Identifying a Suitable Divestiture Buyer and Related Issues

General Principles

Identifying and obtaining antitrust authorities’ approval of a suitable divestiture buyer is a critical aspect of deal planning and successful execution when an antitrust authority may insist on a divestiture remedy. Although preliminary antitrust risk assessments typically focus on the scope of a potential divestiture, merging parties should also carefully evaluate whether there are suitable buyers for assets that might need to be divested and, if so, the number of buyers. The answer to those questions can have important implications for whether the parties can convince the authorities about the feasibility of a remedy proposal at all and, if so, the effects on deal value from a remedy. Furthermore, the identity of the divestiture buyer can affect the scope of the divestiture that will be required (e.g., a limited asset divestiture versus a divestiture of a complete ongoing business). Carefully planning for and finding a suitable divestiture buyer is therefore critical to the success of transactions in which a divestiture remedy may be required.

The US Department of Justice Antitrust Division’s (DOJ) Merger Remedies Manual, updated in September 2020, explains that approval of a proposed divestiture buyer ‘will be conditioned on three fundamental tests’:^[2]

• ‘divestiture of the assets to the proposed purchaser must not itself cause competitive harm’;^[3]
• the DOJ must be certain that the buyer ‘has the incentive to use the divestiture assets to compete in the relevant market’ and will seek evidence of the buyer’s intention to do so;^[4] and
• the DOJ will evaluate the ‘fitness’ of the proposed buyer to ensure that the buyer ‘has sufficient acumen, experience, and financial capability to compete effectively in the market over the long term’.^[5]

Similar requirements apply at the US Federal Trade Commission (FTC),^[6] the European Commission (EC)^[7] and in other key jurisdictions.^[8] Under the EU Merger Remedies Notice:

• the proposed buyer is required to be independent of and unconnected to the merging parties;
• the proposed buyer ‘must possess the financial resources, proven relevant expertise and have the incentive and ability to maintain and develop the divested business as a viable and active competitive force in competition with the parties and other competitors;’ and
• the acquisition of the business by a proposed buyer ‘must neither be likely to create new competition problems nor give rise to a risk that the implementation of the commitments will be delayed’. Therefore, the proposed buyer ‘must reasonably be expected to obtain all necessary approvals from the relevant regulatory authorities for the acquisition of the business to be divested’.^[9]

Although evaluating divestiture buyers has always been a crucial issue in merger control, the process has recently received heightened scrutiny. In 2017, the FTC published a report evaluating the efficacy of merger remedies based on orders issued from 2006 until 2012 (the FTC Study). The FTC Study concluded that parties ‘appeared to understand the remedy process and usually proposed approvable buyers’,^[10] but the Study reflects an intensive focus on ensuring that divestiture proposals work in practice and actually replace the competition lost as a result of the merger. Two Democratic FTC commissioners expressed similar concerns in strongly worded dissents from consent decrees providing for divestitures to address competitive concerns when there was a Republican FTC majority. Now that Democrats comprise a majority at the FTC, these dissents may presage the FTC majority’s views for several years to come. In AbbVie/Allergan, for instance, Commissioner Rohit Chopra wrote that ‘merging parties have little incentive to sell to a strong competitor, and, in fact, succeed more when the buyer fails. . . . The agency must always closely vet divestiture buyers and conduct careful financial due diligence to determine whether they can or will aggressively compete’.^[11] Commissioner Chopra emphasised that the FTC should sue to block mergers if there are no truly suitable buyers for divested assets, rather than settling on terms that might not fully protect consumers.^[12]

Given antitrust authorities’ intensive scrutiny of proposed divestiture buyers, the increasing inter-agency cooperation in mergers subject to parallel reviews,^[13] and the possible challenges in finding a suitable divestiture buyer, merging parties should pay close attention to identifying potential suitable buyers early in the transaction planning process.

This chapter considers suitable buyer selection from the perspective of two broad questions that are central to evaluating potential divestiture buyers:

• whether the proposed divestiture buyer has the ability and incentive to replicate pre-merger competition; and
• whether a divestiture to the proposed buyer would create new competitive concerns.

