Brief Summary

Competition Law — Merger Control — Approval of merger subject to conditions — Competition Commission prohibited merger between Astral Foods Limited and National Chick Limited due to substantial lessening of competition — Tribunal approved merger with conditions to ensure continued competition in broiler and animal feed markets — Conditions included non-discriminatory supply agreements and divestiture of Nutrex shareholding — Tribunal's decision aimed at maintaining competitive market structure while allowing merger to proceed.

Comprehensive Summary

Summary of Judgment

Introduction

The proceedings concerned an intermediate merger referred to the Competition Tribunal for consideration in terms of section 16(1)(a) of the governing statute described in the reasons as “the Act”. The matter arose after the Competition Commission issued a Prohibition of Merger Notice in respect of the proposed transaction.

The merging parties were Astral Foods Limited (the primary acquiring firm) and National Chick Limited (Natchix) (the primary target firm). The proposed transaction contemplated Astral acquiring the remaining issued share capital of Natchix that it did not already own, which would in turn result in Astral acquiring control of Nutrex (an animal feed business controlled by Natchix).

Procedurally, the Commission prohibited the merger on 6 December 2001. The parties then filed a request for consideration with the Tribunal on 14 December 2001. A pre-hearing took place on 21 January (at which the Tribunal requested further information), and hearings were held on 19 February and 20 March 2002. Various witnesses testified for the Commission and the merging parties, and an intervenor made submissions focused on investment effects. After hearing argument and evidence, the Tribunal approved the merger subject to conditions, and furnished reasons for that conditional approval.

The dispute concerned whether the merger would substantially lessen or prevent competition in the relevant markets, with the Commission’s main concerns focused on vertical foreclosure in broiler-related markets and the removal of an effective competitor in the animal feed market.

Material Facts

Astral was described as an investment holding company listed on the JSE, controlling several subsidiaries including Meadow Feeds (Pty) Ltd, Ross Poultry Breeders SA (RPB), County Fair, and Earlybird. Natchix was also a JSE-listed investment holding company. At the time of the proposed merger, Astral already held 34.9% of Natchix, with the balance held by management, Old Mutual, and other shareholders. Natchix controlled Nutrex through a 55% shareholding, with the remaining 45% held by minority shareholders (identified in the reasons).

The proposed transaction would be implemented by a scheme of arrangement through which Astral would acquire the remaining 65.1% of Natchix. The transaction therefore had both a horizontal aspect (because Astral and Natchix, through Meadow and Nutrex respectively, both operated in the animal feed market) and a vertical aspect (because Astral, through RPB, operated upstream in breeding stock supply while Natchix operated downstream in the production and sale of day-old chicks).

In the broiler industry context relied upon by the Tribunal, the record described the production chain as involving the supply of great grandparent stock, the breeding and sale of grandparent stock, the production and supply of parent stock (PP), and the downstream production of day-old chicks and broilers for sale into abattoir and retail channels. Astral, through RPB, held a strong position in South Africa in the supply of breeding stock. The reasons recorded that RPB’s market share nationally was 69%, with its main rival (associated with Cobb) at 26%, and a smaller participant supplying the remainder.

Natchix used parent stock to breed and sell day-old chicks to independent broiler producers, and was described as a leading supplier of day-old chicks in KwaZulu-Natal (with a 68% share) and in Gauteng (with a 24% share). The Tribunal recorded that, before the merger, independent broiler breeders absorbed approximately 60% of parent stock, whereas post-merger the Commission alleged that independent broiler breeders would be absorbing around 40%.

The Commission’s concerns, as captured in the reasons, included the risk that Astral could use its upstream position (in parent stock) and its acquisition of Natchix’s downstream position (in day-old chicks) to foreclose independent participants, particularly in circumstances of shortage (such as disease). The Tribunal also recorded concerns raised by industry participants that independent customers would become both customers and competitors of Astral post-merger, and that they would have limited ability to switch suppliers quickly.

