When the Federal Trade Commission (“FTC”) or Department of Justice (“DOJ”) believes a merger or acquisition will have anti-competitive effects, it typically either attempts to block the transaction outright or conditions approval of the transaction on the transaction parties’ acceptance of behavioral or structural remedies.
Historically, the FTC and DOJ preferred structural remedies over behavioral ones. Behavioral remedies, in which the parties agree to restrictions designed to prevent anticompetitive behavior by the combined company, require ongoing conduct limitations and monitoring, if not active policing by the agencies. On the other hand, structural remedies, which often involve the divestiture to a third party of the product or business held by the buyer or target that when combined with the other party’s business raises anticompetitive concerns, represent a one-time fix by changing the competitive landscape.
Private equity sponsors have increasingly played a role in facilitating the structural remedies needed to allow combinations to take place. To take one recent example, when United Healthcare wanted to acquire Change Healthcare but needed to sell its ClaimsXten business to address the acquisition’s antitrust concerns, it was TPG that won the auction—beating out, so market rumor has it, several other sponsors in the process.
However, even structural remedies are facing increasing skepticism from the antitrust agencies, as part of a larger hostility from Washington toward mergers and acquisitions. As Jonathan Kanter, the Assistant Attorney General for the DOJ’s Antitrust Division recently wrote, “merger remedies short of blocking a transaction too often miss the mark…. Complex settlements, whether behavioural or structural, suffer from significant deficiencies.”
Why the hostility? In part, it derives from the concern that the divestiture buyer may not be a successful competitor to the divesting business. For instance, the FTC approved Hertz’s $2.3 billion acquisition of Dollar Thrifty Automotive Group in May 2013, on the condition that the combined company sell a small rental car operator, which it did to Macquarie Capital. Within months, the distributed business filed for Chapter 11 bankruptcy protection.
There are many reasons a divested business might fail. The divestiture buyer may not have the resources, experience, infrastructure or understanding of the business to make a serious go of it. Moreover, there is no certainty that the divestiture buyer will want to continue expending resources on the business, and may simply get distracted. When a buyer uses the divested asset ineffectively, it results in “concentration creep,” a result the antitrust authorities like to avoid.
Despite the hostility, divestitures continue to be a critical means of resolving antitrust concerns. Merger partners and prospective divestiture buyers need to be able to navigate through the stormy waters of regulatory scepticism and to be prepared to evade the occasional rogue wave.
Proposed divestiture buyers must be ready to be closely scrutinized. The authorities will want to delve deeply into the proposed buyer’s business plan, financing and funding structure. More recently, the agencies have also focused on ensuring that the proposed buyer has sufficient time, access to the seller’s management, and adequate information to conduct thorough due diligence. As the parties plot the overall timeline for their transaction, they need to keep this in mind—both the seller and the proposed buyer of a divested business or asset will want to treat the divestiture in much the same way transacting parties treat any sale of a business or asset, but the seller in this context may want to work harder to find ways to share privileged, confidential, or sensitive information with the proposed buyer, because if it doesn’t do so in the first place, the reviewing agency may well require it to do so later.
There is also a growing focus by the DOJ and FTC on ensuring a smooth transition upon the sale of the divested business. While the regulators have always expected there to be robust transition services agreements in place, the agencies will likely place increased emphasis on those agreements, ensuring they include back-office functions like IT services and are sufficient in scope and time to provide for the divestiture buyer’s long-term success. In the same vein, underscoring a greater recognition of the importance of attracting and retaining customers and stepping into third-party arrangements, one can expect the reviewing agency to insist that the seller provide the divestiture buyer greater access to customers earlier in the process and greater assistance to secure necessary contractual assignments and approvals.
While the agencies have for some time expressed their preference for upfront buyers of businesses in certain industries over hold separate arrangements, more recently regulators have pressed merger partners proposing a divestiture remedy to identify at least three potential “interested and approvable” divestiture buyers. Moreover, the authorities are likely to require the use of agency-approved monitors in more and more deals involving divestitures, who will oversee the operations of the divestiture buyer with respect to the divested business, including compliance with the divestiture order. Certain industries—pharmaceuticals in particular—tend to be more on the government’s mind when considering the use of a monitor.
