Competition Law Association

1. Competition Law Association Merger efficiencies and the failing firm defence – a change of emphasis? 26 February 2014 Nigel Parr

2. Imerys/Goonvean - background • Imerys part of the largest industrial minerals company in the world • Goonvean family owned with kaolin turnover of £17m • Both extract and process kaolin in mid-Cornwall • One UK competitor (Sibelco) and several European producers • 90% of production is exported, EC had found European or worldwide markets (e.g. Imetal/ECC, Omya/Huber) • Goonvean also processed kaolin waste into secondary aggregates (it retained this business) • Acquisition completed in November 2012 • Rationale was to improve competitiveness in serving export markets by reducing fixed and variable costs (e.g. by merging adjacent pits), obtaining access to certain Goonvean reserves and extend life-of-mine • Referred to CC due to competition concerns in 4 UK markets: • kaolin for paper filler (parties were the only suppliers) • kaolin for tableware, sanitaryware and performance minerals (parties had market shares of 70-95%)

3. CC Decision • CC found SLC in the supply of CPM kaolin in the UK: • Imerys and Goonvean were competitors, and the merged business would have high UK market shares • Competition from Sibelco and overseas suppliers was limited due to their limited processing capabilities and/or transport costs • the merged business would be able to increase prices or withdraw grades • SLC related to <5 per cent of the parties’ combined production • CC found that full divestment of Goonvean would be effective • Risks could be addressed by an up-front buyer requirement, rapid sale process, inclusion of additional assets and exclusion of liabilities • Partial divestiture would be ineffective due to integrated production platform (assets used to produce SLC grades could not be separated) • CC found that a price control would also effectively remedy the SLC and selected this remedy • More proportionate to the SLC as full divestiture would remove all merger efficiencies • Even a small loss of efficiency benefits to UK customers of non-SLC grades would outweigh the benefits of full divestiture to SLC grade customers

4. Goonvean as a failing/flailing firm • Goonvean/Kaolin business had made persistent losses • Inability to pass on cost increases to customers • Declining sales volumes (customers closing or switching to competitors) • Profits on secondary aggregates business insufficient to offset losses • Historic lack of capital investment (patching up and equipment run until failure) • Engineering report showed one plant was in very poor condition and required c. £10m investment to enable safe operation in the short-term • Further sustenance capex of £5m required within 3 years, but no future profit stream to justify investment • Exhaustion of key reserves within 2 years • Geological survey (with core drilling) undertaken • Reserves used for unprofitable tableware kaolin sales with no alternative identified • Reserves also needed to produce high value life science kaolin • Goonvean had started to inform tableware customers that supplies would run out • Goonvean faced other signficant challenges: • Large pension deficit • Difficulty in recruiting senior management (pre-merger management left on completion) • No alternative purchaser could extract material merger synergies

5. Failing/flailing firm • CC did not find that Goonvean was a failing firm • Counterfactual involved it remaining as an independent producer • Goonvean would have continued to “patch up” and avoid significant capex • Pre-existing competition would have continued other than in tableware • CC accepted Goonvean would exit tableware to conserve key reserve • It was not seeking new customers and would have ceased to supply existing customers in the very near future • Limited pre-merger price competition would have ceased • No SLC found in this market (Provisional Findings reversed)

6. Efficiencies • Parties claimed the merger would create significant efficiencies • Fixed and variable cost savings by integrating adjacent operations • Improved capacity utilisation • Reduction in overheads and capital expenditure savings • Producing Goonvean’s output using Imerys’ more efficient plants • Increased availability of grades (output enhancement) • Combination of Goonvean’s high quality reserves and Imerys’ sophisticated processing • Ability to mine the boundary between the parties’ adjacent pits • Efficiencies would extend kaolin production in Cornwall for a further 10 years (relative to the counterfactual) • Benefits would accrue to UK customers in a variety of kaolin markets • CC found that efficiencies were not timely, likely and sufficient to prevent an SLC • CC requires merger efficiencies to be “rivalry enhancing” • It was not clear how and against whom rivalry would be enhanced in UK kaolin markets • CC doubted that cost savings would be passed on to customers

