PRIMER: EU merger control and tech firms

Author: Amélie Labbé | Published: 5 Oct 2017
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How does competition law work?

The Competition and Markets Authority (CMA), which was formed in 2013 from the merger of the Office of Fair Trading and the Competition Commission, is the body in charge of UK competition law enforcement. It is tasked with ensuring that a merger doesn’t substantially lessen competition (the SLC test): its evaluation looks at the consequences of a merger and if actual and potential competition is reduced if it goes through.

"Determining the likely future impact of merging two centres of innovation is a bit of a crystal ball exercise," said Ashurst partner Nigel Parr. "You have to look at what kind of evidence the regulator is using to intervene on the basis of what might happen in the future."

The EU Merger Regulation sets out a test for concentrations that have an 'EU dimension’ which is applied in a broadly similar way – it relies on a test establishing a significant impediment to effective competition.  

Competition law enforcement is sector neutral although under the UK’s merger control rules contained in the Enterprise Act 2002, public interest can directly or indirectly play a part. Considerations arising from national security, media plurality and accuracy, and financial system stability can be used to determine if a merger goes through or not.

Why are we talking about the technology sector then?

Last year saw $613 billion in technology M&A globally, slightly down on 2015 which hosted $691 billion worth of deals. This year so far looks set to continue the dynamic trend.

Some of the largest deals in value are in the technology sector, as incumbent players use M&A as a tool to scale operations, buy new expertise (cloud, data analytics, mobile or fintech for instance) or to grow market share.

"EU and US rules haven’t come up with a precise definition of innovation, which complicates matters further"

As such, the sector has attracted increased scrutiny because of the level of consolidation taking place, both in the UK and globally. This has not translated into a special technology merger statute but the SLC test will take into account some elements specific to these types of takeovers, as they can more often than not involve new or fast-growing markets.

"There are issues that are particularly important to technology deals that need to be addressed," said Linklaters partner Christian Ahlborn. "But these call for a different methodology when reviewing deals, not for a rule change."

What does this mean in practice?

There are certain things that regulators will pay close attention to when reviewing proposed technology M&A. 

These are, for example:

  • The ownership of data: even if a company is data rich but has not monetised it yet, this resource could be important for competition going forward.
  • The effect of the proposed merger on future innovation: even if the product isn’t on the market today, what’s its pipeline of products/services like? Will access to and distribution of it be affected? Will the combination reduce competition and innovation in the market more generally?

"The fundamental problem is how to approach innovation competition," says Ahlborn. "Economists are good at assessing static competition and the impact of a transaction on prices, but not so good at evaluating the impact of a deal on innovation."

It’s important to note that EU and US rules haven’t come up with a precise definition of innovation competition, which complicates matters further. However, the introduction of the concept makes sense, especially when it comes to horizontal combinations (mergers between companies operating in the same space).

In 2016, the Commission vetoed the proposed takeover of O2 by Hutchinson in part because it would have 'hampered innovation and the development of network infrastructure in the UK’.  In the Novartis/GSK Oncology Business deal, the Commission expressed concerns that existing and pipeline products for the treatment of different types of cancer could potentially be affected.

Disruption to innovation, as a theory of harm, could prove to be a useful tool to address concerns that aren’t covered by the static criteria of turnover and market share. But it’s an uncertain exercise, especially as regulators are looking at the prospective future scenarios. 

"It's also necessary to consider the prospective time period within which the assessment is being made – most regulators are rightly cautious about speculating about what could happen in five years' time," says Parr.

Ahlborn agrees: "Authorities will get better at identifying innovation harm the more they look at individual cases." 

Why are thresholds relevant?

EU Commissioner Margrethe Vestager noted in an April 2016 speech that the Commission was considering looking into notification thresholds again to enable it to examine the acquisition of companies with 'a lot of good ideas but not yet much in the way of sales’. It is taking a similar approach to its US counterparts, the Department of Justice and the Federal Trade Commission.  

  The UK CMA’s overarching goal is to ensure that proposed significant mergers – those where the target has a turnover over £70 million ($93 million), and the combined firms will have more than a 25% market share – do not negatively affect consumer welfare by, for instance, impacting prices, or restricting or preventing access to products and services (so-called PQRS (price, quality, range and service) criteria).

Thresholds are different depending on jurisdictions: German law specifies that the domestic turnover of one undertaking has to be over €25 million ($29.4 million) and Indian rules also include the turnover of the seller in the calculation. The US relies on a size-of-transaction threshold (in excess of $80.8 million) and a size-of-person one, which is associated with minimum net sales or total asset levels.   

EU-level merger control relies on yet another set of different thresholds. For instance, concentrations will have to be notified to the European Commission if they each of at least two of the undertakings in question have EU-wide turnover of €250 million ($294 million).

One problem that arises in the technology space – though this is an issue that can happen in any sector – is when the acquisition target is small and has a turnover lower than the minimal threshold. Many technology startups have little no sales to speak of, meaning they could possibly slip through the oversight net.

That being said, sales aren’t necessarily a good indicator of market presence when it comes to smaller organisations. A small competitor may be a force to reckon with because of its potential to disrupt the market in the future – via innovation, technological improvements, access to key data or resources etc - even if current turnover at the time it’s taken over is negligible.

IdeaIf current turnover isn’t necessarily the right criteria in technology deals, what is?

That’s open to debate. If a future turnover criterion is used, the risk is that a number of companies that have no business being reviewed may be caught in the regulator’s oversight.

Other elements such as a target’s intellectual property (patents for instance) or future product pipeline could be used in the merger control process. It all comes back to innovation ultimately (see question 3).

What about national security concerns?

Regulators in the UK, US, China and Germany have been paying closer attention to proposed combinations that may pose a threat to national security. The transfer of sensitive national technology to a foreign company is a problem that these regulators want to prevent from happening.

"When it comes to the hi-tech industry, under the current UK merger rules, a desire by the government to intervene in an acquisition on public interest grounds has to relate to possible national security implications" said Parr.

Republican US senator John Cormyn told attendees at an event in June that China was looking to 'weaponise’ investment – including via an aggressive international M&A strategy – to get ahead of the US when it comes to key technology. The acquisition of a majority stake in German robotics technology company Kuka by Chinese electrical appliance maker Midea also set regulatory alarm bells ringing last year.

"It’s a completely different ball game here," said Ahlborn. "The underlying issue is often loss of control, not of competition, so there is a much wider range of issues involved."

Commission president Jean-Claude Juncker announced in his State of the Union speech in September a draft regulation to streamline foreign direct investment into the EU.

This would not create an EU-level oversight mechanism for foreign acquirers targeting the EU but would harmonise existing standards, after calls from a number of member states to toughen the EU’s stance on FDI to match the US and China’s approaches.

See also

POLL: countering M&A protectionism
Brazil steps in to prevent gum-jumping
Brexit spells end of EU merger control’s one-stop-shop