COMPETITION TRIBUNAL OF SOUTH AFRICA
Case No: 127/LM/Dec08
In the matter between:
ASPEN PHARMACARE HOLDINGS LIMITED Acquiring Firm
and
FINE CHEMICALS CORPORATION (PTY) LTD Target Firm
Panel : D Lewis (Presiding Member), N Manoim (Tribunal
Member) and Y Carrim (Tribunal Member)
Heard on : 8 April 2009
Order issued on : 8 April 2009
Reasons issued on : 12 May 2009
Reasons for Decision
Introduction
[1] On 8 April 2009 the Tribunal approved the acquisition by Aspen Pharmacare
Holdings Limited (“Aspen”) of Fine Chemicals Corporation (Pty) Ltd (“Fine
Chemicals”). The reasons follow below.
The transaction and parties
[2] The target firm Fine Chemicals, is a manufacturer and supplier of narcotic
and non-narcotic active pharmaceutical ingredients (“APIs”), which are inputs
in the manufacturing of a variety of pharmaceutical products. Fine Chemicals
is jointly controlled by Aspen and Matrix Laboratories (“Matrix”), an
international pharmaceutical manufacturer. Aspen, a manufacturer and
distributor of pharmaceutical products intends to acquire the remaining 50%
1
shares in Fine Chemicals from Matrix. Thus the proposed transaction is a
move from joint to sole control.
Background to the transaction
[3] In 2004 Aspen acquired sole control of Fine Chemicals. This was notified to
the Commission as an intermediate merger. The Commission imposed
certain behavioural conditions1 which were in force for three years, and which
expired in 2007. It is not clear why the conditions imposed were limited to a
period of 3 years. When asked to clarify this point at the hearing, the present
staff at the Commission dealing with this matter said that they were not
involved in the previous evaluation and could not explain why those
conditions were imposed for only three years. All they could confirm was that
the behavioural conditions had indeed lapsed when they expired in 2007.
[4] Subsequent to the expiry of the conditions, in 2006, Aspen sold 50% of its
shares in Fine Chemicals to Matrix. This transaction was not notified to the
Commission as it constituted a small merger and small mergers are not
subject to compulsory pre-merger notification. The proposed transaction in
this matter thus restores the previous situation in 2004, where Aspen
acquired sole control of Fine Chemicals.
Rationale for the transaction
[5] According to Aspen, Matrix’s strategic interests in Fine Chemicals changed
since 2007, when Matrix became a subsidiary of Mylan Inc., a US
pharmaceutical company, which made Matrix less valuable to the joint
venture with Aspen. For this reason Aspen proposed to buy back the
remaining shareholding of Fine Chemicals from Matrix. By the same token
Matrix avers that Fine Chemicals no longer fits into its broader portfolio, and
for this reason, opts to dispose of its interests in Fine Chemicals.
1 The conditions were put in place to allay concerns regarding discriminatory practice in
relation to supply and price for customers. .
2
The relevant market and competition effects
[6] Aspen manufactures and suppliers various pharmaceutical products. Fine
Chemicals is the only supplier of narcotic APIs in South Africa, which include;
codeine phosphate, codeine hydrochloride, morphine sulphate, morphine
hydrochloride, pholcodine and fentanyl, which are used as inputs in the
manufacturing of pharmaceutical products. Fine Chemicals also supplies non-
narcotic APIs which include; paracetamol powder, scopolamine N butyl
bromide and azathioprine.
[7] The proposed transaction does not result in any horizontal overlap between
the merging parties, and will not directly change the concentration of the
markets in which they operate. However, there is vertical integration in that
Aspen manufacturers pharmaceutical products which uses some of Fine
Chemical’s narcotic APIs as inputs. Currently Aspen buys two narcotic API
products from Fine Chemicals which are; Codeine phosphate and
pholcodine.2
[8] The distinction between narcotic and non-narcotic APIs is important. Due to
the potential for abuse of narcotic substances, it is international practice for
the United Nations as well as national governments to put in place controls to
impose limits on the number of firms in a country that are permitted to
manufacture these substances and to restrict their import. Hence, the South
African Department of Health (“DOH”) requires manufacturers of narcotic
API’s to apply for a licence, and it has restricted the importation of certain
categories of narcotic API’s.
[9] From a demand side APIs have distinct characteristics and usage which limit
the possibilities for substitution between them. Furthermore it is difficult to
switch to other APIs once a drug is developed because approval must be
obtained from the Medical Controls Council of South Africa. On the supply
side, as mentioned earlier, there are regulatory restrictions on imports of
side, as mentioned earlier, there are regulatory restrictions on imports of
some of the narcotic APIs such as codeine phosphate and pholcodine which
are prohibited from being imported into South Africa by the DOH. FCC holds
the only licence in South Africa to manufacture certain of these controlled
2 Aspen is said to contribute approximately 34% and 28% of Fine Chemical’s sales of
Codeine Phosphate and Pholcodine.