7. Relevant Customer Benefits • CC took efficiencies arguments into account in considering RCBs • Most weight placed on output enhancing efficiencies (continued and increased access to kaolin reserves for a longer period) • CC also considered that the merger might result in significant cost synergies for Imerys • RCBs taken into account when deciding on remedies • RCBs lost due to the implementation of a particular remedy are considered a cost of that remedy • Full divestiture of Goonvean would lead to loss of all RCBs; even a small loss of RCBs could outweigh the benefits of a divestiture in the SLC market • Price control remedy would preserve RCBs and effectively remedy the SLC

8. Scope of the Undertakings • Grades: • Imerys grades: Speswhite, Polwhite B, Polwhite E, Devolite and Polsperse • Goonvean grades: Crystal Sheen, Opal Alpha, Opal Beta, Opal Gamma, Opal Epsilon and Opal Rho • Grades must conform to product specification sheets • Undertakings do not apply to new grades • Customer: • Existing (not new) UK Customers’ of the grades • Undertakings only apply to their purchases in the UK • Maximum Annual Volume • For each Customer, its highest annual UK purchase volume for each Grade in 2009/10, 2010/11 and 2011/12, plus 10 per cent

9. Pricing/transition to alternative grades • Ex Works Prices subject to a Price Cap: • Ex-Works Prices cannot be increased in 2014 or 2015 • Ex-Works Prices are capped for 2016, 2017 and 2018 at The Ex-Works Price at 31 December of the previous year + RPI – 0.5% • Delivery costs: • Imerys may not change delivery costs during a calendar year, unless the customer changes its delivery requirements or a Fuel Variance Clause applies • Imerys cannot mark-up third party haulage costs • Customers can switch to ex-works supply at any time • Undertakings include a process for transitioning customers to suitable alternative grades • This may be necessary due to cost, reserve availability considerations • Transition cannot occur until 1 January 2016: Imerys must continue to supply the Initial Grade within each Price Controlled Product in 2014 and 2015 • Where the Customer accepts the alternative grade it must be supplied in accordance with the Undertakings (with the same price cap as the Initial Grade) • Customer can either accept supply of the alternative grade instead of the Initial Grade or initiate a Dispute • An Independent Expert (paid for by Imerys) will determine whether an alternative grade is a suitable alternative to the Initial Grade for the relevant application in which it is used by the Customer • If it is, Imerys can supply the alternative grade. If not, Imerys must continue to supply the Initial Grade but can continue reformulation work

10. Akzo/Metlac • Merger of metal packaging coatings manufacturers • Azko one of three global producers, Metlac found to be a maverick competitor • SLC found, with increased prices and loss of innovation likely • CC found no efficiencies or relevant customer benefits: • Akzo claimed purchasing, manufacturing, distribution and R&D efficiencies would benefit customers • CC found no incentive for Akzo to pass on cost savings once Metlac had been removed as a competitive constraint • CC required compelling evidence of RCBs, which must arise in the form of lower prices (or better quality, service, choice or innovation) than if the merger did not take place.

11. Conclusions • CC thresholds for efficiencies and failing firm are high • Efficiencies will not be sufficiently rivalry-enhancing to prevent an SLC • Failing firm analysis is based on a short-term perspective • CC may take a holistic view of the situation in its final decision • Failure of part of a firm (e.g. Goonvean exiting tableware) reducing scope of SLC • Longer-term failure of the firm may influence duration of remedy • Consideration of RCBs in choosing between effective remedies • Need to submit compelling evidence • Imerys/Goonvean – combination of: • witness statements • internal e-mails/documents • engineering reports (initial and commentary on PFs) • geological survey The facts matter; don’t give up!

12. Competition Law Association Merger efficiencies and the failing firm defence – a change of emphasis? 34030322