The UK remains an attractive environment for foreign investments. However, in recent months, we've seen trends that indicate that mergers and acquisitions in the tech and life sciences sectors may be subject to closer scrutiny by the UK competition authority (the CMA) and by the UK government in future. The CMA's recent practice of reviewing mergers in these sectors and the recent changes to the rules on foreign direct investment are signs of this increased scrutiny
CMA review of mergers
The UK merger regime is voluntary: there is no requirement to notify a merger or acquisition to the CMA. However, the CMA can open an investigation if the transaction meets the jurisdictional thresholds and the parties have not notified it. Jurisdiction of the CMA is triggered when two or more companies cease to be distinct and when the turnover of the target is over £70 million or the transaction results in the creation of (or increase in) a 25% or more share of supply in the UK.
Share of supply
The share of supply test – which does not correspond to economic markets – has always been used mostly to capture products and services that the acquiror and the target both supplied in competition with each other (the so-called "overlaps").
Recently, the CMA seems to have changed its decision-making practice, especially in innovative sectors such as pharmaceuticals and digital (tech, data, platforms), creating much more uncertainty for the parties. The CMA is expanding the interpretation of the share of supply test. By applying the test "creatively", the CMA is able to capture mergers that it is interested in reviewing, and that in the past might not have been examined.
Roche/Spark – Feb 2020 (cleared)
This was the acquisition of Spark, a US biotech company engaged in the development of potential gene therapy (GT), including Haemophilia A. The deal was not notified to the CMA, but the CMA "called it in", as it concluded that the share of supply test was met. Spark does not sell products in the UK and does not generate turnover in the UK.
But Roche and Spark overlapped more than 25% in the supply of novel non-GT and GT Hem A treatment in the UK, because:
- Roche and Spark employed more than 25% of workers employed in the UK who are engaged in R&D activities for that treatment (which contribute to the supply of goods or services in the UK).
- Roche and Spark procured more than 25% of UK patents for treatment of Hem A.
Since the transaction was cleared, there has not been an appeal that would have shed light on this "innovative" use of the 25% share of supply test.
Sabre/Farelogix merger – May 2020 (blocked and currently on appeal)
Sabre’s platform connects airlines, hotels, and car rental companies to travel agencies. Farelogix sells a suite of IT solutions to airlines and has no revenue in the UK or direct contracts with UK customers. In the past, Farelogix entered into a "technical agreement" with American Airlines to facilitate booking of code share tickets between the American Airlines and British Airways.
Although British Airways did not contract directly with Farelogix, the existence of the technical agreement was enough for the CMA to determine that Farelogix provided services to a UK airline in the UK. The CMA concluded then that both companies were active in the "supply of IT solutions to UK airlines for the purpose of airlines providing travel service information to travel agencies to enable travel agencies to make bookings".
As Sabre alone supplied more than 25%, Fabelogix’s de minimis share – the contract with American Airlines was not worth much – led to an increment and satisfied the share of supply test. The CMA also issued an order prohibiting the parties to merger for 10 years.
The case is under appeal so it will be interesting to see what the court says about the 25% share of supply being met in such peculiar situation and the 10 year prohibition.
Material influence
The CMA can investigate mergers where two undertakings have ceased to be distinct and brought under common control. Control is not limited to the acquisition of outright voting control, but includes:
- legal control (acquisition of a controlling interest in an enterprise)
- de facto control (acquisition of the ability to control the policy of an enterprise – eg through veto rights over strategic business decisions), and
- material influence (acquisition of the ability materially to influence the policy of an enterprise – falling short of outright control or veto rights, this covers influence over strategic business decisions, for example, through board representation and/or relevant industry knowledge).
Until recently, material influence might have been found with a minority shareholding as low as 17.9% in conjunction with other specific factors:
- BskyB/ITV (2007; 17.9%): Analysing past voting patterns, the authority concluded that BskyB would be able to block special resolutions proposed by ITV’s management. In addition, BskyB’s "importance and stature as an industry player", coupled with its position as ITV’s largest shareholder, would "give additional weight" to its views, increasing the ability to influence other ITV shareholders.
- Ryanair/Aerlingus (2013; 29.62%): The authority looked at a "range of factors" here; in particular, Ryanair’s ability to block special resolutions and the sale of Heathrow slots under the Articles of Association. Ryanair could therefore influence Aer Lingus’s ability to pursue its commercial strategy and policy.