Potential divesture buyer abilities and incentives to compete

A suitable divestiture buyer must have the financial resources and access to relevant industry expertise to compete effectively for the long term and must have the incentive to do so. The scope of the required divestiture may depend in part on the capabilities of the proposed buyer. A proposed buyer with substantial complementary assets and industry expertise may be able to effectively replicate pre-merger competition with a narrower set of assets than a proposed buyer lacking those attributes. Accordingly, if a buyer has few complementary assets or little industry experience, the authorities are more likely to adhere to their normal preference for a divestiture of ‘a business that can operate on a stand-alone basis’.^[14]

We describe the characteristics of a suitable divestiture buyer below.

Relevant industry expertise and experience

The antitrust authorities will look closely at whether the divestiture buyer has the relevant industry expertise and experience necessary to restore pre-merger competition in markets where the merger is alleged to harm competition, accounting for the scope of the proposed divestiture package. Some relevant expertise and experience will be transferred to the buyer with the divestiture,^[15] but the antitrust authorities will closely scrutinise whether the buyer has, among other things, the necessary management expertise to develop the divested business as a competitive force in the long term. This is less likely to be an issue if the proposed buyer is an experienced industry player. However, industry expertise and experience may be a significant issue if the proposed buyer would be entering the market de novo, such as a financial buyer without portfolio company expertise in the relevant industry, or a buyer whose business focuses on different markets.

In his dissenting statement in AbbVie/Allergan, for example, Commissioner Chopra expressed concern that Nestlé lacked the industry expertise to fully replicate pre-merger competition in a market for the treatment of exocrine pancreatic insufficiency and ensure future competition in the sales of IL-23 inhibitor drugs. He observed that ‘Nestlé is not a pharmaceutical company. Its core focus is on food, beverages, and other grocery store items’.^[16] Sometimes financial or other buyers that do not currently participate in the relevant market will partner with individuals (e.g., retired senior executives) or entities with relevant experience. The authorities will account for these arrangements in evaluating the potential buyer’s suitability.^[17]

Proposed buyer’s existing business capabilities

The potential divestiture buyer’s existing business capabilities (e.g., production facilities, employee base, facilities and intellectual property) will be critical in determining the scope of:

• the divestiture itself: For the divested package to be viable, it must include the assets necessary for the divestiture buyer to compete effectively in the relevant market, and the required scope of the asset package can depend significantly on the relevant assets the buyer already has;^[18] and
• any temporary supply arrangements between the merged firm and the divestiture buyer: Antitrust authorities do not permit ‘continuing entanglements’ between the merged firm and the buyer of the divested assets;^[19] accordingly, although the authorities will require transition services agreements (TSAs) insofar as they are ‘necessary to maintain the full economic viability and competitiveness of the divested business for a transitional basis’, they will allow such arrangements only insofar as ‘they do not affect the independence of the divested business from the parties’.^[20] In practice, the authorities will typically permit TSAs for two to three years after closing. The feasibility of addressing buyer start-up challenges through a TSA, and the scope of the required TSA, can turn significantly on the buyer’s existing capabilities.

Similar considerations apply to the ‘back-office’ operations of the divested business – for example, human resources, information technology, accounting, payroll and security. If the divestiture package does not include these operations (for example, because the divested assets are part of a larger business structure), the merging parties may be able to convince the authorities that the divestiture buyer has its own means of efficiently providing those operations. If not, back-office assets may need to be divested.

Furthermore, some mergers raise concerns regarding their impact not only on existing competition but also on innovation and future competition. In these cases, antitrust authorities will assess, additionally, whether the proposed divestiture buyer has the capability to maintain innovation competition at pre-merger levels and engage in future competition that would have prevailed but for the merger. This often requires a detailed assessment of the proposed buyer’s research and development (R&D) capabilities and funding. And if those capabilities are lacking, the authorities may require a broader divestiture than would otherwise have been the case.

