A predictive approach to merger analysis
Conflicting decisions serve to highlight the complexities involved in making the correct factual assumptions in order to determine the relevant counterfactual
TO BE or not to be: that is the question. This often quoted line is arguably the best known introductory statement from Shakespearean literature. Through Hamlet’s troubled monologue, Shakespeare explores the dilemma faced in making a determination on whether the certainty of life is preferable to the uncertainties of death.
This debate, which attempts to weigh up the here-and-now versus an uncertain future event, serves to illustrate (with some poetic licence) the unenviable task that the competition authorities face in considering the relevant counterfactual scenario in South African merger analysis.
The counterfactual is an analytical tool that assists in answering the question of whether a particular merger gives rise to a substantial lessening or prevention of competition, or generates public interest harm. The counterfactual, which typically describes a future world absent the merger, is compared against the factual, which is a world in which the merger goes ahead. The importance of a counterfactual scenario in a given merger will depend on the facts of each case, and in particular, may be used where the prospect of harm to competition or public interest is high.
The conflicting decisions of the Competition Tribunal and the Competition Appeal Court (CAC) in the proposed merger between Pioneer Hi-Bred International Inc and Pannar Seed (Pty) Ltd serve to highlight the complexities involved in making the correct factual assumptions in order to determine the relevant counterfactual.
The difference in approach by the Tribunal and CAC was founded on the opposing arguments presented by the merging parties and the Competition Commission. The merging parties submitted that the proposed merger would provide Pannar with advanced breeding technologies from Pioneer, which would prevent Pannar’s decline as a competitive force in the hybrid maize seed breeding market in SA. The Commission, on the other hand, argued that anti-competitive harm would arise by virtue of two out of the three significant competitors in the hybrid maize seed market becoming a merged entity.
The tribunal’s decision in the Pannar matter supports a more conservative approach to the application of a counterfactual scenario to merger analysis, preferring the assessment of current market conditions to an assessment of a future (albeit somewhat foreseeable) situation. The tribunal noted that the relevant counterfactual in this matter could either be (i) the status quo, ie a scenario where the merger does not happen, thereby maintaining the prevailing pre-merger market conditions; or (ii) an alternative foreseeable situation that was significantly different from the status quo.
The tribunal held that the Competition Act allows for only one permissible departure from the status quo as an appropriate counterfactual proxy, and that is where the business of a party to the merger has failed or is likely to fail — the so-called failing firm defence.
The tribunal decided that the relevant counterfactual in this matter was the status quo, as, even though the facts indicated that Pannar was in decline, the nature and extent of its decline did not seem to necessitate a failing firm analysis (nor did the merging parties raise the failing firm defence). Of importance to the analysis of the status quo was that Pannar had alternative strategies that it could pursue that may ameliorate or remove the possibility of its decline in the market, such as partnerships with other firms that would not give rise to anticompetitive effects in the relevant market. Therefore the tribunal prohibited the proposed merger.
In overturning the tribunal’s decision, the CAC appears to criticise the tribunal for failing to have due regard to the correct factual assumptions to be used in constructing the relevant counterfactual. In particular, the CAC noted that the alternative partnerships that Pannar may have pursued with other firms identified by the tribunal were not in fact viable, as there was very little complementarity between the firms that would allow Pannar to continue developing hybrid maize seed.
Interestingly, while the CAC affirmed that the Pannar matter could not be decided in terms of the concept of a failing firm, the CAC held that the relevant counterfactual was the continued decline and exit from the market by Pannar.
While not explicitly dismissing the tribunal’s interpretation of the counterfactual scenarios permitted under the Competition Act, the CAC appeared to put forward the proposition that a “forward looking” counterfactual, which contemplated an alternative foreseeable situation to the status quo absent the merger, could be used in a “less than” failing firm scenario (ie where the failing firm defence is not formally raised by the merging parties).
The CAC concluded that the proposed merger would prevent the loss of a valuable competitive force, and would increase competition and the nature and quality of seeds produced in SA. Consequently, the CAC approved the merger, subject to various conditions.
The challenges highlighted in the decisions of the tribunal and CAC in the Pannar matter — in which the competition authorities must somehow evaluate the present versus the uncertain future and determine which “world” is more competitively desirable — find echo in Hamlet’s dilemma. To approve or not to approve? That is indeed the troublesome question.
Mark Garden is a director and Rutendo Hlatshwayo a candidate attorney in the ENS competition law department.