3
narcotic API substances. 3 In addition FCC is the only South African
manufacturer of paracetamol, though the scale of import in the paracetamol
product is significant.
[10] No competition implications arise in regard to the non-narcotic APIs as no
legislative restrictions to their imports exist. The Commission found that the
scale of imports in the non-narcotic products is significant, therefore there are
competitors to Fine Chemicals with regard to the final products containing
non-narcotic APIs, and customers of these products have alternatives to
purchase these products from international sources and import them into
South Africa. 4 It would seem that transport costs do not give importers a
competitive disadvantage as given the small size of the product, transport
costs can be spread across large volumes, and hence are not a material part
of the cost.
Issues raised in the proposed transaction
[11] The issue raised in the merger is whether the increase in Aspen’s share from
50% to 100% and the concomitant change in control from joint to sole control
changes the incentives of Fine Chemicals from what they were pre-merger,
given that Aspen is a purchaser of inputs from Fine Chemicals. The fact that
Aspen has joint control and owns equity in the target firm is a given pre-
merger, and whatever the merits of the Commission’s decision in 2004 not to
impose conditions on the firm on a long term basis – this scenario cannot be
undone.
[12] At present before the merger takes place Fine Chemicals has Aspen as its
joint shareholder and controller and is not subject to any regulatory
restrictions as to how it exercises that control. Nevertheless, as we have
previously held, a move from joint to sole control has competition implications,
because the incentives of a target firm may change post merger. What we
have to consider is whether the presence of Matrix acted as a constraint on
Aspen, a constraint that may be absent post merger?
Aspen, a constraint that may be absent post merger?
3 The DOH had also indicated that there was unlikely to be another supplier who would be
given license to supply Narcotic APIs into South Africa.4 During the Commission’s investigations DOH submitted that currently other players in the
market currently import close to about 50% of paracetomol from international players.
4
[13] In considering this, we examined a number of competitive concerns which are
raised in the proposed merger: the first theory of harm concerns potential
foreclosure of rivals to Aspen in the upstream market who buy narcotic API’s
from Fine Chemicals; secondly, whether the merger will lead to monopoly
pricing by Fine Chemicals in the upstream market, and thirdly whether
barriers to entry in the downstream market will increase? We further
considered the public sector implications that arise due to the proposed
merger. All of these concerns are dealt with in some detail below:
Foreclosure concerns
[14] The concern is that the merged entity could foreclose its downstream rivals
with inputs and possibly raise their costs by charging higher input prices given
that Fine Chemicals is the sole supplier of narcotic APIs in South Africa. It is
noteworthy to mention that narcotic API products are subject to a single exit
price regime, and price changes must be approved by the DOH. The input
products are not subject to regulation. It is thus possible that foreclosure
could be partial in that the merged firm could raise prices for the API input to
rivals who faced with the ceiling of the regulated price downstream, but
increased costs, might experience a margin squeeze.
[15] Adcock Ingram which is a customer of Fine Chemicals and a competitor of
Aspen in the manufacture and marketing of pharmaceutical products, made
written submissions to the Commission where it raised concerns that the
proposed merger would enable Fine Chemicals to unilaterally increase
prices, especially because upon expiry of the conditions imposed in the 2004
merger, Fine Chemicals increased the price of paracetamol by approximately
28%. Adcock expressed the view that the current transaction would also
further Fine Chemicals ability to unilaterally increase API prices, and increase
Aspen’s competitive advantage in that Fine Chemicals may favour Aspen
Aspen’s competitive advantage in that Fine Chemicals may favour Aspen
over Aspen’s competitors, through preferential pricing and supply.5
[16] Be-Tabs Pharmaceuticals, also a customer of Fine Chemicals and competitor
of Aspen, also raised concerns on the grounds that the market for narcotic
5 It was also submitted that there has been recent increases in the Codeine price. However, at
the hearing the parties submitted that this was motivated principally by raw material costs and
exchange rate considerations given that Fine Chemicals sources its Codeine from Australia.
See transcript, pg. 29.
5
APIs is already strictly regulated, and that the proposed merger would give
Aspen competitive advantage as it would be able to control the inputs
required in the manufacture of the pharmaceutical products, driving Aspen’s
competitors to be price takers of APIs.
[17] Resmed which is also a customer of Fine Chemicals for many years, as well
as Aspen’s competitor, particularly in the tender market, raised concerns that
the proposed merger would negatively affect its tender business as Aspen
would effectively control the prices of APIs and thereby Resmed’s tender
prices as well.
[18] The DOH similarly raised concerns that the proposed transaction would
potentially result in increased API cost/prices, which could be felt not only in
the private sector, but also in the public sector tender market.
