The expanding presence of financial investors — many of which focus their investment activity in specific industry sectors — is increasingly generating additional antitrust risk for mergers and acquisitions involving their portfolio companies. As the coffers of private equity funds swelled, these firms have been deploying their capital across a wider range of portfolio companies — often within the same industry. Not surprisingly, this influx of capital has also boosted M&A activity involving portfolio companies of private equity funds. As a result, the antitrust agencies are increasingly reviewing the ownership structure of the merging parties and their competitors to determine whether transactions involving portfolio companies of financial investors are likely to cause a lessening of competition in any market in which they operate.
Several recent antitrust enforcement actions by the Federal Trade Commission, primarily in the energy industry, indicate that the antitrust authorities are carefully examining the ownership interests of financial investors when analyzing the antitrust issues of mergers and acquisitions involving their portfolio companies. In particular, if a private equity investor has minority ownership interests in multiple companies competing in the same market, the antitrust agencies may not view these firms as separate and independent competitors. If a merger reduces the number of non-affiliated competitors in a market, the enforcement agencies may have concerns that the transaction will result in harm to competition by increasing the incentive and ability of the remaining competitors, including those affiliated with the private equity investor, to coordinate their competitive conduct.
In addition, the antitrust agencies may also be concerned that the elimination of a non-affiliated competitor would make it possible for one of the commonly owned, private equity-backed firms in the market to unilaterally raise prices. While a price increase might cause one of these firms to lose sales to it rivals, if a large percentage of these lost sales are likely to be captured by competitors that are affiliated with the same investor, the common investor may actually benefit from a price increase since it would recoup these lost sales through its ownership interest in other competitors. Thus, the antitrust agencies are likely to carefully study whether a common investor has the incentive and sufficient influence and control over one or more of its portfolio companies to successfully implement one of these anticompetitive strategies.
We briefly discuss two recent enforcement actions to illustrate how the presence of financial investors has impacted the agencies’ analysis of antitrust issues involving mergers of their portfolio companies. These include:
1. In the Matter of Magellan Midstream Partners, L.P., and Shell Oil Company
On June 23, 2004, Magellan agreed to acquire a package of pipelines and terminals in the Midwestern United States from Shell, including a refined petroleum products terminal in Oklahoma City that supplies light petroleum products, such as gasoline and diesel fuel. The FTC challenged the proposed transaction because it would eliminate competition in the Oklahoma City market for terminaling of gasoline, diesel fuel, and other lightweight petroleum products. To resolve the FTC’s concerns, Magellan agreed to divest the Shell Oklahoma City terminal to a buyer approved by the FTC.
Magellan initially proposed divesting the former Shell Oklahoma City terminal to SemFuel, L.P. However, Magellan later withdrew this proposal because the FTC raised concerns about whether this transaction would restore the competition previously provided by Shell. The FTC’s concerns stemmed primarily from the fact that Carlyle Riverstone (CR), a private equity funded established by The Carlyle Group and Riverstone Holdings to invest in the energy and power industry, had minority ownership interests in both Magellan and SemGroup L.P., the parent company of SemFuel.
Interestingly, both Magellan and SemGroup are organized as publicly traded master limited partnerships (MLPs) that have more complex ownership structures than most corporations, and these complex ownership structures can further complicate the antitrust analysis. For example, MLPs are managed and controlled by a general partner, but the general partner is often not entitled to receive a majority of the profits interests generated by the assets owned by the MLP. Indeed, CR and another private equity investor, Madison Dearborn, each owned 50% of the general partner that managed Magellan; however, CR’s had less than a 15% interest in the profits generated by Magellan. Likewise, CR only owned approximately 30% interest in the profits generated by SemGroup and had only a 30% interest in the general partner that managed and controlled SemGroup.
Even though CR’s ownership interests in SemGroup did not provide it with either (1) the unilateral ability to control the management of the company or (2) the right to receive a majority of its profits, the FTC’s rejection of Magellan’s divestiture proposal indicates that it did not consider SemFuel to be sufficiently independent of Magellan to restore the competition previously provided by Shell. Thus, Magellan agreed to divest the Oklahoma City terminal to another buyer that did not have any common ownership interests.
