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Handing the Federal Trade Commission its biggest courtroom defeat in years, a D.C. federal judge last week denied the agency’s request for an injunction to block a merger between two baby food makers. In doing so, U.S. District Judge James Robertson created a significant new precedent, one that almost certainly will be invoked by other companies trying to pull off mergers in highly concentrated markets. The companies, the Milnot Holding Corp., which owns Beech-Nut Nutrition, and H.J. Heinz, successfully argued that the efficiencies created by their $185 million merger will outweigh any competitive harm caused by just two companies in control of 98 percent of the baby food market. “This is the first time a court has explicitly recognized that competition can be enhanced by the combination of two smaller brands fighting against an entrenched dominant player,” says Beech-Nut counsel Mark Kovner, a D.C.-based partner at Chicago’s Kirkland & Ellis. Adds Wilmer, Cutler & Pickering antitrust specialist William Kolasky Jr., who has followed the case: “Parties in mergers often argue that efficiencies will outweigh anti-competitive harm, but having a court accept that argument is a very significant development.” A billion-dollar industry, jarred baby food in the United States has been dominated by three companies: Gerber, which controls about two-thirds of the market and enjoys the strongest brand loyalty of any product in the nation; Heinz, with a 17.4 percent market share; and Beech-Nut, with 15.4 percent of the market. In purchasing Beech-Nut, Heinz calculates it will save around $10 million each year by consolidating production and distribution as well as by sharing recipes and supermarket shelf space. For the first time, the company says, this would make it a viable competitor against behemoth Gerber. But the FTC, led by Richard Dagen, assistant director of the Anti-Competitive Practices Division, countered that the merger would create a duopoly and increase the likelihood of collusion between Heinz and Gerber. “Based on the structure of this industry alone, that is, a reduction from three firms to two, a significant increase in concentration, and no likelihood of entry (there has been no significant [new] entry in 60 years), the Commission is presumptively entitled to preliminary relief. Indeed, no court has allowed such a merger, absent strong argument that one of the companies is failing in a dying industry,” Dagen wrote in court papers filed July 14. FTC lawyers assert that the merger fails under the Herfindahl-Hirschman Index guidelines, any market with an HHI over 1,800 is considered highly concentrated, and any merger that increases the index by more than 100 points is considered presumptively anti-competitive. According to the FTC, the HHI for baby food would jump 510 points to 5,285 after the merger of Heinz and Beech-Nut. “The government’s case was essentially structural,” says Edward Henneberry, a longtime partner at Howrey Simon Arnold & White who litigated the case on behalf of acquiring party Heinz. “But the whole point of antitrust today is that you don’t do it by rote.” In what some onlookers call a triumph of fact over theory, the judge relied on a detailed analysis of the dynamics of the baby-food market to conclude that the merger would not harm competition. “My conclusion in this case does not rest upon aspirational testimony, but instead credits powerful evidence in the record about the efficiencies realized by the merger, and about the enhanced prospects of the merged entity to introduce innovative products to compete with Gerber,” Robertson wrote in the Oct. 18 opinion. “The Commission’s prima facie case inaccurately predicts the merger’s probable effect [on] future competition.” IT’S THE ECONOMETRICS For Kirkland & Ellis’ Kovner and his partner Tefft Smith, the victory is especially sweet. The last time they went up against the FTC in court, they were on the losing side, representing Office Depot in its failed 1997 merger bid with Staples. This time around, Kovner says, “We did a lot of things that the FTC did in Staples that they did not do here.” In particular, Beech-Nut and Heinz hired American University Law Professor Jonathan Baker, who headed the FTC’s Bureau of Economics from 1995 to 1998, to do three econometric studies consumer substitution of brands. First, Baker found that even when the price of Heinz increased, consumers still did not switch to Beech-Nut, in part because the two brands are almost never sold at the same store. Second, he studied whether prices differed in cities where all three brands were available, and concluded they did not. (In the Staples case, he says, he conducted similar studies, but found dramatic differences in price.) Third, Baker found that competition effect on pricing. To lawyers following the case, the judge’s matter-of-fact reliance on econometric evidence is noteworthy. Traditionally, courts put far more weight on sources like internal company documents. The FTC offered no equivalent evidence to counter Baker’s econometric studies, and Charles “Rick” Rule of Covington & Burling speculates that this was a major weakness in the government’s case. “The agency can’t take the easy way out,” he says. “Even where it superficially looks like, based on pure theory, competition may be reduced, [this decision] shows that the FTC has to understand the dynamics of the marketplace to really, truly understand the impact of the merger.” Rule predicts that the case will have long-term significance as well as bring about some immediate changes. For one, he says, it may compel FTC staff to give a bit more weight to efficiency arguments. To date, the staff reaction has been “very, very skeptical,” he says, adding, “They have never met an efficiency they believe.” Another near-term effect, he says, is that some companies may decide to revisit deals that were not pursued out of fear of antitrust obstacles. An FTC spokesman says the agency is “disappointed in the District Court ruling.” Agency lawyers Dagen and David Shonka last week asked Robertson to stay his decision, writing, “The Court’s unprecedented approval of a merger in the circumstances of this case, raises important antitrust and public interest issues that warrant careful review by the Court of Appeals before the structure of the market is irrevocably altered by defendants’ merger.” Robertson refused the request. Today, the FTC will seek a stay from the U.S. Court of Appeals for the D.C. Circuit to prevent the companies from completing their transaction. The full FTC must vote to approve the actual appeal. The commission split 3-2 on bringing the case in the first place, with Orson Swindle, a Republican, and Sheila Anthony, a Democrat, voting against. Both decline comment. Some observers wonder whether the vote will go through, since a loss would create such a bad precedent for the FTC at the appellate level. “There are a lot of unhappy campers at the FTC today,” says one D.C. antitrust lawyer who asked not to be identified by name. “This is what the bureaucrats hate, because it looks like they misused the force of government and the taxpayers money.”

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