[19] The Commission in its investigations considered all of the above concerns
and found that due to the existence of import competition of final
pharmaceutical products, the merged entity would not be able to significantly
influence the downstream prices, particularly since the merged entity is not
dominant in any of the downstream markets, and therefore does not have any
incentives to raise costs since it might lose customers and profits in the
upstream.6 In addition, the Commission held that there are price regulations
which restrain the merged entity from monopolising prices downstream so
there would be no effect on the prices to final consumers.
[20] Although the tribunal invited some of the concerned customers to participate
in our hearings through oral submissions none of them took up the
opportunity to do so.
Upstream Monopoly concerns
[21] At the hearing the Tribunal also raised concerns that Aspen could potentially
monopolise prices in the upstream market for narcotic APIs, particularly in
absence of price regulation at this level. This might be because Matrix had an
absence of price regulation at this level. This might be because Matrix had an
interest in maximising sales of the input since it was not engaged in the sale
6 Some of Aspen’s competitors downstream include firms like; Pharmachem, Adcock Ingram,
and Johnson and Johnson.
6
of the downstream product in South Africa. However, the Commission found
that even in the upstream market, the merged entity does not have the
incentive to raise prices, and that currently it has the ability to do so, but does
not. The reason the Commission submitted is that there are local
manufacturers of pharmaceutical products who are able to manufacture
products elsewhere and import these products as finished products to
compete with Aspen’s products locally, which exerts some constraint’s on
local prices, hence serving as a discipline to Aspen’s pricing strategy.7
[22] The parties also submitted that a lot of the major generic international
manufacturers of APIs, such as in India and China, are much more cost
effective than Fine Chemicals as their volume of production is so much larger.
Barriers to entry
[23] It is common cause that barriers to entry in the market for narcotic APIs are
absolute given the licence and other policy restrictions characteristic in this
market which is significantly made up of import products. The challenges are
more in respect to imports of liquid products, which due to their nature, are
problematic to transport. The Commission indicated that in light of this
problem, liquid products often have to be manufactured domestically, but that
these do not make a substantial portion of the overall market given that most
of the international players import a final narcotic product into the market.
Supply concerns
[24] The Tribunal considered the question whether Aspen has sufficient capacity,
or would have the capacity to increase its own production to supply the final
products to the domestic market, particularly in the event that Adcock or some
other domestic producer, exit the market. The Commission submitted that
Aspen is currently considering expanding its operations, and asserted that
even with its current facilities; there are no foreseeable reasons why it would
even with its current facilities; there are no foreseeable reasons why it would
not be able to provide sufficient supply to the domestic market.
7 For example; Adcock moved its operations to India where it manufactures most of its
products and imports those into South Africa.
7
Impact on the public sector
[25] Finally, the Tribunal raised concerns regarding the impact of the proposed
merger on the public sector. The merging parties submitted that the proposed
merger does not have public sector implications because firstly there is a
tender system in place by the state which has significant countervailing
power, which is why generally the prices supplied to the state are significantly
cheaper than the ones in the private sector. Secondly, that the proposed
merger will not impact on the supply of ARVs by the state because the APIs
produced by Fine Chemicals are not for ARVs, instead Aspen sources its
APIs for ARVs from offshore producers such as Matrix. Similarly, other
competitors in the ARV market such as Adcock, also source their APIs for
ARVs from other international producers, and not from Fine Chemicals.
Conclusion
[26] Although it is a matter of concern that Aspen will enjoy sole control of a firm
that supplies a key input to its downstream rivals, this is mitigated by a
number of factors. Firstly, imports from firms that make the final product more
cheaply at present than would Aspen, would inhibit its incentives to foreclose
rivals or to consider such a strategy profitable. Profits foregone upstream in
such a strategy would not be recouped downstream given the strength of this
competition and the fact that the downstream price is regulated. Secondly, the
monopoly enjoyed by FCC is a creation of regulation, and whoever owns this
firm would, as a result of public policy, be the recipient of a domestic
manufacturing monopoly; the merger does not change this.
[27] To the extent that Fine Chemicals might now be more likely to exploit this
monopoly than pre-merger is difficult to determine, but the fact that the final
product can be imported competitively, suggests that this strategy would have
its limitations and even if it leads to the demise of domestic rivals, it is by no
its limitations and even if it leads to the demise of domestic rivals, it is by no
means clear that the market downstream would be there for Aspen to
command. Thus an upstream monopolist strategy, (assuming that it is not
already maximising its pricing power pre-merger, which we do not know for
certain) could prove counter-productive.8
8 If the firm is already profit maximizing upstream then the merger makes no difference.
8
[28] Based on the above, the Tribunal finds that the proposed transaction is
unlikely to substantially prevent or lessen competition in any of the relevant
markets. Further, no public interest issues are raised.
___________________ 12 May 2009
N Manoim Date
D Lewis and Y Carrim concurring.
Tribunal Researcher: L Xaba
For the merging parties: Antony Norton
For the Commission: Sibusiso Madonsela, Edwina Ramohlola and Sung
Fung
9