Proposed acquisition by Cargill of Cerestar

No. ME/1042/02

A report under section 125(4) Fair Trading Act 1973 on the advice of the Director General of Fair Trading, given on 18 February 2002, to the Secretary of State for Trade and Industry under section 76 of the Act

Jurisdiction

The merger satisfies the share of supply test of the Act in respect of the supply of glucose syrups and blends.

The parties

Cargill Incorporated (Cargill) is a diversified US company active internationally. Its principal businesses include commodity trading, commodity processing, the marketing of non-branded food ingredients to the food and beverage industry, and the production and marketing of agricultural inputs to farmers. In the year ended 31 May 2001, it reported pre-tax profits of £3.4bn on a turnover of £35bn and gross assets of £19bn.

Cerestar is currently part of the Eridania Béghin-Say (EBS) group of companies and is ultimately controlled by the Montedison Group. It is a producer of starch and sweeteners (including native and modified starches, maltodextrines, spray-dried glucose, glucose syrups and blends, dextrose, isoglucose and polyoils) made from maize, wheat and potatoes. Cerestar also produces vital wheat gluten, crude maize oil and raw materials for animal feed as by-products of its starch and sweetener processes. In the year ended 31 December 2000, Cerestar reported pre-tax profits of £38.9m on a turnover of £1.06bn and gross assets of £1.3bn.

The transaction

Cargill is to acquire sole control of Cerestar by purchasing Montedison's majority (56.019%) stake. In addition, Cargill has notified the EC of its intention to make a follow-on offer for the remaining shares in Cerestar, which are listed on the Euronext Stock Exchange following Cerestar's demerger from EBS on 2 July 2001.

Background

The transaction was originally notified to the EC on 28 November 2001. On 20 December 2001, on my advice, you requested that one particular aspect of the transaction (the supply of glucose syrups and blends in the UK) be referred back to the UK competent authorities under Article 9 of the EC Merger Regulation (see note 1). Having formally cleared the remainder of the proposed transaction, the EC granted the UK's request on 21 January 2002.

Product market

Glucose syrup (also known as liquid glucose, starch treacle and corn syrup) is a starch derivative produced mainly from maize or wheat. It is an aqueous solution of several compounds, principally glucose, dextrose and maltose, and is used in a variety of applications (confectionery, bakery, soft drinks, fermentation etc) as an alternative to sugar. Glucose syrups are classified generally by reference to specific gravity, expressed in degrees of the 'Beaume' scale, and by degree of sweetness expressed as a 'dextrose equivalent content' (DE). Although most glucose syrups tend not to be as sweet as sucrose, other sweeteners such as fructose may be added to form 'blends' that either approximate or exceed the sweetness of sugar.

Glucose syrups and blends are part of a wider segment for natural sweeteners that includes dry (spray-dried) glucose as well as sugar. Whether sugar and spray-dried glucose are sufficiently substitutable as to be regarded as a single relevant product market for the purpose of competition analysis requires further consideration.

The Monopolies and Mergers Commission's (MMC) 1991 report (see note 2) concluded that glucose had different characteristics from sucrose and for many purposes was not an effective substitute. In August 2000, the EC (see note 3)  left open the extent to which sweeteners derived from starch should be considered as distinct from sugar, or indeed from artificial sweeteners and sugar substitutes such as saccharin and aspartame.

The majority of third party respondents to OFT's enquiries have submitted that glucose syrups and sugar are distinct types of product that are not generally substitutable by reason of (a) the specific characteristics of glucose syrups (in terms of viscosity, colour, sweetness etc), and (b) the price. The price of sugar is nearly twice that of glucose syrups, in part because of the production quotas and import tariffs that are placed on sugar through the Common Agricultural Policy.

The parties do not produce sugar or artificial sweeteners and overlap only in spray-dried glucose and in glucose syrups and blends. They submit that these two forms of glucose are not, by and large, mutually substitutable, a proposition which is supported by consultation with customers, who point to the fact that their own production lines are generally specific to either one or the other type of glucose ingredient.

On the supply side, it would not be easy for suppliers of sugar to switch to producing glucose: the production process and the feedstock are fundamentally different. It appears, however, that producers of glucose syrups and blends might be more easily able to switch or extend production to spray-dried glucose. Other producers of glucose syrups have indicated that a price increase of 5-10% would not be sufficient to trigger the investment required for switching to production of spray-dried glucose.

