South Africa: Efficiency Arguments In Favour Of Mergers And Acquisitions

American anti-trust officials while carefully scrutinising the merger between Exxon & Mobil had concerns that the merger would affect competition at almost every level in the petroleum industry.

In large mergers of this nature, companies often have to demonstrate some compelling efficiency argument in favour of the merger in order for it to obtain the necessary approval. In this article I propose to deal with some of the efficiency arguments and their respective merits.

The South African Competition Act of 1998 ("the new act"), provides that the Competition Commission must be notified about an intermediate or large merger. Although such notification only becomes compulsory when the new act comes into operation, parties to mergers should take cognisance of the recently published Competition Amendment Bill.

The Competition Amendment Bill published in March 1999 was designed to prevent mergers in contravention of the provisions of the new act being rushed through before the act came into effect. It provided that any merger regarded as an intermediate or large merger under the new act and that takes place between October 30 1998 and the date of implementation of the new act, will be deemed to be in contravention of the new act for a period of 12 months after the new act comes into operation, unless:

• The transaction has been approved by the Competition Board in terms of the existing Maintenance and Promotion of Competition Act, 1979; or
• The merger is notified to the Competition Commission within 3 months after the date on which the new act comes into operation.

The practical affect of the Competition Amendment Bill is that merger notification became compulsory as of 30 October 1998 to the extent that a merger is regarded as a large or intermediate merger under the new act.

In view of the requirement of merger notification and the attendant investigation by the competition authorities as to whether a merger is likely to substantially prevent or lessen competition in the relevant market, the question arises as to what efficiency arguments can be put forward by companies to justify mergers which are potentially anti-competitive.

In terms of the new act, the competition authorities can condone an anti-competitive merger, provided there are some compelling technological or efficiency gains which would be greater than or off-set the effects of any lessening of competition.

It is evident from the decision of the Competition Board in the Sasol/AECI matter, that efficiency gains are judged on their "overall welfare enhancing attributes" and not on "purely enterprise-centric pecuniary or managerial economies".

Three basic types of efficiency arguments are often put forward by companies to justify mergers which have anti-competitive implications.

The first efficiency defence is that a merger of the firms will result in cost savings. Cost savings can take several forms. Two established categories are "pecuniary" and "real economies". Pecuniary savings usually take the form of monetary savings from buying goods or services more cheaply because the larger size resulting from the merger will give the merged entity bargaining leverage relative to its suppliers.

"Real economies" on the other hand generally refers to economies or scale of some kind, such as revamping production lines and eliminating duplication. Competition authorities generally do not react positively to purely "pecuniary" cost saving efficiencies, which are often perceived to be "ephemeral" and "exaggerated". Indeed Eleanor Fox makes the point that "large costs attend large mergers", which when balanced against the pecuniary cost savings tend to undermine the validity of the cost savings argument. "Real economies" tend to be viewed far more favourably, provided there is some hard factual evidence to substantiate the claims.

The second category of efficiency defences are what might be termed technological or innovation gains. Improved efficiency in producing the particular goods or services through technical innovation and advances is a credible justification for large mergers.

If it can be demonstrated that technical initiatives as a result of a merger would result in new products being produced or existing products being produced more cheaply, to the benefit of consumers, this is likely to elicit a favourable response from the competition authorities.

Once again, the benefits of technological innovation have to be tangible and firms cannot simply assert that research and development will be greatly enhanced under the merged entity, as this has all the hallmarks of a self-serving justification.

The third category of an efficiency defence to an anti-competitive merger relates to reducing management and labour inefficiencies. Often the merger of two large firms results in a management reshuffle, designed to replace inefficient management with a more productive and efficient one. Changes in management are also inevitably accompanied by restructuring of the relevant labour force, usually by way of retrenchments. Indeed large mergers have become synonymous with equally large lay-offs.

While restructuring of management and labour can result in a more efficient organisational structure and a leaner operation, it is unlikely that this will be met with great approbation by the competition authorities. If a merger is likely to have anti-competitive consequences and also result in wide scale lay-offs it is unlikely to be approved.

In conclusion it is apparent that the greater the extent to which competition is lessened as a result of a merger or acquisition, the more manifest and substantial the efficiency gains must be.

It is incumbent on the parties to the merger to demonstrate that tangible efficiency gains will accrue to consumers as opposed to purely enhancing the interests of the companies themselves.

It is recommended that parties planning a merger should carefully weigh up the potential efficiency benefits of the transaction, particularly if they have reason to believe that the merger will be anti-competitive.

A credible efficiencies defence, while high-lighting the benefits to the relevant parties concerned, must demonstrate fundamental long-term benefits for society as a whole, including labour, the investment community and consumers in particular.

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The material contained in this article is provided for general information purposes only and does not constitute legal or other professional advice. We accept no responsibility for any loss or damage, which may arise from reliance on information contained in this article.

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