How COVID-19 Applies To Weakened Competitor M&A Defense

By James Langenfeld and Chris Ring
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Law360 (June 2, 2020, 5:21 PM EDT) --
James Langenfeld
James Langenfeld
Chris Ring
Chris Ring
It appears that there has been a substantial slowdown in merger filings because of the financial hardships resulting from COVID-19 and the uncertainties surrounding a return to business. As markets adjust and recovery begins, there will likely be a spate of mergers involving damaged firms.

Federal Trade Commission officials have warned firms that the agency will be skeptical of justifying an otherwise anti-competitive merger because a firm may be failing due to COVID-19.[1] However, is the traditionally difficult so-called failing firm defense the right benchmark?

In the recent decision New York v. Deutsche Telekom AG, regarding the T-Mobile/Sprint merger,[2] the court in part relied upon Sprint's weakened competitor status as the reason to approve the merger despite the plaintiff states showing a presumption of anti-competitive harm based on market shares.

This decision and the large number of weakened competitors due to the pandemic will likely result in merging parties justifying a potentially anti-competitive merger primarily on the basis of efficiencies and weakened competitor status, which will require the agencies and courts to pay closer attention to these arguments.

Failing, Flailing and Weakened Competitors

The FTC and the Antitrust Division of the U.S. Department of Justice discussed a failing firm defense in less than a page in their 2010 horizontal merger guidelines.[3] If a firm is likely to exit the market, then being bought by competitor is not likely to reduce competition.

However, the agencies make the merging parties carry the burden of proof to show the assets are likely to exit the market. In fact, the agencies require not only a showing of the likelihood of exit but also a showing that the failing company has not found a less anti-competitive buyer or other means for continuing to operate.

The court in the state attorneys general's challenge to the T-Mobile/Sprint merger allowed the merger despite its finding that the plaintiffs successfully carried their burden to show a prima facie case of reduced competition based on market concentration.

The court found the merger on balance would not be anti-competitive based on the merging parties showing: (1) substantial verifiable efficiencies that are merger specific; (2) that Sprint was a weakened competitor unlikely to continue as an effective competitor absent the merger; and (3) that the consent with the Department of Justice and the requirements of the Federal Communications Commission order were adequate remedies that would boost competition compared to Sprint continuing independently.

The court found that these three elements worked together to show that output would be expanded, quality improved, and prices lowered by realizing cost savings not otherwise available to Sprint and T-Mobile, while providing DISH Network Cop., a viable new entrant that already had a portfolio of useful spectrum, with divested cell towers and access to the T-Mobile network to provide national coverage while DISH built out its own network, and customers from the divestiture of Sprint's Boost brand to generate cash flow to fund that expansion.

The court recognized that the weakened competitor defense should be applied judiciously, stating:

Assuming that the weakened competitor defense is applicable only in narrow circumstances, the Court concludes that the Proposed Merger nonetheless present a rare case.[4]

These circumstances included Sprint's record of poor network quality and consumer perception. These could be traced back to certain poor business decisions, such as using limiting CDMA technology, small cell towers, insufficient investment compared to Verizon Communications Inc. and AT&T Inc., offering low price plans without adequate investment in the infrastructure and lack of low-band spectrum.

The court also found Sprint's 11 years of losses, $37 billion of debt, and its inability to meet the targets set in its five-year plan to limit Sprint's ability to compete effectively against its competitors in mobile wireless telecommunications services. Mistakes of the past can in theory be corrected with new management and loans. Sprint was not going out of business any time soon and so was not a failing firm. However, the court found that these mistakes put Sprint in a position that prevented it from continuing to compete effectively.

For example, Sprint needed more low-band spectrum for 5G to compete, but the available small purchases would not be adequate, and the FCC was not planning on more low-band spectrum auctions. The court focused on Sprint's Plan B without the merger, in which it would deprioritize 51 of its 99 local markets, and concluded that there would be the equivalent of a four-to-three merger without efficiencies in these areas if the merger were blocked.

Sprint's weakened competitor status absent the merger was critically linked to the efficiencies anticipated from the merger, such as the $43 billion in network and other operating cost savings, and the settlement to more than offset any upward pricing pressure due to the merger. According to T-Mobile lead trial counsel, George Cary:

The key to the successful invocation of a weakened competitor argument here was a showing that, as in General Dynamics, Sprint lacked an element essential to its competitiveness going forward, namely low-band spectrum for 5G; and a parallel showing that the assets that Sprint did have, its capacious mid-band spectrum, could better serve consumers when paired with T-Mobile's complementary low-band spectrum. In short, the weakened competitor argument was reinforcing of the efficiency argument.

