While
large mergers in concentrated industries make national news and present
a serious problem, the focus on headline-making mergers can ignore a
potentially more concerning trend: the intentional consolidation of
fragmented industries through small, “serial
acquisitions.” Long a core aspect of the private equity business model,
serial acquisitions are now endemic to American commerce. Whether it is
magic mushrooms, youth addiction treatment centers, mobile home parks,
nursing homes, comedy clubs, ad agencies, water bottles, local
newspapers, or health care practices, many local businesses normally
thought of as independent are being swept up in serial acquisition
sprees. Today even publicly traded firms and start-ups use this
consolidation strategy to pursue higher returns.
However, Section 7 of the Clayton Antitrust Act sought to prohibit such serial acquisitions with a standard for “incipientmonopolization.” It stated that no firm can acquire the stock or assets of another “where
the effect of such acquisition may be to substantially lessen
competition between the corporation whose stock is so acquired and the
corporation making the acquisition.” The 1950 Celler-Kefauver Amendment
bolstered the focus on curbing monopolization in its incipiency by
removing loopholes and broadening the standard to block vertical and
conglomerate mergers or acquisitions.
This incipiency standard of the Clayton Act — prohibiting acquisitions that might
harm competition in the future — was initially interpreted very broadly
to prohibit mergers large and small. As the Supreme Court interpreted
it, the standard“requires
not merely an appraisal of the immediate impact of the merger upon
competition, but a prediction of its impact upon competitive conditions
in the future.’” Small-scale mergers were not exempt, because “remaining [competitive]vigor
cannot immunize a merger if the trend in that industry is towards a
monopoly,” as is the case with many industries being consolidated
through small acquisitions today.
Serial
acquisitions were explicitly considered in both the legislative
background of the 1950 Celler-Kefauver Act and in subsequent
interpretations of it. The legislative history reveals a fear that
companies would extend “their power by successive small acquisitions” which would “convert an industry from one of intense competition among many enterprises to one in which three or four large [companies] produce the entire supply.” The 1962 Brown Shoe and 1966 Von’s Grocery decisions
both blocked small mergers in unconcentrated markets, based on concerns
about future threats to competition. When ruling to block a banking
merger in 1963, the Supreme Court stated, “A
fundamental purpose of amending § 7 was to arrest the trend toward
concentration, the tendency of monopoly, before the consumer’s
alternatives disappeared through merger, and that purpose would be
ill-served if the law stayed its hand until 10, or 20, or 30” more firms
were absorbed.
However,
changes to the legal and regulatory landscape weakened incipiency
enforcement since the 1970s, such that, despite their expanding
prevalence in many industries, serial acquirers fly under the regulatory
radar into an antitrust twilight zone. In addition to generally scaling
back merger enforcement, merger filing thresholds under the
Hart-Scott-Rodino Act (HSR)
only require that companies report acquisitions to the FTC if they are
valued at over $101 million, so serial acquirers rolling up industries
with many small transactions are never seen or reviewed by antitrust
enforcers. To give a sense of the potential scale of the problem, in
2021, there were 21,994 total merger transactions in the United States,
yet under 20% — only 4,130 — were reported to the FTC. Similarly, in
2020, there was a total of 16,723 transactions, and only 1,637 — under
10% — were reported. While these legal changes primarily served to
weaken enforcement against large mergers in concentrated industries,
they also had the effect of limiting the scrutiny that smaller serial
acquirers face.
As
a result, companies have found many benefits in pursuing a strategy of
serial acquisitions in the loose regulatory environment of the past 40
years. Multiple studies show strong, positive correlations between
serial mergers and acquisitions and total shareholder returns (TSR) and enterprise value (EV).
How serial acquirers turn acquisitions into shareholder value varies.
