decision is Section 33(1) of the EA 2002, which confirms that the CMA must refer a merger where the criteria are met and the merger has resulted or is expected to ‘result in a substantial lessening of competition' within any UK market. This is known as the ‘substantial lessening of competition’ test.

In order to determine whether there will be a ‘substantial lessening of competition’ (SLC), the CMA will consider factors such as the extent to which the parties operate as competitive constraints on each other prior to the merger and the ease of market entry and expansion. If it is found there would be a SLC, the CMA must refer the merger unless one of the following exceptions applies:

  1. The de minimis exception applies, whereby the market(s) concerned are not of sufficient importance to justify making a reference.
  2. Customer benefits in relation to the creation of the merger situation outweigh the substantial lessening of competition and any adverse effects of it.
  3. The merger is not sufficiently advanced or likely to justify making a reference.

In addition, the merging companies can avoid a reference to the inquiry group if it offers an undertaking in lieu of reference (UIL) and the CMA accepts it. This will only be the case where the CMA is confident the UIL will resolve the competition concerns identified without requiring further investigation. UIL are divided into two categories and can include the following examples:

  1. Structural: a divestment of one of the overlapping businesses, or
  2. Behavioural: a commitment to observe a price cap for a period of time.

Phase 2

If the merger is referred to an inquiry group, Phase 2 commences. This consists of four main stages. Firstly, the CMA will gather information and consider the potential anti-competitive effects of the proposed merger. The parties to the merger are prohibited from acquiring interests in one another’s shares until the CMA inquiry ends.

Secondly, an assessment is conducted on the basis of an issues statement produced by the CMA. At the same time, an accompanying news release is made, which is followed by hearings with the parties and others.

Thirdly, the CMA will publish a notice of its provisional findings, giving provisional conclusions and explanations of its reasoning. Publication begins a 21-day time period, during which the parties to the merger may comment on the findings. Additionally, if a SLC was identified by the CMA, it may publish a notice of potential remedies to resolve this matter. After the 21-day period, the CMA will then publish its final report on the merger.

Finally, if any remedies were required by the CMA and the parties agree, these will be implemented after publication of the final report and the merger may proceed. If the parties do not agree, the merger will be blocked.

Application to Sainsbury’s and Asda

The size of the proposed merger between Sainsbury’s and Asda makes it evident that the basic requirements for a referral are met. While the CMA requirements stipulate that either the turnover of the business must exceed £70m or the merged company must have a market share of at least 25%, the Sainsbury’s/Asda merger exceeds both: Asda’s Report and Financial Statements ending December 2016 reported an annual turnover of £21.6bn, and the merged company expects to have a 31% share of the groceries market.

In fact, a referral is so anticipated that Sainsbury’s chief executive has requested that the CMA skip Phase 1 completely and jump to Phase 2, as occurred during the 2016 merger of Ladbrokes and Coral. This would save some time and costs, but would not allow Sainsbury’s and Asda to avoid any conditions the CMA may ultimately require in order for the merger to be approved. Indeed, Patrick O’Brien – UK retail research director at GlobalData – anticipates that the CMA will require the companies to sell 75 stores as an ‘absolute minimum’.

A preliminary invitation to comment – allowing ‘all interested parties to submit any initial views on the impact’ that the proposed merger would have on competition in the UK – was launched by the CMA on 18 May and closed on 4 June, with the responses being published on 18 June. These responses – received from a wide variety of sources, including other supermarket groups, wholesalers, suppliers and trade associations – generally expressed concerns that the merger would lead to ‘increased concentration in the market and fewer national players'. In turn, concerns were expressed this concentration in the market could lead to ‘higher prices, reduced choice, or a loss of innovation within the supply of groceries’. The CMA has indicated there will be a second invitation to comment once the formal investigation begins.

One particularly alarming assertion made by key figures at Sainsbury’s and Asda is that the merger will ultimately benefit the consumer, because it will allow the companies to offer price cuts of up to 10% on everyday items. These cuts – purportedly beneficial for customers, suppliers, staff and shareholders – will occur through ‘streamlining’ the supplier base by forcing lower prices out of Sainsbury’s and Asda's ‘top 100 suppliers’.

These claims, however, are widely criticised. Lord Haskins has argued that small and independent farmers will ultimately pay the price for these cuts, no matter how the big suppliers – such as Unilever and Mars – react.

This argument was put to the chief executives of Sainsbury’s and Asda, on 20 June 2018 when they appeared in front of the Environment, Food and Rural Affairs Select Committee. This was a heated event: when both chief executives stuck by their claims, MPs criticised them for 'talking baloney’ and asserted that the merger could ‘cut the throats’ of suppliers. Neil Parish MP, the Committee’s Chairman, was particularly unconvinced, stating:

We are not children, you can’t just come in here and give us a nursey rhyme.

Conclusion

It is as yet unclear whether the Sainsbury’s/Asda merger will be permitted, permitted with conditions, or denied. It was estimated – at the time of the announcement – that an investigation by the CMA would take at least a year. However, whatever the outcome, it is clear that there is a change coming. Competition in many industries has narrowed sharply in recent years, with only a few dominant names remaining in each sector.

Accounting, for example, is dominated by the Big Four – Deloitte, PwC, EY and KPMG  while the UK domestic groceries market is similarly dominated by Tesco, Sainsbury’s, Asda and Morrisons. Digital media is all but controlled by the ‘digital duopoly’ of Google and Facebook, who account for roughly 84% of the market. And E-commerce has long been dominated by Amazon, which had a 37% market share in 2017.

Year after year, Western society creeps closer to an inevitable oligopoly. However, it has been pointed out that this – somewhat paradoxically – helps medium-sized firms in their plans to become bigger: in some instances, it is necessary to limit competition in order to protect it. As the Financial Times notes, the argument goes: ‘if big company A does not – or is not allowed – to buy big company B, even bigger companies C or D will crush both’. Though defeatist, the logic is there: surely it is better for competition to have, for example, three dominant companies rather than just two.

This thinking is evidently present in the Sainsbury’s/Asda merger: Tesco has almost twice as big a market share as either one individually, and Amazon is demonstrating an online threat that could limit their stretch even further. In order to prevent one firm from taking overall dominance, leading to a monopoly, competition may need to be somewhat decreased in order to form and maintain a strong competitor.

However, the consequences of the merger may be felt by smaller parties – in this case, suppliers to Sainsbury’s and Asda – and be too damaging to make the merger worthwhile overall. The CMA must balance these considerations over the next year when considering the Sainsbury’s/Asda merger: this will not be an easy task.

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Tagged: Commercial Awareness, Commercial Law, Competition, Consumer Rights, Regulators, Retail

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