Trade buyers, frustrated by competition rules, which block them from acquiring their direct competitors and who are determined to avoid them falling into competitive hands, are seeking private equity houses to take controlling stakes in those businesses, according to Simon Holmes, competition expert and partner at SJ Berwin. The concept for the private equity house however doesn’t look too appealing, in particular when it comes to working out an exit strategy for the company. Angela Sormani reports. Holmes says: “In sectors where the market is dominated by a handful of players, and barriers to entry are high, competition law makes it difficult for companies to acquire their direct competitors outright. As a result, a number of private equity houses are being approached by trade buyers to be the entity that takes control of the competing company, and to allow the trade buyers to acquire minority stakes in their competitors, in order to reduce competition concerns.”
However, there are obstacles for the private equity firm if it chooses to assist a trade buyer in dodging competition rules. Unless the private equity firm hopes to sell its stake to the minority shareholding trade partner, which is probably unlikely as it would fail to get competition law approval (hence the reason for partnering in the first place), there doesn’t seem to be a viable reason for a private equity firm to do this unless it manages to float the company successfully or sell it on in a secondary buyout. This would leave the acquiring private equity house in the same dilemma when it comes to exiting the business.
And so for private equity houses contemplating this type of deal, Holmes advises they consider their exit strategy very carefully. “Selling this type of investment could be problematic. Funds must ensure that, in ‘assisting’ a trade buyer to take a stake in a competitor, they are not left with a restricted investment which can only be sold to a limited group of undertakings.”
For this reason, this type of deal has yet to take off. The most recent example was last years’ failed attempt by the Daily Mail and CVC Capital Partners to get UK merger control of The Telegraph.
One potential deal of this type that may get off the ground is Spanish construction group Ferrovial’s rumoured bid for BAA, the UK airport operator. Ferrovial, which already runs Bristol and Belfast City airports, is considering a cash offer that is likely to be part of a private equity consortium to avoid competition issues. BAA’s airports include London’s three main gateways, Heathrow, Gatwick and Stansted, and Scotland’s primary hubs, Glasgow and Edinburgh.
But, according to Holmes, trade buyers who pursue this course of action may not escape competition issues completely. He says: “The main concerns in this type of deal relate to the significance of minority holdings, information flows and potential collusion between competitors. Such issues are considered in the light of both the merger control regime and the provisions of Article 81(1) of the EC Treaty. It is therefore important for trade buyers to realise that competition issues will not simply disappear with the use of a private equity investor; the focus is simply shifted from one competition concern to another.”
The main focus of traditional merger control analysis is whether the target and the entities taking control over the target are active within the same product and geographic markets, that is whether there is a ‘horizontal overlap’. Merger control review processes will focus primarily on the relationships between the product portfolios of the target and those taking control.
However, if the industry buyer takes rights but does not acquire control then there will be no direct horizontal overlap between controlling businesses. The private equity partner can then take control and, providing its portfolio does not contain any businesses that it controls and which are in the same product and geographic markets, there will be no direct horizontal overlap issue.
But for competition reasons the industry player may never be able to integrate its business entirely with that of the target. By having a partnering agreement, the industry player may seek to assert some control over the future ownership of the target and certainly over the timing of its release back on to the market. This may cause problems for the private equity house. Holmes says: “The industry player may have a right of first refusal in the event that the private equity house decides to sell. Put and call options could also be used. Having a sufficient holding to block other take-over bids in the case of a public company could also be used to prevent consolidation of the target with a feared competitor.”
For the private equity house, the priority is to ensure that the trade buyer doesn’t take too big an interest. And if a private equity firm envisages that selling the investment may be problematic in the future, it will be unwilling to make the initial commitment. A fund therefore has to ensure that if it is ‘assisting’ a trade buyer take a stake in a competitor, it is not left with a restricted investment that can only be sold to a limited group.
Careful structuring of deals can help minimise or even eliminate competition concerns for both parties. Holmes says: “There was a time when merger control mattered little in private equity-led deals. Funds rarely held any significant market shares or indeed businesses that overlapped with that of the target, and virtually all large deals qualified for simplified merger review procedures by the European Commission. However, as funds build up their portfolio of investments and acquire a variety of assets, merger control, and competition law as a whole, has an ever growing impact on their future growth and feasible transaction structures.”
James Stewart of UK mid-market firm ECI Partners can’t see why a private equity firm would assist trade buyers in dodging competition rules and doesn’t anticipate seeing a new wave of this type of deal. “Generally, shared interest between private equity houses and trade buyers doesn’t work. They have conflicting objectives. Trade investors have long-term investment horizons and are looking for business synergies. The private equity investors have a different framework in terms of investment objectives and are investing for returns in a limited time frame therefore I’d be surprised if this type of investment would ever appeal to a private equity investor. My view is that it is unlikely.”
Not only that, but trade competitors generally covet the tactics and strategies they perceive give them competitive advantage. So this adds to the set of potential problems facing such deals in that unless the trade partner was to be the eventual exit route for the PE house, although this is already deemed unlikely for the competition commission reasons outlined, the PE house is unlikely to want to share its investee company’s trade secrets with that company’s competitors, not least because it potentially devalues the investee company at exit.