Sometimes the value derives from increased efficiencies or valuation
increases, but in other cases, it comes from exercising consolidated
market power by raising prices or extracting concessions from
stakeholders like workers or suppliers. As a result, companies that make
serial acquisitions a core part of their corporate strategy are
typically motivated by one or more of five commercial pursuits:
lower-risk expansion, greater efficiency from scale, increased pricing
power, stronger buyer power, and valuation arbitrage. Some of these
motivating factors — like greater efficiency and lower-risk expansion —
can genuinely enhance the quality of products, services, or supply
chains. However, acquirers that seek to increase their market power and
then leverage stronger pricing or buyer power can easily find themselves
in anticompetitive territory or demonstrating monopolistic behavior.
In
addition to some of these intrinsic commercial motivations and the
permissive environment created by the nonenforcement of key areas of
antitrust law, the growing trend of serial acquisitions has been
amplified by several notable factors that converged in the aftermath of
the financial crisis and, more recently, the COVID-19 pandemic. An
increase in the number of acquirers, and their unprecedented access to
capital, has coincided with the “silver
tsunami” demographic change as more business owners look to retire.
Approximately half of businesses are owned by Baby Boomers, and 60% are
expected to sell within the next 10 years. These combined factors have
produced record M&A activity across all segments of the market.
The
rise of private equity is a significant contributor to the rise of
serial acquisitions. Cheap debt from the Federal Reserve following the
2008 financial crisis helped balloon the private equity industry. At the
same time, large institutional investors dramatically increased their
allocations to private equity. U.S. pension funds, as an example, have
increased their private equity allocations almost 40% from 6.5% to
almost 9% between 2010 and 2021, and now total approximately $480
billion. This translates to more industry consolidation, and less
transparency in markets. There are now more than twice the number of
private equity-owned companies as there are public companies — more than
8,000 nationwide.
As
the industry grew, private equity investors went looking for less
crowded deals, resorting to roll-up strategies in fragmented industries
with lower acquisition costs. The investment structure of private equity
creates strong incentives to pursue serial acquisitions, and in 2020,
71.1% of private equity deals in the U.S. were add-on acquisitions that
consolidated the acquired companies. Many of these add-ons fall below
the HSR reporting threshold, with the median buyout size now around $70
million, and over 50% of add-ons falling below $100 million.
Three
case studies demonstrate the dynamics of serial acquisitions in
different industries and its prevalence across different types of
investors: private equity’s roll-up of physician practices;
EssilorLuxottica’s eyewear monopoly gained through small, serial
acquisitions; and the start-up Thrasio, which has raised significant
venture capital investment to roll-up Amazon third-party sellers.
To
address the anticompetitive harms of serial acquisitions, we make the
following recommendations, with more detail in the full report:
Reinvigorate the Clayton Act’s Incipiency Standard
Section 7 prohibits any acquisition or merger where “the
effect of such acquisition may be substantially to lessen competition,
or to tend to create a monopoly.” The FTC and DOJ already have the
authority to act against these harmful serial acquisitions through
reinvigorating and enforcing this law – particularly for mergers and
serial acquisitions in similar or adjacent industries, or which draw
from the same labor pool. This revived incipiency standard should be
included in the new merger guidelines.
Consider Non-price Effects
Merger
policy and enforcement has, for too long, had a near singular focus on
efficiency through price, which has ignored many other substantial harms
to stakeholders. In addition to price effects, regulators and enforcers
should focus on additional harms such as monopsony effects on labor,
quality of products and services, new firm exit and entry rates, effects
on innovation, and disinvestment strategies by the acquiring firm.
Consider Role of Debt in Merger Analysis
Serial
acquirers typically have access to and carry higher levels of debt,
which provides them with a competitive advantage over other prospective
acquirers such as local acquirers or independent entrepreneurs.
Additionally, high levels of debt, especially in a rising interest rate
environment, can put pressure on serial acquirers to pursue price hikes
or wage cuts. The FTC should investigate the role of bank and non-bank
lenders in enabling consolidation through serial acquisitions, and also
consider incorporating the amount of debt as an indicator for the
anticompetitive intent of the merger.
Remove “Safe Harbor” Provisions From Merger Guidelines
Since 1982, merger guidelines have included general guidelines for a “safe
harbor” — a level of industry-wide concentration below which the
agencies will not challenge a merger. The FTC and DOJ should eliminate
any such assurances in the new merger guidelines.
