Back to the future: potential future competitors playing a role in ACCC merger consideration

Merger parties can be surprised to learn that the current state of the market is not the only factor when determining whether an acquisition will, or is likely to, substantially lessen competition in a market in Australia – a point underscored recently by the Australian Competition and Consumer Commission (ACCC).

On 19 December 2019, the ACCC raised preliminary concerns that the proposed acquisition of pharmaceutical developer Juno PC Holdings by pharmaceutical company iNova Pharmaceuticals Australia would be likely to substantially lessen competition in the supply of phentermine-based weight-loss medications and weight-loss medications more broadly, in contravention of section 50 of the Competition and Consumer Act 2010 (Cth) (CCA). In its Statement of Issues, the ACCC expressed a preliminary view that the proposed acquisition would remove potential and likely competition from Juno PC, thereby substantially lessening competition in the relevant weight-loss medication market in Australia.

The ACCC's concern was with the removal of the possibility that Juno PC, a potential future competitor, would enter the market and otherwise constrain iNova – notwithstanding that Juno PC's product is still in development, and the parties' claims that Juno PC lacks the infrastructure, funds and experience to market its product.

Although iNova has withdrawn its proposed acquisition of Juno PC in the wake of the ACCC's concerns, this Statement of Issues is a reminder that, in approaching its task of peering into the crystal ball in merger cases, the ACCC will examine the possibility of potential future sources of competition and the dynamic characteristics of relevant markets, such as those within the pharmaceutical sector.

The proposed acquisition

iNova is the leading supplier of phentermine-based weight-loss medication in Australia, with an estimated 70% market share by revenue in the supply of prescription and over-the-counter weight-loss medication. Juno PC is a special purpose joint venture formed as an investment vehicle to support the development of a patent-protected, alternative phentermine-based product. According to the patent application, Juno PC's product resolves some of the drawbacks of iNova's prescription product, and ensures a more consistent release of phentermine for optimal efficacy.

Importantly, at the time of publication of the ACCC's Statement of Issues, Juno PC's product was still in development and subject to various regulatory approvals and registrations. As a result, the ACCC's preliminary assessment was based on the view that, absent the proposed acquisition, Juno PC's product "would likely compete directly and strongly with iNova and put downward pressure on prices for phentermine-based weight-loss medications" [emphasis added].

The forward-looking nature of the competition test

Section 50 of the CCA prohibits direct or indirect acquisitions by a corporation that have the effect, or likely effect, of substantially lessening competition in any market for goods or services in Australia. Both formal merger authorisations and informal merger reviews conducted by the ACCC are generally assessed before completion of the relevant acquisition. This means that a forward-looking analysis is usually required into the foreseeable effects of a merger to determine whether a substantial lessening of competition is likely to occur.

The counterfactual (that is, the state of play in the absence of the relevant acquisition) is the benchmark against which a merger proposal is judged by the ACCC. The ACCC must identify the future state of the market without the acquisition and compare that to the future state of the market with the acquisition. For this reason, the competition test in section 50 is often referred to as a future "with and without" test.

The ACCC notes in its Merger Guidelines that:

"Focusing on the state of competition prevailing at the time of the merger might… disguise a substantial lessening of competition in situations where a merger hinders or prevents competition that would otherwise have emerged… in particular, [for] mergers involving firms that are likely to be more effective competitions in the future and those involving failing firms."

The meaning of "likely" for the purposes of the competition test in section 50 is not yet settled. There is a line of authority that adopts the meaning of the word as it appears elsewhere in the CCA – that is, that there must be a "real chance" of the relevant anti-competitive effect eventuating. Justice French (as he then was) observed that the bar must not be set "so high as effectively to expose acquiring corporations to a finding of contravention simply on the basis of possibilities, however plausible they may seem". He went on to describe section 50 as providing a "competition risk management policy" that must operate in the real world.