The merging parties should therefore consider whether a proposed buyer has the required R&D and other resources to successfully carry forth acquired R&D projects and initiate new projects going forward. It can be very helpful if the proposed buyer has a well-documented history of successful innovation in the relevant industry.

The divestiture buyer’s innovation capabilities were especially critical in Bayer/Monsanto (2018), in which the complaint alleged reduction of competition in 17 distinct agricultural product markets, as well as ‘a significant impact on innovation’.^[21] The DOJ scrutinised BASF to ‘ensure that BASF would replace Bayer as an effective competitor and innovator in each of the 17 markets’ and found that BASF was ‘the only buyer the [DOJ] has evaluated and deemed suitable to resolve the range of competitive concerns raised by the merger’.^[22] This was because ‘BASF already has extensive agricultural experience, but [lacked] a seeds and traits business’.^[23] The divestiture to Bayer included significant intellectual property and assets in respect of ongoing R&D, as well as provisions allowing BASF the right to hire R&D personnel from Bayer.^[24]

The EC had similar concerns, observing that ‘the market features of both the crop protection and traits industries suggest that rivalry (or competition) is likely an important factor driving innovation, and that a merger between two of only a few important rival innovators is likely to lead to a reduction in innovation competition’.^[25]

In approving BASF as the divestiture buyer, the EC stated ‘BASF is, at present, not yet active in seeds and traits development. . . . The divestiture of those businesses to BASF would turn BASF into a global seeds and traits player’.^[26] Therefore, the commitments would ensure that the transaction ‘does not lead to a reduction in the number of global seeds and traits players’.^[27]

Evaluating proposed divestitures for whether they adequately address concerns regarding innovation competition promises to be a continuing area of focus moving forward. In AbbVie/Allergan (2020), for example, FTC Commissioner Rebecca Slaughter authored a dissent that was focused on potential innovation concerns, noting that these issues ‘deserv[e] particularly substantial and vigorous investigation when it comes to transactions between pharmaceutical companies’.^[28] Commissioner Slaughter referenced the covid-19 pandemic, observing how it made the world ‘keenly aware of the need for companies to innovate by creating and manufacturing products for testing, prevention, and treatment’.^[29]

Financial resources

The divestiture buyer’s financial resources are another critical consideration. Antitrust authorities will scrutinise the proposed buyer’s sources of acquisition financing and financial plans in determining whether the proposed buyer will compete effectively in the long term. The EC ‘will normally not accept any financing of the divestiture by the seller, and, in particular, any seller financing if this were to give the seller a share in the profits of the divested business in the future’.^[30] The US agencies follow a similar approach.^[31]

Recent examples of divestiture failures illustrate the importance of this requirement and have heightened the authorities’ focus:

• In 2015, US supermarket operators Albertsons and Safeway agreed to sell 168 supermarkets to four buyers to settle FTC charges that their proposed merger would be anticompetitive.^[32] Later that same year, however, Haggen Holdings, the buyer of most of the divested supermarkets, filed for bankruptcy. The FTC eventually permitted the merged firm to buy back some supermarkets that had originally been included in the divestiture package.
• The EC approved the acquisition of Embraco (Whirlpool’s refrigeration compressor business) by Nidec in 2019.^[33] The clearance was subject to a divestiture of Nidec’s plants in Austria, Slovakia and China. Several months after EC approval, however, the divestiture buyer announced plans to cease production in one of the divested facilities. The EC initiated an investigation to determine whether Nidec, which had promised funding to the buyer for the divested business,^[34] complied with its remedy commitments.^[35]

Incentive to compete

It is not enough for a divestiture purchaser to be able to compete effectively in the market. The proposed buyer must also have the incentive to do so. The DOJ Merger Remedies Manual states that ‘a [divestiture] seller may wish to sacrifice a higher price for the assets today in return for selling to a rival that will not be especially competitive in the future. In contrast, if the firm selling the assets is itself exiting the market, its incentive is simply to identify and accept the highest offer’.^[36] Thus, in some cases there may be a conflict between the incentives of the divestiture buyer (for instance, to buy the divested assets at a low price and exploit them as a cash cow) and the authorities’ purpose in ordering a divestiture (i.e., to maintain competition in the relevant market at pre-merger levels). Antitrust authorities also will not approve a divestiture buyer that is likely to redeploy the acquired assets elsewhere, because an intent to redeploy signals that the purchaser does not have the requisite incentive to compete.^[37]

