5 insights from the failed Sysco-US Foods merger
About a month since the Sysco-US Foods merger fell through, there is much to discern. U.S. District Judge Amit P. Mehta granted the Federal Trade Commission its request to block the merger. Judge Mehta released his 128-page redacted opinion a few days after issuing that injunction, and the food industry has since had time to examine the judge’s reasoning.
Taking these revelations, litigation strategy, and historical context into consideration, the food industry has at least five insights that could prove beneficial to other merger strategies.
1. Expert testimony cannot void damaging internal documents
One of Sysco and US Foods’ main arguments was that their merger would still enable healthy market competition and that Sysco’s divestiture of 11 distribution centers would help create a new national competitor out of Performance Food Group (PFG). However, the FTC uncovered internal documents from Sysco and US Foods that suggested that each company was the other’s main competitor. And, documents from PFG said that even with the divestiture, PFG would still not be able to compete on the same level as the merged company.
"Those sorts of documents can be very difficult to run from in court," said Adam Hudes, partner and group leader of Mayer Brown's Antitrust & Competition practice. "They were hardly the end of the case, as expert testimony is necessary and important in merger cases, but even the best experts can run into trouble when experts’ views can’t be reconciled with the party’s contemporaneous business records. That’s exactly what happened here."
2. Never underestimate third-party testimony
The FTC based much of its research and arguments on 92 third-party testimonies, and the agency dedicated significant time and effort into finding and speaking with each party. The third-party testimony was proving to be such a critical component of the case leading up to the hearing that Sysco and US Foods’ lawyers actually threatened to release the names of all involved.
"It was the mere fact that the FTC wanted to keep those names secret. Part of the argument was there was a fear of retribution," said Hudes. "It was pretty clear that those declarations were going to oppose the merger."
3. Market definitions can make or break a case
Sysco and US Foods argued that their product market was much broader than the FTC. In the companies’ perspective, the market was made up of not just national players like Sysco and US Foods but also regional players, and the companies said customers choose between various levels of distributors. The companies’ expert witnesses presented analysis to demonstrate what choices customers have available and that even if Sysco and US Foods merged, there would still be a number of competitive options. They also insisted that the merger would not impact price, one of FTC’s chief concerns.
Based on those internal documents, however, the court did not have the same definition of a broadline product market.
"Although the companies’ lawyers argued that combined, they only control about a quarter, or $65 billion of the overall $231 billion foodservice industry, Mehta believed that companies with comprehensive, mass-market services are separate from the more specialized services that thousands of local companies provide. Although the judge agreed that in some instances, the smaller local companies may compete in some sectors, they are unable to produce the wide-range of products and services that Sysco and U.S. Foods can," Legal Reader reported.
More specifically, Judge Mehta said in his opinion, "Fruit can be bought from both a grocery store and a fruit stand, but no one would reasonably assert that buying all of one’s groceries from a fruit stand is a reasonable substitute for buying from a grocery store."
4. Proposed concessions need to maintain or create viable competition
Even PFG didn’t believe that its acquisition of the divested distribution centers was going to be enough to make it a national competitor with combined Sysco and US Foods. PFG documents from 2014 proposed that the company needed more than the 11 distribution centers Sysco eventually offered.
In his opinion, Judge Mehta said, "PFG’s recognition that it needed more than 11 distribution centers to compete nationally is reflected in internal documents that were created months before PFG began negotiating with Sysco. The court credits those internal projections over PFG’s current position that an additional 11 distribution centers is enough to compete for national customers."
"That really was the nail in the coffin because Sysco and US Foods lost on the product market, and the solution they offered wasn’t sufficient," said Hudes."The deal’s not going to go through."
5. Precedents matter
The FTC had concerns with another similar merger case in the food industry, which also involved defining a core group of customers, Whole Foods Market and Wild Oats Markets. The merger was proposed and completed in 2007 but challenged by the FTC, which said that the merger would combine Whole Foods with its closest competitor, and, "After the merger, Whole Foods likely would be able to raise prices unilaterally, to the detriment of customers of premium natural and organic supermarkets," according to an FTC press release.
While the federal judge in charge of the case initially denied the FTC’s request for an injunction, in 2008, a federal appeals court brought the FTC’s antitrust case back to life, and in 2009, Whole Foods settled with the FTC by selling the Wild Oats brand, several stores, and leases and assets for several other closed stores.
"The government’s case here as to the relevant market is even stronger than the FTC’s case was in Whole Foods'" said Hudes. "If Whole Foods supported the notion of defining a market around a target customer, then certainly the government’s case with respect to Sysco and US Foods was at least consistent with that approach and probably presented a far stronger argument."
The Sysco-US Foods case may now also set a precedent for contested mergers in the future, particularly those for whom a market definition is essential to the case.
"This notion of a national broadline product market, which is defined at least in part on a subset of customers, is probably one of the elements of (Judge Mehta's) opinion that pushed boundaries a bit, but it was well-reasoned," said Hudes. "It was intellectually honest, and Judge Mehta even acknowledged that this is one area where they are some differences in the case law. But nonetheless the government now has a defensible opinion that justifying the product market in this way that can be appropriate, and I think that’s something we will undoubtedly see more of and will be utilized in cases down the road."
What happened with the Kraft-Heinz merger?
Kraft-Heinz did not see the same degree of antitrust concerns. With Sysco and US Foods, both companies listed the other as its top competitor. While Kraft and Heinz were competitors in the processed foods category, they had so many other competitors, including other major players in addition to smaller local and regional companies. Also, their portfolios complemented rather than overlapped. Finally, because combining the companies could mean lower costs, that could also mean a larger selection and lower prices for consumers, which was the opposite of the concerns surrounding the Sysco-US Foods merger.
The end finally came for the Sysco-US Foods merger, perhaps more decisively than may have been surmised. Judge Mehta wrote in his opinion, "The proposed merger of the country’s first and second largest broadline foodservice distributors is likely to cause the type of industry concentration that Congress sought to curb at the outset before it harmed competition."