DealMakers - Q3 2023 (released November 2023)
Public interest in merger control:
does the end justify regression to the mean?
by Chris Charter and Albert Aukema | Cliffe Dekker Hofmeyr
“This is the patent age of new inventions / For killing bodies, and for saving souls. / All propagated with the best intentions.” Lord Byron
It is, by now, settled law that mergers in South Africa are to be assessed through two lenses: not only must the impact of a merger on competition be assessed to determine whether it might result in a substantial lessening or prevention of competition, but the Competition Act also mandates a complex public interest assessment in relation to each merger brought before the competition authorities.
Merger control contains elements of fairness, policy and value-based assessments intended to achieve the transformative constitutional outcomes that have been sown (and sewn) into the South African legal landscape through the jurisprudence of the Constitutional Court. The purpose of the Competition Act, as set out in section 2, foists on those tasked with interpreting and enforcing the Act a daunting responsibility to promote and maintain competition, not just for its own sake, but also thereby to achieve even more ambitious externalities, such as the promotion of employment and the advancement of “the social and economic welfare of South Africans”, to ensure that Small and Medium Enterprises (SMEs) “have an equitable opportunity to participate in the economy”, and to “promote a greater spread of ownership, in particular to increase the ownership stakes of historically disadvantaged persons”. The orthodox competition law objective of providing consumers with “competitive prices and product choices” seems simple in comparison.
Developing a framework for the assessment of public interest in mergers will have to be a uniquely South African exercise. Many mature jurisdictions, including the United States and the European Union, have not sought to place such significant challenges before single pieces of legislation and a single hierarchy of regulatory authorities.
It is possible to have technical and even ideological debates about the precise nature of and the balancing and counterbalancing that should occur in relation to the competition and public interest assessments in mergers. However, the gradual development of the South African position over the course of more than two decades, to a point where it is now clear that the public interest assessment forms part of the crucible of merger regulation, means that it is necessary to think deeply about the public interest assessment as a self-standing assessment in each merger.
In South Africa, the elevated status of the public interest effect of mergers raises important questions in the context of developing an assessment framework that blurs the line between socio-economic and industrial policy and law.
The Commission’s mandate to drive public interest considerations was purportedly strengthened through amendments in 2019. Besides clarifying that a public interest assessment is of equal and separate import to competition merits, the amendments also introduced a new public interest factor relating to a merger’s effect on “the promotion of a greater spread of ownership, in particular to increase the levels of ownership by historically disadvantaged persons and workers in firms in the market”.
This “promotion of ownership factor” is a major inflection point for mergers, as the Commission interprets this as imposing a positive obligation on merging parties to proactively address ownership representativity concerns in the market in which they operate. Many recent transactions have seen the imposition of ownership conditions, including the establishment of Employee Stock Ownership Plans (ESOPs) or Broad-Based Black Economic Empowerment (B-BBEE) transactions. This regulatory zeitgeist has been given further, and potentially controversial, impetus in the Commission’s publication of revised guidelines for the assessment of public interest in mergers.
The revised guidelines (out for public comment until mid-November) betray a worryingly binary approach that runs a serious risk of substantially curtailing, if not killing off, any hoped-for investment growth in South Africa’s beleaguered economy. By way of example:
The Commission appears to consider that all mergers will attract an obligation to increase the spread of ownership. Ostensibly, this applies even to foreign-to-foreign transactions where South Africa is merely incidental, and to mergers that have no effect on a current spread of ownership.
Even if a merger represents an increase in black ownership, this will not preclude the obligation to increase worker ownership, and vice versa.
Board representation, broad-based ownership and direct participation in operations are important factors in determining the extent of the public interest benefit.
Facilitating black ownership as to no less than 25% + 1 share is a likely minimum obligation to justify any merger as promoting ownership.
Although an ESOP might be deployed to address a dilution of black ownership, it will need to be of equivalent equity (e.g., a reduction of 10% black ownership will require a 10% ESOP).
Although no-one can deny that the skewed representation of the South African economy along racial lines requires addressing, and that a number of policy interventions are likely required, one must question the wisdom of a policy that appears so obviously to impose a significant tax on investment and, in particular, merger activity. Self-evidently, a robust and dynamic M&A environment is inherently good for economic growth, particularly in the mid-cap space where the heat generated by investment churn ensures liquidity of capital markets, provides opportunity for lenders and borrowers, and secures capital injections and attendant innovation to justify the risk taken. Current, and likely long-term, economic malaise means that many potential mid-market mergers are increasingly marginal and risky, and yet it is these marginal businesses (not failing per se, but languishing) that would benefit the most from a more frictionless investment environment, generating a rising tide that can lift more boats.
In criticising the Commission’s more strident forays into public interest engineering, commentators have focused on the potential chilling effect on foreign investment. The message being sent to boardrooms around the world about the Sisyphean task awaiting deal makers in South Africa is of concern, but one might wager that the “mega deals” involving massive takeovers by multinationals over key local businesses will happen if the upside is clear (with space, funds and forex to price-in substantial public interest commitments). Far more insidious is the effect of a “one size fits all” policy on local investors or foreign direct investment on smaller deals, where the upside is hardly guaranteed and break fees do not serve to drive “hell or high water” commitments. We may never know how many potential investors, weighing up the risks in the face of debt and uncertainty, will be scared off by the notion that after leveraging to the hilt, they will need to find funds to give up equity just for a ticket to the game, in circumstances where their acquisition does not have any substantial negative effect on any public interest factor. Undoubtedly, the avowed approach weighs heavily in any SWOT (strengths, weaknesses, opportunities and threats) analysis, and it would be a shame if a policy that inflicts additional commercial pain on an already sagging M&A market were to push our economy further into stagnation.
Ultimately, the Commission’s approach in the draft guidelines renders it a mere conduit for policy, as opposed to the resourced and capable adjudicative body that it otherwise is. The transformation imperative is predicated on the end justifying the means. But if the means itself jeopardises the end (a vibrant and growing economy from which all South Africans can benefit), then the policy will have failed, and while some significant wins for SA Inc might be catalogued, regression to the mean is inevitable.
Charter is a director and national head and Aukema a director in the Competition practice | Cliffe Dekker Hofmeyr.