Mergers That Diminish Innovation Present Deal Risk

On April 27, 2015, the Department of Justice’s (“DOJ”) Antitrust Division released a statement regarding Applied Materials Inc. (“AMAT”) and Tokyo Electron’s (“TEL”) joint announcement that they abandoned their merger.  The Antitrust Division’s statement indicates that the transaction was blocked because the combination would have diminished innovation.  In other words, the Antitrust Division was concerned about the potential loss of head to head competition in the development of future cutting edge semiconductor products and made no allegation that the combined firm would have monopolized any existing or actual product market.  The Antitrust Division’s tough stance against AMAT indicates that it is willing to scrutinize and challenge deals that raise longer-term anticompetitive concerns related to future competition even if there is no past pricing evidence that may predict that the merger will result in higher prices regarding actual products.

Background

On September 24, 2013, AMAT and TEL announced a definitive agreement to merge via an all-stock combination, which valued the new combined company at approximately $29 billion.  The companies claimed that securing regulatory clearances should not be a problem because their product offerings were highly complementary with few overlaps.  Indeed, AMAT was strong in markets where Tokyo Electron was not and vice versa.  In areas, where they directly competed, the combined shares were low.  Nevertheless, the transaction would have combined AMAT, the largest semiconductor equipment supplier in the world, with TEL, the third largest equipment supplier.

It was widely known that AMAT’s scale and resources gave AMAT advantages in competing with smaller chip equipment firms, in areas ranging from research and development (“R&D”) to marketing as well as service and support.  As the standard in the chip equipment space, AMAT has a massive installed base of tools and engineers in nearly every chip-manufacturing facility in the world.  AMAT developed close relationships with major chipmakers.  AMAT has scale and resources that are unmatched and invests heavily in R&D.

Yet, AMAT/TEL believed they would be able to obtain regulatory approvals because they were relying on the outcome of past merger reviews.  Indeed, the DOJ previously analyzed consolidated and highly concentrated semiconductor markets, including AMAT’s acquisition of Varian in 2011; ASML’s acquisition of Cymer in 2013, and Advantest’s acquisition of Verigy in 2011.  In each of these situations the mergers combined complementary offerings where the actual or pipeline products were not directly substitutable.  In AMAT/Varian, the DOJ focused on R&D and innovation concerns.  In ASML/Cymer, the DOJ focused on vertical concerns.  In Advantest/Verigy, both companies were in the business of supplying semiconductor companies with semiconductor components and automated test systems.  The transaction left only one other significant player in the market.  While the DOJ demonstrated an interest in each of these highly concentrated markets by issuing second requests and conducting thorough merger investigations, the DOJ allowed these transactions to close without requiring any conditions.

Moreover, traditional antitrust analysis is generally concerned about the merged firm’s ability to raise prices, reduce output, or exclude competitors.  The antitrust agencies are normally focused on whether the combination of two competitors will substantially lessen competition such that the combined firm can illegally raise prices or exclude rivals.  But in this merger, the firms were not direct competitors in any of each other’s core products.  There was very little direct overlap and where there was, the market shares were low, so no head-to-head history of price competition.  Besides the argument that the two firms do not directly complete with regards to price, the merging firms believed that large sophisticated customers such as Intel and Samsung have the ability to sponsor entry and control pricing.  Therefore, based on past precedent and traditional merger analysis, AMAT and TEL were under the impression that merging two firms with complementary offerings even in a highly concentrated technology industry would be approved.

The DOJ, however, took a tough stance against AMAT’s proposed acquisition of TEL because they were two of a very small number of R&D leaders in their industry.  Given the DOJ’s position, AMAT and TEL determined that there was no “realistic prospect for completion of the merger”.  AMAT offered a divestiture package of assets along with a proposed buyer, but the Antitrust Division was not satisfied.  Indeed, Renata Hesse, the Acting Assistant Attorney General explained that AMAT’s “proposed remedy would not have replaced the competition eliminated by the merger, particularly with respect to the development of equipment for next-generation semiconductors.”  Ms. Hesse further stated “the proposed merger of Applied Materials and Tokyo Electron would have combined the two largest competitors with the necessary know-how, resources and ability to develop and supply high-volume non-lithography semiconductor manufacturing equipment.”  Clearly, the DOJ was concerned not about the reduction of competition for any actual product but about the loss of future head to head R&D competition.

DOJ’s Focus on Future Competition is Not New

The antitrust agencies have always been concerned about future competition concerns in merger reviews.  Indeed, the 2010 FTC/DOJ Horizontal Merger Guidelines (“Merger Guidelines”) discuss the importance of evaluating effects to innovation in merger reviews.  The Merger Guidelines state that enhanced market power can be “manifested in non-price terms and conditions that adversely affect customers, including reduced product quality, reduced product variety, reduced service, or diminished innovation.”  Moreover, under the Merger Guidelines the Antitrust Division is to “consider whether a merger will diminish innovation competition by combining two of a very small number of firms with the strongest capabilities to successfully innovate in a specific direction.”

Lessons Learned

There are a number of lessons learned from the DOJ’s recent stance against AMAT that corporate and antitrust counsel of companies contemplating a merger of firms involved in R&D competition should consider going forward.

First, when the Antitrust Division evaluates the competitive effects of a merger, it is not simply focused on actual product or service overlaps in highly concentrated markets.  The Antitrust Division does not need evidence of price effects or a long history of price competition to challenge a merger.

Second, the Antitrust Division will examine a combination for its potential impact on innovation especially in an industry where a small number of firms are driving R&D efforts to develop new products or solutions.  Therefore, when two innovative firms are merging, antitrust counsel must consider and assess as part of its competition analysis, potential anticompetitive effects related to the loss of future competition.  The analysis is difficult because innovation effects are more difficult to quantify than price effects.

Third, antitrust and corporate counsel must be prepared for a long investigation if the combination raises innovation concerns.  The AMAT investigation took 18 months.  The Antitrust Division will examine other evidence such as industry structure, internal company documents, history of innovation, and strategic documents discussing current and future R&D plans to determine anticompetitive effects.  Therefore, when evaluating the antitrust concerns of a combination of innovative firms, antitrust counsel must be ready to explain not only how the firms do not compete on actual products but also be prepared to explain how their current and future R&D plans are complementary and not competitive with each other.

Fourth, it may be difficult to craft a remedy to resolve innovation concerns as they present unique challenges that are more complex than simply divesting existing business and product lines.  The Antitrust Division will intensely scrutinize upfront buyers.  Not only must the buyer obtain existing business lines, products, and all of the assets necessary to transfer the technical know how to allow the new entrant to step into the place of the lost innovation, but the buyer must also be able to demonstrate that it has the incentive and the wherewithal to be successful in future R&D efforts.

Fifth, the Antitrust Division is serious about taking action against mega-mergers in highly concentrated industries.  While the Antitrust Division may have analyzed previous mergers within a certain industry in a particular way, the antitrust agencies are not obligated to use the same analysis in the next transaction within the same industry.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com