TheChek News Flow

- Few mitigating factors on overlaps

- Ardagh/ Saint-Gobain precedent case

- 70% market share in Brazil

Rexam (LON:REX) and Ball (NYSE:BLL) have a price, but the companies must brace themselves for the expected in-depth antitrust review and craft a merger agreement that properly accounts for the risk, two US antitrust attorneys said.

The UK and US industrial companies announced on 5 February that they are in talks over a potential GBP 4.3bn cash and stock transaction that would create a dominant producer of metal packaging for beverages in the US and Europe.

Based on the positive reactions of both firms’ stocks, a Rexam shareholder said he believed the companies would do “whatever it takes” to reach a deal. He said Rexam’s management has likely spent considerable time on the transaction to be in a position to reveal a potential deal with an offer price.

To prepare for antitrust risk, Rexam and Ball will need to conduct a thorough assessment of likely demands from regulators, followed by the creation of a merger agreement between the merging parties that entails a delicate interaction between termination fees, best efforts obligations, as well as divestiture thresholds, the antitrust attorneys said.

A 2011 reform to the UK Takeover Code complicates the potential to use termination fees in this effort, though there are precedent cases of buyers agreeing to reverse termination fees in the event they are unable to close an acquisition on agreeable terms.

The Federal Trade Commission (FTC), the US regulator likely to take the merger, is often reticent to bless mergers that bolster a dominant player’s market share of a specific product, the attorneys said. According to an analyst that covers the companies, in the North American aluminum beverage can space, Ball holds 40% market share, Rexam 21% and Crown Holdings (NYSE:CCK) 19%.

Rexam is particularly strong with its relationship with energy drink company Red Bull, while Ball has good connections to brewers, a second analyst said.

Still, a 60% market share is extremely unlikely to be deemed acceptable to the FTC, the antitrust attorneys said.

And wiggle room appears to be minimal, one of the antitrust attorneys said, who explained that it is unclear what mitigating factors the merging companies could invoke to soothe anticompetitive concerns. Both attorneys said that traditional justifications deployed by merging parties do not appear to be applicable for this industry.

Complimentary geographic footprints do not seem to make sense, as the FTC will likely view the market for metal beverage containers as national; adjacent entry is not likely, as interchangeability with other products is not easily accomplished; and arguments of overcapacity do not match up with data that indicates an increase in can usage, the attorneys said.

The companies’ best bet, according to the first attorney, may be to argue for a broad product market definition that would include plastic bottles as a competitive restraint. Even that argument, the same attorney said, would only conceivably be used for the soda segment, as beer producers will not drift away from their choice of metal or glass. Soda represents some 40% of the relevant market leaving a significant range of alcohol beverage customers potentially at a disadvantage.

Glass and metal containers are widely considered to be superior ways to store beer over plastic, though plastic is used in some cases like sporting events. The beer industry has been moving away from more expensive glass to aluminum cans in recent years.

According to data obtained from the Beer Institute, shipments of aluminum cans in 2012 increased about 8% compared with 2006. Bottle shipments fell by 14%. The same data demonstrates the compound annual growth rates from 2000 to 2012 for can shipments grew by 0.7%, while bottle growth was flat.

US antitrust regulators last conducted a major review of the beverage container market in 2013 when they filed a complaint on the merger of glass container businesses Ardagh Group and Saint-Gobain Containers, which operated in the US under the name Verallia North America (VNA).

The complaint, which defines the market for glass containers and the markets for aluminum and plastic as separate and distinct, is the precedent for the Rexam-Ball review. The FTC defined two relevant national markets: the manufacture and sale of glass containers to brewers, and the manufacture and sale of glass containers to distillers.

The FTC did not include non-glass packaging materials, such as aluminum cans or plastic containers, in the relevant product markets because not enough brewers and distillers would switch over in response to more expensive glass. Due to commercial constraints such as consumer preferences and brand identity, brewers and distillers do not view aluminum cans and plastic containers as interchangeable for glass, regulators wrote.

While aluminum and plastic cost less than glass containers, brewers still sell beer in both glass bottles and aluminum cans because they view the two as complementary and not substitutes, according to the FTC.

A merger of the second- and third-largest glass container manufacturers would likely lead to anti-competitive pricing in part due to lost head-to-head competition, likely output reductions, “speculative, unverifiable, or non-merger specific” efficiencies and high barriers to entry, regulators argued. Potential entrants would face, among other obstacles, the large capital investment and fixed costs needed to build and operate a factory.

The FTC ultimately settled the case with Ardagh and Saint-Gobain and required the companies to divest Ardagh’s Anchor Glass business.

To remedy the Ball deal, the companies will need to create a divestiture package that would include a robust mix of production facilities, the attorneys and an analyst said, though it remains unclear whether the FTC would be willing to see those assets go to Crown thereby creating a symmetrical duopoly.

This news service previously reported that significant divestitures may be needed in Europe along with the US, and the first attorney also speculated that a Ball joint venture in Brazil may also need to be shed. The second analyst said the combined market share is around 70% in Brazil, with Rexam having around 50%. Antitrust regulations in the South American country are still developing and regulators have not moved to block any major international mergers.

Since Rexam and Ball are likely focused on international growth, they may be more open to making US divestitures, the second analyst said. He noted that US capacity utilization is around 90% with growth primarily coming from beer and energy drinks as soft drink demand is declining.

If the companies lose some US plants in the short term, it may be a fair trade for emerging market assets, he said.