To assess incentives, antitrust authorities will examine evidence such as the buyer’s ‘business plans, prior efforts to enter the market, or status as a significant producer of a complementary product’.^[38] Customer and supplier views will be considered also.^[39]

Financial buyers

Financial buyers, such as private equity or investment firms, may raise special issues in the divestiture context. They frequently have significant financial resources and general acquisition experience but may lack the specific industry expertise or incentive to compete effectively in the market.

Antitrust authorities will typically use the same criteria to evaluate both buyers that are already in the relevant industry (strategic buyers) and financial buyers. Financial buyers will often be suitable buyers. They may have strengths such as transaction experience, flexible investment strategy, commitment to the divestiture assets, or willingness to deploy additional capital when necessary.^[40] They also will typically be less likely than strategic buyers to raise competition issues based on their own interests in the relevant market for the divested assets. However, the authorities will closely scrutinise whether financial buyers have the necessary industry-specific expertise (accounting for personnel and other assets that may be included in the divestiture) and incentives to compete aggressively in the long term (e.g., they do not plan to quickly flip the acquired assets). Accordingly, agencies will usually scrutinise financial buyers’ post-purchase plans especially thoroughly.^[41] In the United States, FTC Commissioner Rohit Chopra has been particularly vocal in expressing reservations about the viability of certain financial buyers, observing in his dissent in Staples/Essendant (2019) that not all financial firms ‘have a strategy that is aligned with vigorous competition’.^[42] In that case, Commissioner Chopra cited evidence that the proposed private equity divestiture purchaser had, in previous cases, quickly resold the divested assets, suggesting that it would ‘operate assets much differently than a typical buyer’ and contrary to the FTC’s purposes in requiring a divestiture.^[43]

The EU Remedies Notice also recognises potential concerns regarding private equity buyers’ incentives. Specifically, Paragraph 49 of the Notice provides that the EC may require that the divestiture buyer be an industrial purchaser, rather than a financial purchaser. The EC will normally require this commitment if ‘a financial buyer might not be able or might not have the incentives to develop the business as a viable and competitive force in the market even considering that it could obtain the necessary management expertise (e.g., by recruiting managers experienced in the sector at stake) and, therefore, the acquisition by a financial buyer would not remove the competition concerns with sufficient certainty’.

Merging parties that intend to propose financial divestiture buyers should prepare for thorough scrutiny of the proposed buyer’s industry expertise and incentives. They should also consider that financial purchasers without portfolio companies in the affected industry may be less likely to be deemed suitable divestiture buyers, at least when the divestiture does not comprise a stand-alone business. The merging parties should satisfy themselves that participating financial purchasers understand the scrutiny they are likely to face and are ready and able to respond to questions and potential scepticism from the reviewing authorities.

Regulatory obligations

An important factor for assessing potential divestiture buyers in highly regulated industries, such as pharmaceuticals, is whether these buyers already have, or can quickly obtain, the required government approvals (e.g., licences, permits, registrations, or other qualifications at buyer or customer level) to effectively operate the divested business immediately after closing.

The seller may be able to transfer some approvals to the divestiture buyer, or it may be possible to operate the divested business using approvals under the seller’s name for a certain period. This must be a transitional solution only, however. The proposed buyer ‘must reasonably be expected to obtain all necessary approvals from the relevant regulatory authorities for the acquisition of the business to be divested’^[44] and there must not be ‘a risk that the implementation of the commitments will be delayed’.^[45] In the United States, the authorities’ position in ‘upfront buyer’ settlements is that the buyer must obtain all regulatory approvals required to effectively operate the divested business or make acceptable alternative arrangements before the primary transaction may close.^[46]

