Foodstuffs merger: What the supermarket giant will consider as it mulls an appeal of declined application

Chris Quin, CEO of Foodstuffs North Island, has led the unsuccessful merger effort of Foodstuffs North Island and Foodstuffs South Island; he is now mulling an appeal of the regulator's ruling.

ANALYSIS

The Foodstuffs companies have until November 21 to decide whether to appeal the Commerce Commission’s October decision to decline its merger application.

Chris Quin, chief executive of Foodstuffs North Island, has suggested an appeal is likely, although he’s said it is also dependent on understanding the regulator’s full decision to decline the merger, released two weeks ago. On Tuesday, a spokesperson said the companies are still digesting that decision.

There are certainly good reasons for Foodstuffs to pause and consider the odds of a successful appeal; history indicates they’re pretty long. But there are also reasons why Foodstuffs might just make the bet anyway.

Foodstuffs North Island and Foodstuffs South Island operate some of New Zealand’s best-known supermarket banners – New World, Pak’nSave and Four Square – and while each retails only in their respective island, the companies already collaborate across various business areas, including marketing and home brand purchasing. Their combined revenue was nearly $13 billion in the last fiscal year.

In their application to the commission for clearance to merge, the parties essentially argued that they do not compete at either the retail or wholesale level and they would be more efficient and better equipped to drive down grocery prices as a single streamlined entity.

The commission, however, was not convinced that the benefits of such an arrangement would flow to customers, and moreover, its main concern was that a merger would reduce the number of buyers in the “upstream market” for grocery supply from three to two – this market is currently dominated by the two Foodstuffs entities and Woolworths NZ.

In its decision, the commission noted that this reduction would be a structural change and would likely lessen competition in multiple acquisition and retail markets. It also emphasised that competition in the country’s highly concentrated grocery market was already weak.

The Foodstuffs operates some of the country's best known supermarket banners, including Pak'nSave, New World and Four Square. Photo / Mark Mitchell

Specific appeals regime

The commission’s merger decisions are subject to a specific appeals regime whereby the High Court takes the decision again.

”Foodstuffs does not have to show that the commission ‘got it wrong’, it just has to convince the High Court that a different decision is the correct one … that might sound like a fine distinction, but it means that a sympathetic judge could overturn the commission’s decision if Foodstuffs makes a convincing argument. A clever argument that supplier markets don’t affect the long-term interests of consumers might convince the right judge on the right day,” Edward Willis, an associate professor of law at the University of Otago told the Herald.

However, it is Willis’ view that Foodstuffs does not have a strong case: “purely on matters of competition law and policy, I don’t think there is much chance of success.”

The High Court’s findings can be appealed to the Court of Appeal and the Supreme Court.

Foodstuffs’ other options include judicial review (also heard by the High Court) if it thinks the commission has failed to exercise its statutory powers correctly.

A thin history of appeals

Only rarely do companies that are denied the ability to merge appeal their cases. In the past decade, the Commerce Commission, which regulates competition, has handled 109 applications from companies seeking to merge. Of these, nine were declined, including Foodstuffs’ application (a further 11 were withdrawn after the commission raised competition issues and before the assessment was complete).

Just one of these cases was appealed: the 2016 case of media outlets Fairfax New Zealand and NZME (which owns the NZ Herald). The commission declined the merger and the parties unsuccessfully challenged the decision in the High Court and also in the Court of Appeal.

Importantly, merger applications to the commission can be divided into two categories: applications for clearance to merge and applications for an authorisation to merge.

The media companies sought authorisation, which requires a more complex determination than clearance. Authorisation is sought when there is a likelihood that a merger will substantially lessen competition; the regulator can nevertheless authorise such a merger when it is satisfied that it would result in so significant a benefit to the public that it should be permitted.

Most merger applications, including that of Foodstuffs, are the more straightforward clearance variety. In these cases, the commission will approve the application if it is satisfied that the merger would not be likely to significantly lessen competition in any New Zealand market.

No merger clearance decisions have been appealed in the past decade. The “significant lessening of competition” test for such mergers was introduced in 2001, and since then only two clearance applications, declined by the commission, have been successfully appealed: the National Foods’ tie-up with Dairy Foods in 2002, and Brambles NZ’s acquisition of GE Capital Returnable Packaging Systems in 2003.

It is possible that Foodstuffs could return to the commission and seek authorisation to merge, but this course - to seek merger clearance and then seek authorisation - appears to have no precedent and would be highly unusual.

Cost considerations

Foodstuffs has been reluctant to disclose its spending on merger efforts – by its own account the two companies had spent $7.5 million as of the end of March. But that figure has undoubtedly risen significantly.

A total to date could be well north of $10m, and will include the considerable expense of Chapman Tripp lawyers, Australian specialist economics consultancy Houston Kemp, and German competition consultancy Dusseldorf Competition Economics, all of whose work has featured in Foodstuffs’ and Foodstuffs-funded submissions to the commission through the merger application process.

But the full merger-related business operating costs will be far greater and entail internal time and focus and the likes of preparing dual business plans on a go/no-go basis for the past year or more (the formal application to merge was lodged in December last year, but Quin told the Herald in a July interview that the companies had been hatching the plan for a couple of years before that).

It is clear that the direct expense of any appeal – perhaps $1m on court fees, lawyers and independent experts at Willis’ estimate – would be negligible in the context of the broader cost already incurred, and relative to the value of a win.

How far the benefits of reduced operating costs and competitive advantage would reach beyond a merged Foodstuffs is certainly in doubt, but that it is a very significant prize is not.