In reversing a decision of the ACCC to block the acquisition by Metcash of the Franklins supermarket business, Justice Emmett of the Federal Court held (at first instance) that, where a particular counterfactual is advanced for the purpose of the section 50 test, the ACCC must show that:

• it is more probable than not that a particular counterfactual will come to pass absent the proposed acquisition; and
• there is a real chance that, if the proposed acquisition does proceed, the proposed acquisition would result in a substantial lessening of competition compared to the scenario in which that counterfactual eventuates (Australian Competition and Consumer Commission v Metcash Trading Limited (2011) 282 ALR 464).^[1]

On appeal, it was not necessary for the Full Federal Court to rule on Justice Emmett's approach, although Justice Buchanan (in obiter dicta remarks) cast doubt on the application of the "real chance" test for the purposes of section 50. However, the Full Court has since accepted that likely competition "may be established by showing a real chance of competition", but that that real chance must be commercially meaningful (Australian Competition and Consumer Commission v Cascade Coal Pty Ltd [2019] FCAFC 154).

In ACCC v Pacific National Pty Limited (No 2) [2019] FCA 669, which is subject to an appeal by the ACCC, the Federal Court held that "likely" for the purposes of the section 50 test means a real commercial likelihood of a substantial lessening of competition. Justice Beach stressed that to apply section 50 on the basis of a real chance of a substantial lessening of competition "built upon a real chance in the counterfactual may, depending on how one does it, be erroneous".

The court's interpretation of the required degree of possibility or likelihood that the target will expand and compete is likely to be further clarified in the pending decision on the proposed TPG/Vodafone merger.

iNova/Juno PC issue of concern: removal of "likely" closest future competitor

Whether Juno PC's alternative phentermine-based product will indeed be so successful as to place a "direct and strong" competitive constraint on iNova is of course uncertain and requires a degree of crystal ball gazing on the part of the ACCC. By ventilating a preliminary issue of concern around the removal of iNova's "likely closest future competitor", the ACCC sought to preserve the "opportunity for Juno PC's new product to enter the market as a strong competitor to iNova".

The ACCC considered that the competitive constraint that Juno PC's product might place on iNova is likely to be greater than both the existing constraints imposed by competing prescription and over-the-counter weight-loss medicines, as well as any possible new entry of generic phentermine-based medications. In the ACCC's view, any possible future generic phentermine-based products would likely only compete on price at the point of purchase, and only if the prescribing doctor had not excluded generic substitution, whereas Juno PC's product would likely be in a better position to compete with iNova on both price and non-price factors due to its patent-protected extended-release profile.

Nevertheless, the ACCC expressed the view that, if the Proposed Acquisition did not proceed, Juno PC would be likely to sell its business to an alternative purchaser or market its product in partnership with a third party. In the ACCC's view:

• an alternative purchaser could overcome some of the risks associated with the development of phentermine medication;
• Juno PC's investors would have been unlikely to invest in the company if iNova was the only viable purchaser; and
• entry into the market for phentermine-based medication (which generates approximately $70 million in annual total sales) is likely to be an attractive opportunity for an alternative purchaser or distribution partner.

Interestingly, in reviewing the Metcash/Franklins acquisition, the Full Federal Court concluded that it was too speculative to assume that, if not sold to Metcash, Franklins would be sold to another bidder which would maintain Franklins' wholesaling activities and compete against Metcash. In that case, the Franklins business had the features of a "failing firm" that was "leaving the market, whatever it was"; here, the Proposed Acquisition concerned entirely new market entry.

Future market developments: an evolving situation

This Statement of Issues is the latest in a recent trend of ACCC merger decisions raising competition issues based on future market developments and possible opportunities for alternative competitive constraints to emerge absent a proposed acquisition, most notably, the TPG/Vodafone merger currently before the Federal Court.

The ACCC's approach to the iNova/Juno PC transaction underscores that, in determining whether an acquisition will or is likely to substantially lessen competition in a market in Australia – and therefore, whether an application for authorisation or informal review by the ACCC is warranted – it is important to look forward to the likely future development of the relevant markets, and any possible opportunities for competitor entry, including emergent firms with nil market share.

"Although the Full Federal Court, agreeing that the ACCC's original decision should be reversed, did not expressly endorse Justice Emmett's formulation, it is consistent with a long established approach in cases considering other provisions in the CCA - including the reasons of Justice French in AGL v ACCC."^{Back to article}