Given the above, the most appropriate frame of reference for competition assessment would appear, at this stage, to be the supply of glucose syrups and blends. For the purpose of this advice I have taken that to be the relevant product market. The parties estimate that the value of total sales of glucose syrups and blends in the UK amounts to some £175m.

Geographic market

The parties argue that the market is EEA-wide in scope. The EC's investigation confirmed the existence of significant intra-Community trade but has also indicated that countries located at appreciable distances from the major centres of production (a triangle of plant in Benelux, Northern France and Germany) may be considered as national markets. On such a basis, the EC reasons that the Nordic countries, Spain, Portugal, Greece, the UK, Ireland and Italy may each be distinct for the purposes of competition analysis.

Third party responses – and further information from Cargill – have been contradictory on the question of whether the relevant geographic market is best considered to be European or national. All the producers suggest that the relevant geographic market is European-wide, while all but one of the ten UK customers consulted suggest that it is no wider than the UK.

Four issues which may be relevant to the assessment of the relevant geographic market are: the level of imports into the UK; transport costs; comparison of UK price levels with those in other member states; and the requirement of many customers for delivery on a "just-in-time" basis.

Imports

Cargill submits that 20% of UK sales of glucose syrups and blends in 2000 were imported. Cargill's data also indicate, however, that the great majority (92%) of imports were sourced either from the parties' own European plants or from those of the other two main UK-based suppliers, Roquette and Amylum. In the year 2000, 76% of total imports came from Roquette's plant near Lille (one of the plants in continental Europe closest to the UK).

Some suppliers who do not own plant in the UK have indicated that it is not profitable to export to the UK, not only because of transport costs but also because of demand and supply conditions. (Some suppliers, for example, have not exported much to the UK, but do supply to countries which are a similar distance away, but where overall prices are significantly higher). An issue for consideration is the margin by which UK prices would have to rise above current levels to make importing into the UK a more attractive proposition for such 'external' suppliers. A high proportion of third parties have indicated that they expect prices in the UK to rise in the near future as demand increases and production capacity becomes increasingly constrained.

The constraining effect of imports into the UK, particularly those from parties other than those who own plant in the UK, is an issue that would benefit from further investigation.

Transport costs

To avoid crystallisation, which renders the product useless for its end purpose, glucose syrups and blends must be transported in isothermic food tankers capable of maintaining the target temperature for two to four days. This adds significantly to the high cost of transportation (10-15% of selling prices according to one of the parties' competitors). Cargill argues, however, that glucose syrups and blends can be transported economically over very considerable distances when haulage companies have the opportunity to 'back-haul' shipments of other products from the destination back to the country of origin. Cargill submits that there are also cost savings in the operation of large plant in continental Europe - due to scale economies and the use of wheat rather than maize as feedstock - which outweigh transport costs to the UK. Cargill further argues that the cost of transportation from continental Europe does not substantially affect final prices in the UK. It has supplied data which show that price trends within the UK are broadly similar to those in other European countries (although there remain some significant differences).

Average prices, however, appear to vary significantly across Europe, to a greater extent than can be explained by differences in transport costs alone. In my view, this warrants more detailed investigation, since it cannot be concluded confidently at this stage that average prices in the UK are - and would post-merger continue to be - competitively constrained by market conditions elsewhere in Europe.

Further comparison of UK price levels with those in other member states

Cargill submits that price levels for sweeteners in general are comparable throughout the EEA, and argues that any divergence in average prices paid for glucose syrups and blends in different countries can be explained by distortions such as variable sales volumes, the grades of glucose for use in different applications, and the differences between individual customers' scale and growth potentials.

Data provided by Cargill, however, show that the average price of glucose syrup has typically been higher in the UK than in the Netherlands and Belgium and that average prices appear to vary significantly across Europe. It is not clear whether these variations are entirely attributable and proportionate to the factors referred to by Cargill.

Requirement for 'just-in-time' deliveries

A large proportion of customers require glucose syrups and blends of a particular specification and quantity to be delivered on a 'just-in-time' basis. Cargill has argued that such requirements can be met by overseas suppliers, but it is unclear how easy it is for such suppliers to ship the required product in the correct volumes to more remote areas on a timely basis. Overseas supply might not be a realistic alternative for "just-in-time" customers who may have limited storage capacity and may be concerned at the risk of supplies arriving too early, too late, or in poor condition.

Conclusions on the relevant geographic market

Although it has not been possible in the time available to the OFT and in the light of sometimes conflicting evidence from Cargill and third parties to reach a conclusive view, it remains a clear possibility that the supply of glucose syrups and blends in the UK is best regarded as a national market. This is a crucial element of the competition analysis in this case, and it would benefit from investigation in greater depth by the Competition Commission.

