Private equity feels the heat as antitrust agencies turn spotlight on roll-ups

Issue

The progressive trend in antitrust enforcement that questions the value of M&A is extending to private capital firms that previously were seen as competitively benign investors. As an example there has been a concerted effort by enforcement authorities across the world to clamp down on “roll-ups”, whereby acquirers buy smaller assets that on their own fall below merger control notification thresholds and then combine them into a larger entity that concentrates market power.

Sponsors likely to face closer scrutiny in future years

In September the U.S. Federal Trade Commission launched a lawsuit against private equity firm Welsh, Carson, Anderson & Stowe, accusing it of a “multiyear scheme” to consolidate anaesthesia services in Texas (you can read more in our briefing here). The UK Competition and Markets Authority has similarly shown its teeth, in one case investigating a roll-up of 17 independent veterinary businesses over a 12-month period. The acquirer was forced to divest 12 of the businesses after completion, prompting a wider market review into concentration levels in the sector.

Alongside the U.S. antitrust agencies, the Dutch competition regulator has also promised to crack down on private equity roll-up strategies, and while antitrust intervention ultimately turns on the facts, PE firms’ focus in recent years on creating value through more complex transactions involving multiple assets means they’re likely to face closer scrutiny in the years to come.

FTC imposes prior approval remedies in all deals involving merger consent decree

Notwithstanding this activity, perhaps the biggest impact on financial sponsors has come from procedural changes such as those in the U.S. that extend clearance times and in Germany that allow the Federal Cartel Office (FCO) to review deals where it thinks specific buyers are consolidating an industry. The FTC is also now imposing “prior approval” remedies in every transaction that requires a merger consent decree, meaning the relevant buyer must seek the agency’s permission to close certain future deals.

These obligations kick in even if the deal doesn’t otherwise satisfy the HSR notification requirements, and unlike the HSR process, prior approvals have no set timetable meaning deals can be delayed indefinitely. In response we have seen buyers omit certain assets to avoid falling into scope.

The DOJ and FTC have also announced changes to the HSR forms, which will be the most significant overall in 45 years. The information disclosure burden will rise significantly, and among a long list of other requirements, parties will need to give the agencies detail on fund ownership structures, cross-directorships (see article on interlocks) and details of prior acquisitions going back 10 years. Through these steps the agencies will be able to keep a close eye on roll-ups occurring within industries.

DOJ adopts more expansive interpretation of ‘theories of harm’

This is all part of a broader trend involving regulators paying ever-closer attention to sponsor acquisitions of, in particular, consumer-facing businesses. Authorities, including in the US and UK have also recently expressed scepticism over whether PE firms are suitable remedy purchasers in merger review processes, questioning whether they have proper incentives to support a viable business for the long term.

This is a further area where we expect funds to come under ever-closer scrutiny in future. In response they will need to develop thorough business plans for deals where they want to act as a remedy taker, and show commitment to growing the target and maintaining competition.

Solution

As antitrust authorities’ focus increasingly settles on private capital dealmaking, so sponsors need to adopt a more corporate-style approach to M&A execution. This involves factoring antitrust due diligence into their deal processes from the outset (particularly if the target is a consumer-facing business) and considering “fix-it-first” strategies that pre-empt potential regulatory concerns.

Private capital firms should also prepare for tougher lines of questioning from authorities when presenting themselves as divestment purchasers in merger control processes. Here, the theory is that sponsors may prioritise financial returns over innovation and competing aggressively, potentially putting the rationale for the divestment at risk, or may not have the experience to run the business as a credible competitor to the merged firm.

It has become increasingly important for sponsors to craft deal narratives that reflect prevailing macro headwinds and political concerns about the strength of domestic supply chains. Integrating legal and communications strategies has long been critical to strategic acquisitions, and PE sponsors will need to adopt similar tactics to give their deals the best chance of success.