Industries With Weakened Competitors

There are several industries that will likely have weakened competitors due to the pandemic. For example, airlines have been especially hard hit. According to the International Air Transport Association, "the COVID-19 crisis will see airline passenger revenues drop by $314 billion in 2020, a 55% decline compared to 2019."[5] Airlines have been included in stimulus packages intended to help them survive the crisis.[6]

However, these efforts may be insufficient to keep some airlines afloat. Colombian airline Avianca SA, which typically conducted about 700 flights per day and is the second oldest continuously running airline, has already filed for bankruptcy.[7] Industry consultants have released dire warnings that most airlines could end up bankrupt due to the pandemic.[8] Some observers, such as a professor involved in the startup of Frontier Airlines Inc., have already speculated that "some airlines will need either to file for bankruptcy or seek consolidation through a merger."[9] Air Transportation has had a 25.6% year-over-year decline in employment.[10]

Several firms in other industries have already declared bankruptcy and could conceivably attempt to merge with a rival in order to survive. For example, one of the major bankruptcies of the COVID-19 crisis is rental car company Hertz Global Holdings Inc., which filed for bankruptcy on May 22.[11] Hertz cited the impact of COVID-19 in its filing, noting that COVID-19 caused "an abrupt decline in the Company's revenue and future bookings."[12] Analysts had noted that up until the COVID-19 crisis, Hertz had been performing well.[13]

Retail trade employment has declined by 13.5%.[14] JCPenney Co. Inc., J.Crew Group Inc. and Neiman Marcus Group have all filed for bankruptcy, and others such as Sears Holdings Corp. may do so as well.[15] These retailers had already been struggling prior to the pandemic, and there is doubt that they will be able to reemerge after it is over.[16] All of these retailers had large debt loads and could face struggles in refinancing debt.[17] If these companies are unable to find a way out of bankruptcy on their own, merging with a rival may become an attractive option.

Many hospitals are also in unprecedently poor financial positions, and, despite their critical position in the battle against COVID-19, have seen overall drops in traffic. For example, according to an analysis by Crowe LLP, hospitals outside of San Francisco and New York City "experienced an average decline in patient volume of 56% between March 1, 2020, and April 15, 2020."[18] This was equivalent to an estimated decline of $1.44 billion per day for U.S. hospitals with more than 100 beds.[19]

The Crowe analysis found that COVID-related increases in patient volume were offset by declines in other patient volumes.[20] The Crowe analysis also found that the average hospital would need to operate at 110% capacity for six months to make up for COVID-related losses.[21]

Separately, the American Hospital Association estimated that four months of COVID-related losses would cost U.S. hospitals about $200 billion, factoring in both lost revenues from cancelled procedures and additional COVID-related costs like PPE purchases.[22] A Guidehouse analysis in February 2019 showed that many rural hospitals were already facing financial difficulty before the effects of COVID-19. The analysis stated, "21% of rural hospitals nationwide are at a high risk of closing unless their financial situations improve."[23]

Another hard-hit industry is the leisure and hospitality industry, which has seen a 47.2% year-over-year decline in employment as of April 2020, according to the Bureau of Labor Statistics.[24] Two tourism-heavy states have the largest year-over-year percentage increases in unemployment rates between April 2019 and April 2020, Nevada (24.2%) and Hawaii (19.6%).[25]

Other notable unemployment rate increases were found in Michigan (18.4% increase) and Indiana, New Hampshire, Rhode Island and Vermont (all over 13% increases). Continuing to use employment data as an indicator, other hard-hit industries include manufacturing of durable goods (11.6% decline in employment), construction (11.2% decline), and mining (12.3% decline).

Conclusion

It seems clear that coming out of the pandemic will result in many industries with substantially weakened competitors. Based on the court's decision in the states' case against the T-Mobile/Sprint merger, it does not look like just being financially distressed would permit a merger where there is a prima facie case for challenging the merger.

A weakened competitor merger would need to be tied to verifiable efficiencies unique to the merger. A weakened competitor together with a strong showing of related efficiencies can show competition would be enhanced by a merger, rather than substantially reduced.



James Langenfeld, Ph.D., is a senior managing director and Chris Ring is a senior director at Ankura Consulting Group LLC.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.


[1] Bryan Koenig, "'Apocalyptic' Virus Merger Args Won't Work, FTC Official Says," Law360 (May 27, 2020, 6:50 EDT).

[2] See State of New York, et al. v. Deutsche Telekom AG, et al. , 1:19-cv-05434, United States District Court Southern District of New York, Decision and Order, February 10, 2020.

[3] Section 11, available at https://www.ftc.gov/system/files/documents/public_statements/804291/100819hmg.pdf.

