25 June 2009
On March 18, 2009, the US District Court for the District of Columbia issued a preliminary injunction that stopped the proposed merger between CCC Holdings, Inc., and Mitchell International, Inc., and caused the parties to abandon their transaction. This was the first preliminary injunction successfully obtained by the Federal Trade Commission (FTC) in seven years, and the first since the US Court of Appeals for the DC Circuit salvaged the agency’s failed attempt to halt the merger of Whole Foods and Wild Oats.
In enjoining the CCC Holdings merger, the DC Circuit adopted an approach to preliminary injunction standards that the FTC has been pitching to federal courts for years — that Section 13(b) of the Federal Trade Commission Act requires only that the FTC show “a reasonable probability that the acquisition may substantially lessen competition,” and that in order to meet its burden of showing a likelihood of success, the FTC need only raise “questions going to the merits so serious, substantial, difficult and doubtful as to make them fair ground for thorough investigation, study, deliberation and determination by the FTC in the first instance and ultimately by the Court of Appeals.” The CCC Holdings case is a timely example of how these standards can work in the FTC’s favor, particularly when they are combined with the prospect of an extended trial on the merits for the parties under the FTC’s “Part III” administrative proceedings.
The Parties and the Relevant Markets
CCC Holdings and Mitchell are two of the three largest providers of estimatics products. Broadly speaking, estimatics products are used by car insurance companies to estimate the cost of repairs for damaged vehicles or replacement value for vehicles that are stolen or incapable of repair. There are two types of estimatics products: communicating and non-communicating. The former are used by insurance companies and repair facilities that are part of a “direct repair program” (DRP) and allow the members of the DRP to instantaneously relay information about claims to each other. Non-communicating estimatics products, as their name suggests, cannot be used to communicate claims information between insurance companies and repair facilities; consequently, non-communicating products often are used by low-end repair facilities that are not part of a DRP.
According to the FTC, CCC Holdings, Mitchell and a third company, Audatex North America, Inc., account for approximately 99 percent of the estimatics market. The remaining 1 percent is held by two small players, Web-Est LLC and Applied Computer Resources. In CCC Holdings, the FTC alleged that these two minor competitors are unable to compete because each produces only non-communicating products, and that Mitchell, in its licensing agreement with Web-Est for access to Mitchell’s database of parts and labor costs, placed on Web-Est various non-competition restrictions, including a prohibition on selling to the top 50 insurance companies.
In addition to estimatics products, CCC Holdings and Mitchell overlap in the production of total loss software systems (TLV). TLV systems “contain comprehensive databases of vehicle sales information that [are] regularly compiled from numerous sources and hundreds of localities” and are used by insurance companies to estimate replacement value of vehicles that have been totally destroyed or stolen.
The FTC alleged that the TLV market is highly concentrated. Again, CCC Holdings, Audatex and Mitchell are the three largest producers of TLV products. Unlike the estimatics market, however, Mitchell is a relatively new entrant into TLV. Until 2005, CCC Holdings and Audatex were the only two producers of TLV systems. Then Mitchell entered with its WorkCenter Total Loss product and within two years captured almost 5 percent of the market. Between them, CCC Holdings, Audatex and Mitchell account for more than 90 percent of TLV sales.
The Court’s Analysis
The court’s analysis began by defining the relevant product and geographic markets. There was no dispute as to the proper scope and definition of the estimatics market — the parties conceded that this was a market unto itself. Nor was there much debate over the geographic market — given the nature of the products (vehicle replacement, parts and labor costs) the market was limited to the United States.
The parties did challenge the FTC’s definition of the TLV market, however, which excluded the option of insurance companies performing their own in-house total loss valuations using appraisal books. In fact, CCC Holdings presented evidence that it had lost a large customer when a major insurance company decided to conduct its total loss valuations in-house. Nonetheless, the DC Circuit found that “do-it-yourself” valuations did not compete with TLV systems. In support of its conclusion, the court cited “real-world evidence” such as the view of appraisal book vendors that they do not compete with TLV, the lack of focus on appraisal book competition in the parties’ internal documents, the practical limitations of appraisal books (e.g., appraisal books cannot provide the same level of local market details), and the lack of evidence that the price of appraisal books impacts the price of TLV or vice versa. Citing to the DC Circuit’s Whole Foods decision, the court concluded that “the FTC is not ‘required to settle on a market definition at this preliminary stage’” and found that even including appraisal books in the relevant market would not change the ultimate conclusion.
Having limited the markets to estimatics products and TLV systems, the court had no problem finding extremely high concentration levels establishing a prima facie violation of Section 7 of the Clayton Act. The court used the Merger Guidelines’ Herfindahl-Hirshmann Index (HHI) to calculate a post-merger HHI of almost 5,700, up from 3,650, for the estimatics market. The post-merger HHI of the TLV market, according to the court, was 5,460 with an increase of 545 points.
Of course, this was not the end of its analysis. The court entertained the parties’ arguments that the HHIs overstated the ability of the parties to exercise market power after the acquisition and that market dynamics would thwart any attempt by the parties to do so. First, the court dealt with the defendants’ arguments on lack of entry barriers, finding their evidence unpersuasive. The court noted that there had been several instances of entry into estimatics products, but that most of these entrants quickly failed and the two that managed to stay in the business — one of which entered in 1993 — had gained only a combined 1 percent share. As to the TLV market, it was true that Mitchell itself entered in 2005 and quickly gained a 5 percent share, but the court attributed this success to Mitchell’s position as an established competitor in the estimatics market; there was no evidence of any other company entering without such an advantage.