2. In the Matter of Dan L. Duncan; EPCO, Inc.; Texas Eastern Products Pipeline Company, LLC; and TEPPCO Partners, L.P.
On August 18, 2006, the FTC announced an antitrust challenge to a previously consummated transaction that was not reportable under the Hart-Scott-Rodino (HSR) Act. The transaction involved an acquisition by an investment holding company (EPCO Inc.) owned by Dan Duncan, the cofounder, chairman, and significant shareholder of Enterprise Products Partners L.P. (Enterprise), one of the largest midstream energy MLPs in the U.S. Indeed, EPCO owns approximately 37% of the limited partnership interests in Enterprise and nearly 87% of Enterprise’s general partner.
In February 2005, EPCO acquired Texas Eastern Product Pipeline Company, LLC for $1.1 billion from Duke Energy. Texas Eastern was the general partner of TEPPCO Partners, L.P., a publicly traded MLP. As part of the same transaction, EPCO also purchased Duke Energy’s 4% interest in TEPPCO for $100 million. Following the transaction, the general partners of both TEPPCO and Enterprise continued to operate independently and maintained separate boards of directors, management teams, and offices.
Even though (1) Enterprise did not directly seek to acquire any interest in Texas Eastern or TEPPCO and (2) the general partners of Enterprise and TEPPCO maintained separate boards and management teams, the FTC challenged the transaction due to a competitive overlap between Enterprise and TEPPCO based on concerns about the common control of both entities by Dan Duncan and EPCO. Specifically, both Enterprise and TEPPCO owned and operated salt dome storage facilities for natural gas liquids (NGLs) in Mont Belvieu, Texas. (TEPPCO’s Mont Belvieu storage facility was actually owned by a 50/50 joint venture between TEPPCO and Louis Dreyfus Energy Services L.P.; however, the FTC alleged that TEPPCO controlled the day-to-day operations of the facility.) Enterprise and TEPPCO collectively accounted for 70% of the storage in Mont Belvieu, and there were only two other competitors that owned competing storage facilities in the area.
Based on the ownership structure of Enterprise and TEPPCO, the FTC concluded "the practical result of the acquisition [involving EPCO and Duke Energy]. . . is that Dan Duncan ultimately owns and controls both entities," i.e., Enterprise and TEPPCO. To resolve the FTC’s concerns, EPCO and Dan Duncan agreed to divest TEPPCO’s interest in the 50/50 salt dome joint venture and related assets.
Both the Magellan and Enterprise/Dan Duncan enforcement actions demonstrate that the ownership interests of investors can potentially generate antitrust issues for both the investors and their portfolio companies. Indeed, press reports indicate that the proposed buyout of Kinder Morgan by management and a consortium of private equity investors is currently under scrutiny by the FTC due to potential competitive overlaps between Kinder and other entities owned by members of the investor group, which includes The Carlyle Group and Riverstone Holdings. While the likelihood of an enforcement action will ultimately depend on the specific facts and circumstances of each case, these FTC actions indicate that the antitrust authorities are more likely to subject a transaction to scrutiny if one or more of the following circumstances is present:
- The private equity investor owns an interest in competing firms that comprise a significant share of a concentrated market. The agencies’ concerns are likely to be greater when the investor holds a majority interest in the voting rights and/or profits interests in at least one of the competing firms; however, ownership of significant minority interests in multiple competitors can also give rise to concerns about the competitive incentives of the commonly owned firms.
- The private equity investor has the ability to control the management of one or both of the competing firms and/or has significant involvement in the day-to-day management of such companies.
- The private equity firm has veto rights over competitively significant decisions (e.g., capital investments to build/expand capacity).
- The private equity investor has access to competitively sensitive business information of one or both companies and/or has insufficient controls to prevent the exchange of such information to other portfolio companies.
In sum, private equity firms and their portfolio companies need to be aware that these issues can arise when they are involved in mergers and acquisitions and develop effective legal and business strategies to address any such issues.