Horizontal issues

Market shares

The four large producers in the UK (Cerestar, Cargill, Amylum and Roquette) currently have broadly equal market shares. This merger would lead to a reduction in the number of significant producers from four to three, with the parties' combined share increasing to [40-50]% of sales and [50-60]% of total capacity. The Hirschman-Herfindahl Index indicates an already very concentrated industry, with the merger bringing about a significant increase in concentration of over 1,000 points.

Effect on prices and competition

Average prices in the UK are currently reported by many as competitive. They are currently higher than in the Netherlands and Belgium, but lower than in some other European countries. It is widely accepted within the industry that supply capacity has exceeded demand for a number of years and that excess capacity could have maintained prices at such a relatively low level. However, there is a general expectation among customers that prices will rise fairly substantially in the near future in view of the rise in demand and increasing supply constraints.

The question at hand is how the merger is likely to affect competitive conditions. Third parties have indicated that Cargill and Cerestar compete directly with each other. It is possible that it is competition between the parties and others in the industry that has allowed UK customers to benefit in terms of prices. The loss of competition between the merging parties and the substantial increase in concentration on the supply side raises concerns in this respect.

In short there is a possibility, which calls for further investigation, that the merger would substantially lessen competition to supply UK customers.

Barriers to entry and expansion

Cargill argues that there are no significant entry barriers to the glucose syrups and blends market. It submits that the European industry has seen increased capacity to meet demand in recent years and that customers are able to sponsor new entry.

Cargill estimates that it would cost in the order of £15m for a new entrant to set up plant with the potential to produce 5% of the current UK supply of glucose syrups and blends. Given that the total value of UK sales is around £175m, the relative sunk costs in building plant alone would appear to be substantial. (However, it should be noted that such plant is usually also used for the manufacturing of products other than glucose syrups and blends. (see note 4)) New plant would take around 12 to 18 months from the initial decision to enter being taken, to operational running. No new plant has been built in the UK within the last five years.

Cargill has stated that levels of output in the UK have increased and that Roquette (which entered the UK by acquiring the ABR plant in 2000) is expanding its Corby plant. Depending on the size and complexity of the investment, the costs of expanding production are in the region of £5m for a 10% expansion in capacity. Cargill estimates that its own capacity utilisation with respect to its glucose refinery in the UK is about [figures excised]%.

Buyer power

Customers who demand highly specified, bespoke products tend not to go out to tender. The more standardised types of glucose syrups and blends are, however, commodities, with larger buyers making purchases through a tendering process. There appears, at present, to be fairly vigorous competition and UK customers have thus far been able to negotiate favourable prices.

Buyer power could however be substantially weakened in the event of further capacity reduction in the UK market or of any substantial reduction in competition. One of Cargill's customers commented that it could not reduce the amount of glucose syrups and blends it sources from Cargill in the UK because only Cargill has the necessary production capacity. It may be that other UK customers would be in a similar position as a result of the reduced choice arising from this merger

Vertical issues

No significant vertical issues appear to arise from the merger.

Undertakings in lieu

The parties have not offered any structural or behavioural remedy.

Third party views

I have received a number of representations from competitors and customers, which have helped to inform the assessment set out above. It is notable that all but one of the ten customers we consulted expressed concerns.

Conclusion

This merger would reduce the number of significant UK producers of glucose syrups and blends from four to three, and give the merged parties a share of supply in the UK, in terms of sales, of [40-50]%. Barriers to entry may be considered significant and, while a degree of buyer power may exist, it might well be mitigated by increased concentration. A key element of the analysis of the effect of this merger on competition is the extent of the competitive constraints provided by imports. The immediately available evidence on this issue is mixed. In the absence of effective constraints from imports, there would, in my view, be a possibility that the merger would give rise to a substantial lessening of competition. This question, among others, calls for fuller investigation.

I therefore conclude and recommend that you should refer this merger to the Competition Commission.

NOTES

1.  Article 9 is the provision in the Merger Regulation whereby the Commission may be requested to refer all or part of a proposed merger transaction to a Member State's own competent authority.

2.  Para 7.9 MMC Report 297 'Tate & Lyle Plc and British Sugar plc', 1991.

3.  Comp/M. 2029 - Tate&Lyle/Amylum.

4.  Eg starch, dextrose and other sweeteners, vital wheat gluten.

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