The parties’ response, as recorded, was that foreclosure would make little commercial sense because the upstream business was volume-driven, and because the franchisor (Aviagen) would react adversely if sales volumes fell. The record also noted evidence that the alternative supplier (Cobb) was constrained in its ability to expand supply in the short term, with an estimate that it would take 5 to 6 years to make significant inroads, and that downstream entry could take approximately 18 months from great grandparent stock to day-old chicks.

On the horizontal animal feed leg, the Commission prohibited the transaction because the animal feed market in the KwaZulu-Natal Midlands was described as highly concentrated and the merger would remove Nutrex as an effective competitor. At the start of the hearing, the parties accepted that the acquisition of Nutrex should not proceed as part of the merger and sought guidance on a divestiture approach. The Tribunal accepted the divestiture proposal in general, but reformulated and imposed specific divestiture conditions, including provision for a trustee if divestiture was not achieved within specified (confidential) time periods.

Legal Issues

The central legal question was whether the proposed merger, considered as an intermediate merger under the Act, would substantially lessen or prevent competition in the relevant markets, and if so, what the appropriate regulatory outcome should be.

The dispute involved a mixture of application of law to fact and economic/competitive assessment. In particular, the Tribunal was required to assess the likelihood and competitive significance of vertical foreclosure and price discrimination risks in the broiler-related supply chain, given the market structure and entry barriers described in the record.

A further issue concerned remedy design: whether the appropriate response to the competition concerns was prohibition, or whether conditions (including conduct-oriented supply and non-discrimination obligations, and structural divestiture on the horizontal overlap) could adequately address the identified anti-competitive effects without imposing an unreasonable monitoring burden.

Court’s Reasoning

The Tribunal approached the matter by distinguishing between the vertical and horizontal aspects of the transaction. It indicated that most of its analysis would focus on the vertical aspect, in part because the parties indicated they had no interest in retaining Nutrex and were prepared to sell it if the merger were approved.

In addressing the vertical issues, the Tribunal relied on the general proposition (also referenced to its prior decision in the Schumann/Sasol merger) that vertical mergers are often treated more sympathetically than horizontal mergers because they typically raise fewer competitive concerns and may generate pro-competitive gains. However, the Tribunal emphasised that warning signals arise where one or both merging parties hold a dominant position, as such transactions may raise barriers to entry or protect existing dominance.

The Tribunal accepted that this transaction raised such warning signals because the dominant supplier (RPB) was acquiring its largest independent customer (Natchix). It therefore considered whether competition would be affected substantially, and whether remedies could address the concerns without outright prohibition.

The Tribunal summarised the Commission’s case as raising both upstream and downstream foreclosure concerns, including the possibility of supply diversion in shortage conditions, and the ability to price discriminate in favour of Astral’s integrated downstream operations. The Tribunal also recorded evidence before the Commission suggesting limited short-term ability by Cobb to take up excess demand, and submissions from industry participants about vulnerability to supply disruption.

In evaluating the foreclosure risk, the Tribunal referenced scholarly criteria attributed in the reasons to Areeda, describing a set of circumstances in which vertical mergers can be presumptively condemned on structural evidence alone. It then found that those factors were present on the evidence before it, including high concentration, high entry barriers, and insufficient independent capacity in the relevant levels of the supply chain to support efficient entry or operation.

Despite finding those structural risk factors present, the Tribunal did not proceed to prohibition. It accepted that structural remedies are generally preferable to purely conduct-based remedies, but held that circumstances may exist where market factors combined with carefully framed conditions can adequately address specific competitive concerns, and where prohibition or divestiture would be too drastic. On the Tribunal’s assessment, the competitive difficulties were characterised as short-term structural problems likely to diminish over time, particularly as rival capacity expanded and switching options improved.

The Tribunal considered the parties’ submissions that foreclosure would be commercially irrational because the upstream business depended on volume and enjoyed its highest margins in the upstream supply of parent stock. It also took into account the competitive dynamic posed by Cobb’s intention to expand and its efforts to attract customers, as recorded in the reasons. Nevertheless, it agreed with the Commission that, in the short run, the risk of foreclosure was present and warranted conditions to maintain competition in the short to medium term.