Multiple buyers

Occasionally, there will be more than one buyer for assets that need to be divested. In those cases, antitrust authorities will carefully examine any dis-synergies created by divesting assets across buyers compared to maintaining the assets with a single owner, and how this would impair restoration of competition in any relevant market, considering the buyers’ complementary assets. When a party other than the proposed buyer itself has significant influence over the proposed buyer (e.g., with a proposed joint venture buyer), antitrust authorities will evaluate whether that party might have incentives and the ability to control the proposed buyer that could make the proposed buyer unsuitable. For instance, if a joint venture partner is, itself, a significant competitor in a market in which the divestiture is designed to restore competition lost through the merger, that could raise issues regarding the joint venture’s suitability as a buyer. Alternatively, a joint venture partner might have incentives and the ability to cause the joint venture to sell the asset quickly rather than compete in the long term. The analysis of these issues is highly fact specific and will depend, among other things, on the competitive environment in the relevant market and the level of influence the joint venture partner has over the competitive behaviour of the proposed joint venture buyer.

Absence of competitive issues

The authorities will not approve a divestiture that will create its own anticompetitive harm. As observed in the DOJ Merger Remedies Manual:

[D]ivestiture of the assets to the proposed purchaser must not itself cause competitive harm. For example, if the concern is that the merger will enhance an already dominant firm’s ability unilaterally to exercise market power, divestiture to another large competitor in the market is not likely to be acceptable, although divestiture to a fringe incumbent might be.^[47]

To evaluate whether a divestiture to a proposed buyer will harm competition, antitrust authorities apply the same analytical framework that they apply to any other transaction. They will assess whether the divestiture is likely to harm competition based on horizontal, vertical or potentially conglomerate concerns, seek input from market participants regarding the potential sale, evaluate documents and data, and conduct economic analyses. However, under this review for competitive concerns, unlike the original transaction, US agencies maintain unreviewable discretion – their decision cannot be challenged in court.

In the European Union, merging parties have only limited ability to challenge the EC’s rejection of a proposed buyer. In Petrolessence SA and Société de gestion de restauration Routière SA (SG2R) v. Commission, the EC rejected proposed divestiture buyers, finding that they would not maintain and develop effective competition. The proposed buyers challenged the rejection before the Court of First Instance (now the General Court). The court rejected their appeal, holding that they had failed to establish that the EC’s assessment regarding their suitability was manifestly erroneous.^[48]

In addition to evaluating horizontal overlaps, antitrust authorities are giving increased scrutiny to potential vertical and conglomerate concerns, and this will affect how they assess potential buyers. In Fresenius/NxStage (2019), Commissioner Slaughter authored a dissent in which she raised concern ‘about the competitive implications of vertical mergers, especially in highly concentrated, oligopoly markets with significant barriers to entry.’^[49] This echoed her dissent in Staples/Essendant (2019), in which she wrote separately from Commissioner Chopra ‘to highlight some observations regarding vertical merger enforcement generally’ and expressed concern that ‘the current approach to vertical integration has led to substantial underenforcement’.^[50] In particular, Commissioner Slaughter called for the substantiation of the benefits cited by merging parties for vertical integration, which she argued should not be taken at ‘face value’.^[51] More recently, President Joe Biden has issued an Executive Order on competition, which (among many other things) encourages the US antitrust agencies to evaluate whether to abrogate their current vertical merger guidelines.^[52]

Horizontal overlaps, or vertical or conglomerate relationships, do not necessarily disqualify a divestiture purchaser, so long as the authorities determine that a divestiture to the proposed buyer is not likely to harm competition. For instance, the DOJ has recognised that the fact a proposed buyer is a ‘fringe incumbent’ in a market where a remedy is required will not necessarily disqualify it, although there are likely to be more significant concerns if the buyer is a major competitor.^[53]

In Bayer/Monsanto (2018), several interested third parties argued to the EC that BASF, the proposed divestiture buyer, was one of the main global crop protection players and had common shareholders with some of its competitors.^[54] The EC ‘recognize[d] the debate related to the possible effects of the presence of common shareholders in an industry’ but found that the presence of common shareholders did not, as such, disqualify BASF as a suitable buyer.^[55]

Divestiture landscape and increased scrutiny: practical guidance

Overall, antitrust authorities are intensively scrutinising proposed divestiture buyers. Merging parties are well advised to carefully plan for a potential divestiture, even if they are optimistic that a divestiture may not be required to gain antitrust clearance. This type of planning should be an integral part of the preliminary transaction analysis and the strategy for obtaining a favourable outcome in the merger review process. There are many benefits from early and continuous planning.