The court cited other evidence that barriers to entry in fact are high in this industry. One source of such evidence was the parties’ own documents boasting the presence of entry barriers and playing down the probability that others could successfully enter either market. Another was the technical barriers to creating and compiling the comprehensive database necessary to provide valuable estimatics and TLV products. CCC Holdings offered to relinquish its exclusive license to Hearst Motor database, which it uses for its estimatics product, thereby enabling a willing entrant to overcome this technical barrier. The court, however, was not moved by this gesture, noting that no potential entrant has contacted Hearst Motor about licensing its database.
The court also found that the ability of the major competitors to bundle multiple products together created an effective entry barrier. To successfully enter, a new competitor could not rely simply on one product, it needed to match the bundles that CCC Holdings, Mitchell and Audatex could offer. Moreover, customers were reluctant to switch because doing so typically involved large costs and the willingness to accept an “unknown” supplier of estimatics and TLV products.
Even Mitchell’s willingness to waive the contract restrictions on Web-Est — which prevented Web-Est from competing for the top 50 insurance companies — did not allay the court’s concerns about high entry barriers. In the court’s view, the evidence was not clear that Web-Est, despite testimony by its CEO that it intended to grow its business aggressively, would gain sufficient traction to offset attempts by the merged parties to exercise market power. In the end, the court rejected the parties’ arguments that entry would discipline pricing in this industry.
The combination of high concentration levels and high entry barriers led the court to conclude that the merger would give rise to coordinated effects among the remaining players, primarily CCC Holdings and Audatex. The court brushed aside claims that product heterogeneity made coordination difficult and unlikely, citing evidence that the top companies generally have similar products and offer four basic bundles. The court also discounted arguments that confidential pricing, high-value contracts, and powerful customers made coordination less likely, instead focusing on evidence that the markets at issue are mature and stable, that switching costs are high and that, while prices may not be completely transparent, the three major competitors keep close tabs on each other’s competitive activities and are acutely aware of each other’s customers.
The court conceded that the defendants made “strong arguments” that “the market dynamics create a number of incentives to compete, and indeed, have maintained a competitive marketplace to this day.” Nevertheless, relying on Whole Foods, the court concluded that the FTC had met its burden of showing that “coordination is possible, and even likely, in these markets.” The court explained,
Whether the Defendants’ argument that the unique combination of factors in these markets negates the probability that the merger may tend to lessen competition substantially, or whether the FTC is correct that the market dynamics confirm the presumptions that follow its prima facie case, is ultimately not for this Court to decide. As Judge Tatel confirmed in Whole Foods, “[c]ritically, the district court’s task is not ‘to determine whether the antitrust laws have been or are about to be violated. That adjudicatory function is vested in the FTC in the first instance.’” The Defendants’ arguments may ultimately win the day when a more robust collection of economic data is lain before the FTC. On this preliminary record, however, the Court must conclude that the FTC has raised questions that are so “serious, substantial, difficult and doubtful” that they are “fair ground for thorough investigation, study, deliberation and determination by the FTC.”
On the issue of whether the merged parties could unilaterally exercise market power, the court held that the FTC failed to provide adequate evidence that Audatex was a distant third player that could not re-position itself to replace lost competition. As to the efficiencies the parties claimed would result from the merger, the court found that the evidence presented did not establish with any degree of certainty whether the projected costs savings would be realized, when they would be realized, and whether they would benefit customers. Finally, the equities weighed in the FTC’s favor, the court reasoned, based on its likelihood of success on the merits and that the only equities favoring the defendants — that customers would lose out on the benefits of the merger — were remote and uncertain at best.
As a result of the court’s ruling, and facing an extended administrative trial under the FTC’s Part III procedures (which can take more than a year even under an accelerated schedule) the parties abandoned the transaction.
There are several useful points to take away from the CCC Holdings case:
First, the parties’ views of the marketplace will be used as critical evidence on how to define markets. Here, the court relied in part on evidence that the parties’ internal documents did not recognize appraisal books as competitive to TLV systems. The evidence also established that the parties did not change TLV pricing in reaction to price changes for appraisal books.
Second, counsel should review transactional documents for statements that could affect the antitrust analysis. In support of its conclusion that entry barriers in the estimatics and TLV industries are high, the court cited in great detail a number of documents emphasizing high entry barriers. Many of these were documents that ordinarily might escape review by antitrust counsel, e.g., rating agency presentations, information memoranda for credit facilities, and other financing documents.
Third, when evaluating entry arguments, focus will be placed on the likelihood and sufficiency of entry, and not just issues of timeliness. Here, the parties offered “fixes” that, they argued, would facilitate entry. The court, however, was more concerned with the fact that few competitors have been attracted to this mature, stable industry and that, given the history in this industry, it was unlikely that an entrant would make an impact in the market within a reasonable period of time.
Finally, it appears that after Whole Foods courts may become more receptive to the FTC’s argument that decisions on whether a merger will substantially lessen competition are for the FTC to decide in the first instance, and not the courts. Coupling this with the threat of protracted Part III administrative proceedings may very well mark the beginning of an FTC winning streak in merger enforcement.