Transparency in Merger Notifications
The
FTC should notify the public of the existence of all Hart-Scott-Rodino
merger notifications the moment they are filed, even as the detailed
filing will remain confidential.
FTC Exemption from the Paperwork Reduction Act (PRA)
The
FTC should be completely exempted from the PRA, which currently
requires Office of Management and Budget for the FTC to seek information
from 10 or more market participants during a 6(b) study.
New Investigative Criteria for Serial Acquisitions
New investigative criteria should be developed to challenge serial acquisition strategies.
- First,
this should include criteria about the size, number, and rate of
acquisitions. The agencies should determine the appropriate levels based
on further review.
- Second,
complex legal or tax structuring can often convolute who the ultimate
acquiring firm is in a transaction. In the case of private equity firms,
beneficial ownership should be traced to their portfolio company, as is
reported to their limited partners, as well as the private equity firm
itself.
- Third, investigators should request information specific to serial acquisitions, including investment
materials, such as private placement memorandums, management or lender
presentations, documents prepared for the purposes of soliciting
investment, and. commercial loan documentation to understand a company’s
acquisition plans and financing strategy.
Preapproval or Moratorium Requirements for Violations
Companies
who have recently been found to have violated the antitrust laws or the
terms of a consent decree should face a time-limited moratorium on
future acquisitions for a period of three to five years following the
violation. An alternative penalty would require the company to seek
preapproval from the FTC for any future acquisitions. The FTC should
study whether a moratorium or preapproval would be a stronger and more
practical deterrent to illegal behavior. Whichever approach the FTC
prefers, we recommend that it apply to all of the portfolio company’s
future acquisitions within the specified time frame, as well as those by
its majority shareholder (i.e., a private equity fund manager) within the same sector or market (including labor markets) for the same time period to get around beneficial ownership obfuscation schemes.
Review Enforcement of Regulations Against Corporate Ownership
In
numerous industries in the U.S., particularly in healthcare, there are
existing regulations that are intended to prohibit corporate ownership
of businesses by non-licensed professionals. However, many of these
regulations have been underenforced by the relevant state or industry
regulators. The FTC and DOJ should work in collaboration with state
regulators to review the lack of enforcement on restricted ownership
and, where necessary, consider changes to enhance enforcement.
Statutory Changes to Merger Review
In
addition to these immediate regulatory and enforcement actions, several
possible statutory changes should be considered to improve merger
review:
- Lower notification thresholds:
Notification thresholds for Hart-Scott-Rodino filings should be
lowered. Evidence indicates that the mere existence of notification
requirements is an effective deterrent to many anticompetitive mergers.
- New notification threshold by number of transactions:
Expand Hart-Scott-Rodino notification requirements to include the most
rapidly acquisitive firms, regardless of their size. We recommend that
firms that make more than six acquisitions in one calendar year —
roughly one acquisition every other month — within the same sector or
labor market, and in cases where the acquisition grants the acquiring
firm a controlling interest, are required to report these acquisitions
to the FTC on an annual basis.
- New Disclosure Requirements:
Merger filing requirements should include new requests for naming the
ultimate beneficial economic owners of the acquiring firm as well as the
disclosure of any investment memoranda or investment summaries used to
attract investment in the acquiring firm or its ultimate beneficial
economic owners.
- Sharing of HSR Filings with States: The FTC should be given the authority to share HSR filings with state governments and attorneys general.
As
the Federal Trade Commission and Department of Justice conduct a
wholesale review of both the strength of current merger guidelines and
agency enforcement practices, we believe serial acquisitions should be
an area of particular attention. They cause substantial harms to
consumers, suppliers, workers, and competition itself. The scale of the
problem is still likely underappreciated, given that neither regulatory
nor public attention has focused on the issue. The antitrust statute
regarding mergers, the Clayton Act, was written specifically to prohibit
monopolization “in
its incipiency,” well before dramatic harms were inflicted on
stakeholders across the economy. Today, a similar strength of vision is
needed to course-correct the roll-up economy threatening American
workers, consumers, and prosperity.