More accurate evaluation of overall antitrust risk

Whether a suitable buyer can be identified and signed up can be an important factor in deciding whether to move forward with a transaction in the first place, or in crafting contractual risk-shifting provisions (such as a ‘hell or high water’ provision). If the acquirer is confident there will be several qualified buyers, that will reduce the risk that the transaction cannot be successfully completed or that there will be an unacceptable loss of value from being forced to sell divested assets at a ‘fire sale’ price. On the other hand, some transactions will be much riskier because of a significant risk that there will be no interested and qualified buyer, and the antitrust authorities may therefore seek to block the transaction entirely.

Saving time

Identifying a suitable divestiture purchaser can take significant time and delay transaction closing. Planning ahead can prevent unnecessary delays and expedite the process.^[56] Antitrust authorities, especially in the United States but increasingly in other jurisdictions also, often require the merging parties to find an upfront buyer and reach a signed sales agreement for assets to be divested before the agency will accept the remedy and clear the transaction, especially when the parties propose to divest less than a complete business.^[57] The updated DOJ Merger Remedies Manual (as updated in 2020) observes that an ‘upfront buyer’ will be required in ‘most merger cases’.^[58]

Although the EC has traditionally permitted merging parties to implement divestitures post-closing, the use of upfront buyer and fix-it-first remedies has greatly increased recently, to 26 per cent between 2014 and  2019. This reflects ‘the [EC’s] growing inclination to require the early identification of suitable buyers in Phase I cases’.^[59]

Accordingly, the parties are well advised to look for suitable buyers – through an auction process or otherwise – long before they intend to close their transaction.

Narrowing the divestiture scope

Antitrust authorities prefer the divestiture of a stand-alone business (including facilities, equipment, R&D, among other things), which they believe is more likely to fully replicate pre-merger competition.^[60] Merging parties will often prefer to divest a package of assets that constitutes less than an ongoing business, typically because divesting an ongoing business would require a broader divestiture package or be inconsistent with the business rationale for the primary transaction. Where merging parties will be seeking to persuade the antitrust agency to approve a divestiture of less than an ongoing business, it is all the more critical to plan well ahead, particularly because success will often depend significantly on the existing capabilities of the proposed divestiture buyer and exacting explanations about how it will successfully compete with divested assets.

Facilitating authority approval

Early engagement with the relevant authorities regarding a potential divestiture can help smooth the path to approval. The parties may be able to solicit informal guidance regarding potential buyers and the assets that will need to be divested to gain approval. The antitrust authorities encourage merging parties to engage early and often with agency staff, ‘to make sure that any negotiated agreement includes all assets and contains all the provisions that staff believe[s] are necessary to resolve the competitive concerns’.^[61]

Conclusion

Identifying and persuading antitrust authorities to accept a divestiture buyer can be a complex and challenging exercise, especially given the antitrust authorities’ intensive scrutiny and sometimes scepticism of proposed buyers, which show no sign of abating. As merging parties seek to identify and vet suitable buyers, it is crucial that they focus on the two fundamental questions – whether a potential buyer has the capabilities and incentive to replicate pre-merger competition and whether a divestiture to that potential buyer would create its own antitrust concerns – and the issues that those questions typically encompass. Early planning and ensuring that evaluation and gaining approval of a divestiture buyer is a central part of the merging parties’ antitrust clearance strategy can pay off enormously by avoiding unnecessary delay, loss of deal value, or even failure of the primary transaction.

Notes