The Tribunal then explained the purpose of its conditions. It required a standard supply contract to be approved by the Commission, with the aim of reducing the Commission’s ongoing regulatory role by creating a benchmark against which downstream participants could complain in the event of non-compliance. It addressed shortage concerns by requiring pro rata reductions across all customers, including Astral’s own group entities, in the event of disease or force majeure. It addressed downstream foreclosure and discriminatory dealing by requiring non-discrimination between group entities and independent customers for equivalent transactions, including on price, discounts, and rebates, while leaving price determination within Astral’s discretion. It also prohibited exclusivity requirements and imposed mutual, reasonable notice requirements and a five-year duration for the contracts, with the regime applying for five years from the date of the order.

On the horizontal animal feed overlap, the Tribunal treated divestiture as the appropriate structural response. It recorded that the parties did not appeal the Commission’s prohibition of the acquisition of Nutrex and sought guidance on divestiture. The Tribunal accepted the divestiture approach but imposed detailed conditions, including Commission approval of an independent and viable purchaser, strict (confidential) time periods, restrictions on Astral’s involvement in Nutrex management and access to records pending divestiture, and appointment of a trustee to effect sale if Astral failed to secure an approved binding offer. It also stated that failure to comply with the divestiture conditions would result in the merger being set aside.

The Tribunal recorded that neither the Commission nor the parties raised public interest concerns.

Outcome and Relief

The Competition Tribunal approved the merger subject to conditions governing both the broiler industry (through supply, non-discrimination, and contract-standardisation obligations applicable for five years) and the animal feed industry (through a compulsory divestiture of Astral’s entire shareholding in Nutrex (KZN) (Pty) Ltd to an independent purchaser approved by the Commission, with a trustee mechanism if divestiture was not achieved within specified confidential periods).

The reasons did not record any punitive order as to costs. The decision was dated 16 April 2002, with the reasons issued as a non-confidential version, and concurrence noted by the other Tribunal members identified in the document.

Cases Cited

Schumann Sasol merger, Competition Tribunal Case No: 23/LM/May01

Legislation Cited

Competition Act 89 of 1998, section 16(1)(a)

Rules of Court Cited

No rules of court were cited in the reasons.

Held

The Tribunal held that the merger raised serious vertical competition concerns, including potential upstream and downstream foreclosure, given high concentration and entry barriers, and that these concerns were most acute in the short run. It nevertheless held that prohibition was not necessary because appropriately framed conditions could maintain competition in the short to medium term, while longer-term market dynamics were expected to mitigate the risks.

The Tribunal further held that the horizontal overlap in animal feed required a structural remedy and ordered divestiture of Astral’s interest in Nutrex (KZN) (Pty) Ltd to an independent, viable purchaser approved by the Commission, with trustee appointment provisions to secure implementation.

LEGAL PRINCIPLES

The Tribunal applied the principle that vertical mergers are generally less likely than horizontal mergers to harm competition and may yield efficiencies, but they warrant close scrutiny where one or both firms hold dominant positions, because such mergers may raise barriers to entry or facilitate exclusionary strategies.

It applied an assessment framework in which vertical mergers may be presumptively problematic where markets are highly concentrated, entry barriers are significant and not susceptible to timely entry responses, and there is insufficient independent capacity at relevant levels of the supply chain to support effective entry or operation by rivals.

The Tribunal applied the further principle that, although structural remedies are often preferred to conduct remedies, conditional approval may be appropriate where anti-competitive risks are short-term and can be effectively addressed through conditions that reduce the likelihood of foreclosure and discrimination without imposing an unreasonable monitoring burden. In this matter, that principle was operationalised through time-bound supply and non-discrimination conditions in the vertical chain, combined with a divestiture condition to address the horizontal overlap.

Astral Foods Limited and National Chick Limited (1) (69/AM/Dec01) [2002] ZACT 25 (16 April 2002)