[4] At 86.

[5] International Air Transport Association, "COVID-19 Puts Over Half of 2020 Passenger Revenues at Risk," April 14, 2020, https://www.iata.org/en/pressroom/pr/2020-04-14-01/.

[6] New York Times, "Crippled Airline Industry to Get $25 Billion Bailout, Part of It as Loans," April 14, 2020, https://www.nytimes.com/2020/04/14/business/coronavirus-airlines-bailout-treasury-department.html.

[7] CNN, "Avianca, one of Latin America's largest airlines, files for bankruptcy," May 12, 2020, https://www.cnn.com/2020/05/11/business/avianca-airline-coronavirus-bankruptcy-chapter-11/index.html.

[8] Bloomberg, "Coronavirus Could Bankrupt Most Airlines by End of May, Consultant Warns," March 16, 2020, https://www.bloomberg.com/news/articles/2020-03-16/virus-to-bankrupt-most-airlines-by-end-of-may-consultant-says.

[9] University of Denver, "Q&A: How Coronavirus Is Changing the Airline Industry," April 30, 2020, https://www.du.edu/news/qa-how-coronavirus-changing-airline-industry.

[10] BLS, "TABLE 4. Over-the-year employment changes and tests of significance, seasonally adjusted (in thousands)," https://www.bls.gov/web/empsit/cesanatab4.xlsx.

[11] Hertz, "Hertz Global Holdings Takes Action To Strengthen Capital Structure Following Impact Of Global Coronavirus Crisis," May 22, 2020, http://ir.hertz.com/2020-05-22-Hertz-Global-Holdings-Takes-Action-To-Strengthen-Capital-Structure-Following-Impact-Of-Global-Coronavirus-Crisis.

[12] Ibid.

[13] New York Times, "Hertz, Car Rental Pioneer, Files for Bankruptcy Protection," May 22, 2020, https://www.nytimes.com/2020/05/22/business/hertz-bankruptcy-coronavirus-car-rental.html.

[14] BLS, "TABLE 4. Over-the-year employment changes and tests of significance, seasonally adjusted (in thousands)," https://www.bls.gov/web/empsit/cesanatab4.xlsx.

[15] JCPenney, "JCPenney to Reduce Debt and Strengthen Financial Position Through Restructuring Support Agreement," May 15, 2020, https://ir.jcpenney.com/news-events/press-releases/detail/613/jcpenney-to-reduce-debt-and-strengthen-financial-position; J.Crew, "J.Crew Group, Inc. Announces Comprehensive Agreement to Deleverage Balance Sheet and Position J.Crew and Madewell for Long-Term Profitable Growth," May 4, 2020, https://www.prnewswire.com/news-releases/jcrew-group-inc-announces-comprehensive-agreement-to-deleverage-balance-sheet-and-position-jcrew-and-madewell-for-long-term-profitable-growth-301051688.html; Neiman Marcus Group, "Neiman Marcus Group Enters into a Restructuring Support Agreement with a Significant Majority of its Creditors to Substantially Reduce Debt and Position the Company for Long-Term Growth," May 7, 2020, http://neiman.gcs-web.com/static-files/2749e148-82d3-42d5-976e-f8fe331b4866; CNN, "Four famous stores that may not survive because of coronavirus," April 7, 2020, https://www.cnn.com/2020/04/07/business/jcpenney-sears-neiman-marcus-j-crew-retailers-coronavirus/index.html.

[16] CNN, "Four famous stores that may not survive because of coronavirus," April 7, 2020, https://www.cnn.com/2020/04/07/business/jcpenney-sears-neiman-marcus-j-crew-retailers-coronavirus/index.html.

[17] Ibid.

[18] Crowe, LLP, "Hospital volumes hit unprecedented lows," May 2020, https://www.crowe.com/insights/asset/h/hospital-volumes-hit-unprecedented-lows.

[19] Ibid.

[20] Ibid.

[21] Ibid.

[22] American Hospital Association, "Hospitals and Health Systems Face Unprecedented Financial Pressures Due to COVID-19," May 2020, https://www.aha.org/system/files/media/file/2020/05/aha-COVID19-financial-impact-0520-FINAL.pdf.

[23] Guidehouse, "Rural Hospital Sustainability," February 22, 2019, https://guidehouse.com/insights/healthcare/2019/rural-hospital-sustainability.

[24] BLS, "TABLE 4. Over-the-year employment changes and tests of significance, seasonally adjusted (in thousands)," https://www.bls.gov/web/empsit/cesanatab4.xlsx.

[25] BLS, "State Employment and Unemployment Summary," May 22, 2020 https://www.bls.gov/news.release/laus.nr0.htm.

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