Friday, January 10, 2014

Deflating The (Allegedly) Goldman-Sachs-Generated Novartis Asset Swap Rumor: §1 Of The Sherman Act -- Actual Legal Analysis

As the less-informed MSM outlets continue to generate derivative stories (cold weather equals slow news days, I guess!) -- on the rumor of a $5 billion swap -- I feel the need to "get granular". Many deals get announced. Not so many of those, structured like this one rumored deal -- ever get closed -- intact. Why? Because the Sherman Act was written to specifically preclude such a market carve-up. That's why. And Merck knows it -- given the Merial experience in Animal Health of 2011 vintage -- a deal cratered by a complex mass of likely antitrust violations (thanks again, Fred and Tom!). [Please search "Intervet" on my site, above, for the market by market EU concentrations in Animal Health. I'll not list them all, here -- but I have previously documented dozens of them.] Now, as to this largely breathless rumor -- a few points:

Point one: Novartis and Merck are presently horizontal market competitors in many sectors of the Animal Health markets (this used to be called the vetrinary market, BTW -- so search that term for the older literature on topic).

Point two: Novartis claims, and Merck tacitly admits, that it is No. 2, worldwide, in those markets, as broadly defined (behind only the Pfizer spinoff, Zoetis -- which holds the legacy Fort Dodge assets and businesses). See the MSM reporting.

Point three: Novartis is much larger than Merck, in many many of the Consumer Health sectors of OTC drugs and treatments, world-wide -- and the two compete, horizontally in many of these spaces. Thus, an asset swap may get annouced, but will likely never close completely intact -- because. . . wait for it. . . the Sherman Act will prohibit it. The Act is enforced by the US DoJ Antitrust Division.

Merck learned this the hard way -- when it had to scrap Fred Hassan's hare-brained Merial scheme -- to build an Animal Health behemoth, via a nominal joint venture with Sanofi-Aventis, then (ultimately, through a series of complicated steps) regain control of the combined operations. That deal foundered -- on the same market-by-market §1 and §7 analyses (and a similar analyses, in the EU and Japan by antitrust regulators there) -- and the US DoJ's concerns about the same.

Since the days of William Howard Taft, i.e., the late 19th Century, such arrangements have been held to be per-se violations of §1 of the Sheman Act of 1890. If, on the other hand, Merck and Novartis claim this will enhance market efficiencies, as it will make each a better competitor -- they need to be prepared to show that each of their smaller, weak sister, businesses in the swap lose money -- to pass a §7 Clayton Act test. We all know that both companies say these businesses are very profitable (stand-alone), in their public statements. So we never say never, but we are decidedly skeptical that any such deal gets closed -- remotely intact.

In a much longer article explaining (among other things) why very-similar asset swaps -- this time, in the medical waste disposal/incineration industry -- were successfully enjoined by the US DoJ, out of Utah, we read some substantive legal analysis of what the Sherman Act §1 prohibition on "carving up markets" actually means, in asset swaps.

. . . .If the principal purpose of a transaction between competitors is to “share or divide markets by allocating customers, suppliers, territories, or lines of commerce,” courts have conclusively presumed, through the application of the per se rule, that the agreement is illegal under §1 of the Sherman Act (or the corresponding state statute). Indeed, “[o]ne of the classic examples of a per se violation of §1 is an agreement between competitors at the same level of the market structure to allocate territories in order to minimize competition.” In such cases, the court will not inquire into the reasonableness of the arrangement, the facts peculiar to the business or industry involved, the nature of the restraint, its effect on competition, the history of the agreement, or the reasons for its adoption. 29U.S. v. Topco Associates, Inc., 405 U.S. 596, 608 (1972). The per se treatment of horizontal territorial allocations under §1 may have had its genesis in U.S. v. Addyston Pipe & Steel Co., 85 F. 271 (6th Cir.1898), aff'd, 175 U.S. 211 (1899), although Judge (later Chief Justice) William Howard Taft left the door open to efficiency-enhancing justifications. The modern proposition that the horizontal division of markets is unlawful per se can be credited to Timken Roller Bearing Co. v. U.S., 341 U.S. 593 (1951). See also, U.S. v. Sealy, Inc., 388 U.S. 350 (1967). . . .

A per se case often depends on a factual predicate being established before the per se analysis is appropriate. Thus, an inquiry into the factual circumstances underlying the agreement usually will be required. First, the enforcement official must make an initial determination as to whether the parties are predominantly horizontally-related competitors. . . .

It is not necessary that the parties to the proposed transaction actually compete in the affected market(s) to run afoul of the per se prohibition against market allocation. It is enough that the parties are potential competitors who agree to allocate territories, routes or customers. Thus, an agreement not to compete between medical waste disposal firms operating in non-overlapping territories may still constitute a per se unlawful horizontal restraint. . . [However,] application of the per se rule will still depend on whether the central purpose of the agreement is to lessen competition through the allocation of resources or to promote competition through efficiency generating integration. Five factors that should be considered when making any such determination are:31 a) The proffered business justification; b) The nature and disposition of the swapped assets; c) The structure of the transaction; d) The market impact; and e) The nature of the express non-compete agreement or barriers to entry (or re-entry). . . .

Is there just one or more than one swap transaction? Multiple swap transactions resemble a coordinated effort to allocate the market, and therefore are less likely to be supported by a legitimate efficiency justification. [Here, the parties to the rumored deal will have dozens of country by country swaps -- in all likelihood.]

Okay -- I'll stop there, for now, and discuss these five factors (immediately above), in another post this weekend.

So -- why is Goldman (and it is very likely a Goldman banker) leaking these swap rumors? The oldest reason there is.

To protect an investment in a fee. Novartis doesn't have much use for a marginally cash generating AH sale -- and there are likely few buyers that want to compete against Merck or Fort Dodge (now Pfizer's spin-off called Zoetis), in the AH space -- head to head. [The reverse statement would be true of Consumer Health -- just switch Merck's name for Novartis's in the prior sentence, and vice versa.]

So this is -- in my opinion -- a largely vain effort to defend Goldman's likely multiple hundreds of millions in transactions fees, should it be able to convince the world's antitrust regulators that this swap (if left largely intact) will increase market efficiency for both parties. I for one am deeply skeptical that the US, and EU authorities in particular, will bite -- and the Merial experience of 2009 to 2011, as well as the black letter law quoted above, supports this view. Here endeth the lesson.

UPDATED: 5 PM EST -- Maybe Mr. Frazier will address the rumors come Monday late afternoon, Eastern time. We shall see.

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