Indeed, healthcare and life sciences transactions are generally attracting heightened regulatory and Congressional scrutiny—and all the more so when those transactions include private equity buyers. Merger partners in these industries should tread particularly carefully in dealing with the antitrust authorities, and expect the unexpected. Knowing, for instance, that the FTC may insist that merger partners in pharma transactions divest the easier to divest product may make the process smoother and less frustrating.
Another recent development for divestiture buyers to note is the FTC’s return to the use of prior approval provisions built into divestiture orders. These provisions generally give the FTC authority to approve or disapprove any sale by the divestiture buyer of the business or assets that were divested, or any portion of them. The provision may last for up to ten years, and would be triggered even if the sale would not have otherwise required an antitrust filing—and the FTC could disapprove any such sale even if there were no antitrust issue with the acquirer’s acquisition of the business or assets in itself. For instance, to complete its proposed acquisition of Novitium Pharma, ANI Pharmaceuticals agreed to divest two generic drug products to Prasco. The divestiture order requires Prasco to obtain prior approval before selling or licensing any FDA authorizations for the divested assets for three years, and for seven years thereafter requires it to obtain prior approval before selling or licensing any FDA authorizations for the divested assets to anyone who owns, or is seeking approval for, an FDA authorization to manufacture or sell a divested product’s therapeutic equivalent.
Given the highly dynamic antitrust landscape, managing the process and coordinating interactions among the regulators, the merger partners and the potential divestiture buyers are of paramount importance. The agencies have found divestiture buyers to be reluctant to raise concerns with the agency staff or monitors, and consequently, regulators will be looking for frequent and open communication among all players. The divestiture seller must keep in mind that a divestiture buyer often has two bites at the apple: in its negotiations with the seller and again during the agency review. The regulators insist that the contract include provisions that allow them to modify the contract, and in the event concerns are raised during the divestiture process, the agencies may require the divestiture of additional assets or contractual provisions that are even more protective of the divestiture buyer than those the buyer negotiated for itself.
In addition to coordinating among all parties and working out when best to introduce potential divestiture buyers to the regulators, merger partners may want to understand what interactions a potential divestiture buyer has had with the regulators in the past—not only as a party to a transaction but also as an industry player contacted by the authorities in connection with the current underlying transaction or a prior transaction. An industry participant contacted by the agencies during the investigation should be careful not to overplay its hand in complaining about the merger’s potential effects if it wants to show up later as a potential divestiture buyer. Companies who might see themselves as possible divestiture buyers should take care as to what they say if asked to provide views on a particular pending transaction.
In short, be patient. Whether the sponsor is a merger party or potential divestiture buyer, recognize that the process takes time, and the authorities are increasingly focused on ensuring the divestiture buyer’s enduring commercial and competitive success. And keep in mind that if the regulators do not believe the proposed remedy sufficiently addresses their concerns, they may go to court to challenge the transaction, further lengthening the process. Here are a few suggestions for sponsors that may help in reaching agreement without being pulled into litigation:
Divestitures are under increasing scrutiny, but they are often the only way to solve competitive concerns, and despite the skepticism, divested businesses have more often than not become successful competitors. They can also present excellent opportunities for the sponsor that is prepared to manage the agency review process to a successful conclusion.
- Have counsel engage with the regulators as early as practicable.
- Be able to demonstrate a track record of successful growth of portfolio companies, especially for carve-outs and in the industry in question.
- Be prepared as a divestiture buyer to provide as much detail as possible as to how the divested business will be operated (including composition of the proposed management team) and to provide details regarding the expected hold period and exit strategy.
- Consider, if it makes sense from an investment perspective, partnering with a strategic company in the relevant industry and involving that company in interactions with the antitrust authorities.
- Ensure that the business plan for the divested business includes details of the growth of the business and how it will meet debt obligations under a variety of scenarios.