In Amazon/Deliveroo (June 2020 – Revised Provisional Findings), the CMA went even further. While Amazon was only acquiring a 16% shareholding, the CMA determined that there was "material influence" because of:
- the size of Amazon’s investment (in both absolute terms and relative to other shareholders) and its associated rights, and
- a strong body of evidence that Deliveroo’s management, its other shareholders, and its commercial/operations teams perceive that Amazon has a special status as a significant "strategic" investor, with various additional rights, and is a credible potential future acquirer of Deliveroo (or source of funding), has commercial and operational expertise from running an online business in directly relevant sectors to Deliveroo, and is a current and potential future strategic/commercial partner of Deliveroo.
Innovation and valuations
In rapidly evolving sectors such as healthcare and tech, the CMA will not only look at price factors – and potentially be concerned that the mergers might lead to an increase in prices – but also how innovation and quality will be affected negatively by the merger.
- Roche/Spark: The CMA analysed competitive interaction between marketed and pipeline products including disruptive new treatment and improvements on already marketed products.
- Illumina /PacBio (January 2020; abandoned by the parties due to opposition of CMA): The CMA found that innovation was a crucial aspect of competition in the market, with both parties’ common desire to be the preferred DNA sequencer for many projects acting as the driver of their innovative efforts.
The CMA is also focusing on the valuation of the deal to test any pro-competitive rationale. Competition authorities are concerned that large firms might acquire targets solely to discontinue the target’s innovative products and services, eliminate an emerging rival, and prevent future competition (so-called "killer acquisitions" in pharmaceuticals and tech). In these sectors, we see extremely high valuation of companies which might not yet have any revenue.
The CMA will look carefully at the rationale for paying such high figures for innovative companies in order to assess whether a pro-competitive rationale exists or not – for example, whether an acquisition is motivated by the intention to incorporate an innovation in another product or develop it further, or simply to stop its production.
New rules on foreign and direct investment
In the UK, the government (through the Secretary of State) can intervene in transactions which are subject to merger review by the CMA on certain public interest grounds: national security, media plurality, financial stability. Those grounds can be expanded, as they were during the financial crisis, when they were broadened to include financial stability.
On 23 June 2020, the UK government introduced another public interest ground: "the capability to combat and mitigate the effects of public health emergencies". The rationale behind this public interest consideration is related to COVID-19. The UK government is concerned that, due to the economic disruption caused by the pandemic, some UK businesses with critical disease fighting capabilities might be subject to hostile takeover or acquired because they are financially distressed.
The new power will allow the UK government to intervene if a business that is directly involved in a pandemic response – for example, a vaccine research company or PPE manufacturer – finds itself the target of a takeover. What's more, on 26 June 2020, the Department for Business, Energy and Industrial Strategy (BEIS) published guidance illustrating that the test is wider than what was thought originally.
Under this ground for intervention, the UK government could intervene if an internet service provider or food supply chain company becomes the subject of a takeover, given the potential for increased demand for internet services or disruption to food supply in a lockdown.
The UK government can also intervene in transactions not subject to merger review but where the target's turnover is above £1 million and it involves goods and services with military dual use and computer hardware technology and quantum technologies. On 23 June 2020, a new statutory instrument was laid in front of Parliament and will come into force when approved. Enterprises involved in artificial intelligence, cryptographic authentication technology, and advanced materials activities could be subject to review.
While we expect Parliament approval and guidance from the government soon, it is clear already that the changes will affect:
- any product where cryptographic authentication is its primary function
- businesses whose activities include research into artificial intelligence, developing or producing anything designed for using artificial intelligence, and supplying services growing these activities
- advanced materials comprises several activities and processes, including in relation to materials capable of modifying the appearance, detectability, traceability or identification of objects.
Final thoughts
These developments have several consequences for merging parties:
- Merger analysis has become more complex and uncertain, as even mergers involving companies with no business in the UK or obvious overlaps could be captured and called in. This uncertainty should be factored in the commercial discussions and the timeline for completion. Clients should be aware of the increased risks and consider engagement (and pre-notification) with the CMA, if necessary.
- The practice of the CMA makes the UK merger regime voluntary on paper only. Companies are making more use of the possibility of informing the CMA Merger Intelligence Unit (through a formal briefing paper) in advance. That in itself is not a guarantee that the CMA will not investigate: Amazon lodged a briefing paper of their proposed investment in Deliveroo believing that the merger should not be notified.
- The risk of a non-notified merger being called in have increased, and the CMA is making more use of Interim Enforcement Orders which prevent further post-closing integration or unwind integration that has already taken place.
- The FDI regime in the UK is due for a complete overall soon, with the introduction of a standalone regime in the form of the proposed National Security and Investment Bill (NSI Bill). In the meantime, transactions in those new areas subject to review by the UK government face additional burden and increased uncertainty.
