Aquisistion by Enterprise Inns Plc of assets of Morgan Grenfell Private Equity Ltd namely the Laurel Pub Group Ltd

No. ME/1255/01

A report under section 125(4) Fair Trading Act 1973 on the advice of the Director General of Fair Trading, given on 5 June 2002, to the Secretary of State for Trade and Industry under section 76 of the Act.

JURISDICTION

The merger satisfies the assets test of the FTA. The ECMR does not apply.

THE PARTIES

Enterprise Inns plc (Enterprise) operates around 3540 leased and tenanted pubs in the UK. The Laurel Pub Group Ltd (Laurel) consists of 1864 leased and tenanted pubs.

ASSESSMENT

Background

Enterprise has recently acquired a 16% shareholding in Coinmajor, a consortium with Cinven, Legal and General, and Princes Gate, which was set up to acquire the Unique and Voyager pub chains from Nomura International plc. Enterprise is entitled to appoint a director to the board of Coinmajor, which will decide policy matters by a majority vote. This transaction was notified, and considered, under the ECMR on the basis of the acquisition by Cinven alone of decisive influence in Coinmajor (and, thus, Unique and Voyager).

Notwithstanding that Cinven was deemed to have sole control of Coinmajor for the purposes of the ECMR, the OFT has considered whether Enterprise acquired the ability materially to influence the policy of Coinmajor within the meaning of section 65(3) of the Act.

When seeking to assess whether material influence arises, it is necessary to examine the individual circumstances of a given case including: the level of shareholding being acquired and the voting rights attached to those shares; the distribution of the remaining shares and the voting rights attached to those shares; the rights to appoint directors and the 'expertise' of those directors; any particular veto rights held by shareholders or others; and any other commercial or financial links between the parties, including option rights. In this case, while Enterprise has a 16% shareholding, this carries no voting rights in itself, matters of policy being decided by a majority vote of board members. Enterprise has one of seven (or eight) directors. At least two of the other directors have experience of the pub retailing market. Enterprise has certain limited veto rights which are designed to protect the value of its investment in Coinmajor but has no veto rights on policy issues. Moreover, Cinven has a significantly larger shareholding, its representatives and appointees account for a majority of the board members (which include those with pub retailing expertise), and it has veto rights on a wide range of policy matters.

It seems likely that where one party, such as Cinven in this case, has a controlling interest in a business and such a wide range of veto rights, then the threshold at which another party might be argued to have the ability to influence materially the policy of that business would be higher than might otherwise be the case. The OFT has taken account of the above factors and believes that Enterprise has not acquired the ability to influence materially the policy of Coinmajor. We have therefore considered the effects of the addition of the Laurel business to that of the Enterprise business only.

Relevant markets

The parties overlap in the operation of leased and tenanted pubs. Market definition helps organise analysis of the competitive constraints on the merged entity. In line with previous similar cases, and despite developments in drinks retailing, we regard the off-trade as insufficiently substitutable with pubs to be included within the relevant product market. Previous Competition Commission and OFT cases have analysed pub competition in the framework of a 'pubs' market, but there is room for considerable debate over the precise nature of competition among pubs, and between pubs and other licensed venues (see note 1).

Location, customer profile, ambience and range of products sold are among the features that companies use to characterise different pub categories. Although each pub company characterises pubs differently, third parties have consistently distinguished between 'local' pubs that are attractive to residents of a small catchment area and 'destination' pubs that offer other features such as entertainment or food that attract customers from greater distances. Many third parties thought that these differences were significant enough to mean that pubs of different categories did not compete against each other. From that it might follow that the most appropriate frame of reference for competition analysis was narrower than all pubs.

On the other hand, pubs might also face competition from other licensed venues, such as clubs, restaurants, and other leisure facilities. Some third parties thought that the products, pricing, and service offered by certain licensed venues made them substitutable for pubs. The degree of substitutability between pubs and other licensed venues would appear to vary considerably according to the individual characteristics of the pubs and venues.

While it is clear that there is substantial heterogeneity within the on-licence trade and between pubs, no precise segmentation is possible. Although we harbour considerable doubts that there is indeed a market for pubs, we presently have insufficient information to conclude with confidence that the relevant market is narrower (or indeed wider in some cases) than that for 'pubs'. In these circumstances, pubs provide an appropriate frame of reference to assess the competitive effects of this merger. Saying this is certainly not to exclude non-pubs from consideration, nor to ignore the manifest variety that exists among pubs.

As to the geographic scope of the relevant market, pub competition tends to be at local level. In previous similar cases, PSDs have been used as the relevant geographic area for assessing the extent of competition among pubs. However, it can plausibly be argued that the actual geographic market might be narrower than a PSD in some areas (such as city centres) or wider in some rural areas. While acknowledging that customers may only be willing to travel short distances when deciding where to drink, Enterprise argues that many significant parameters of competition, such as beer supply agreements, range of products, and pricing, are determined by pub companies on a national level or at least on a regional basis. Evidence from the parties and third parties, however, suggests that local conditions are central to the questions of rent-setting and establishing retail prices.

Again, we doubt that PSDs capture in any complete way the geographic scope of competitive constraints on individual pubs. But, in the absence of a detailed study into local competitive conditions throughout the UK and in the absence of another recognised way of assessing the contours of local competition, PSD areas represent the best available proxy for gauging local competition in this case.

Horizontal issues

In a number of pub cases, the OFT has assessed the competitive effects of a merger in a 'pubs in a PSD' context, applying a 25% share threshold to determine the level at which a merger raises competition problems. Nationally, the combined share of Enterprise and Laurel is 8.2% (increment 2.8%) of pubs and 3.7% (increment 1.3%) of full on-licences. (These data are based on shares of pub numbers and not shares of pub revenue. Accordingly, these share data likely do not accurately reflect the merged entity's position on the basis of revenue.)

Across the UK, there are ten PSDs in which the parties' combined share of pubs creates or increases a share of 25% or more. The concern about concentration at local level is that it may result in less competition to offer customers value for money. To bring all of the local concentrations arising from this merger under the 25% threshold (or the pre-merger level if higher) would require Enterprise to dispose of a total of 59 pubs in these areas. (There is a question, discussed below, as to whether freeing from tie would be a satisfactory alternative remedy.)

Given these local competition concerns and the increases in local concentration that this merger would create, the issues arising from this merger appear to be sufficiently significant to justify reference to the Competition Commission.

It has also been argued to us that concentration among pub companies may lead to an increase in their bargaining power and, thus, a reduction in the price paid to the brewer. A number of suppliers felt that this transaction could result in lower margins for brewers. We do not think that this concern is likely to materialise and, in any event, doubt that such an exercise of buyer power would have anticompetitive effects. The largest pub companies in the UK account for less than 8% of total beer purchases, making it unlikely that withholding their demand from brewers would result in significant price reductions. Further, provided that competition among pubs at a local level remains strong, any price reductions that a larger pub company did manage to obtain from a brewer may be expected to be passed to tenants in lower wholesale prices or subsidised rents and on to consumers in the form of lower retail prices. Arguably, a pub company might be able to exercise some form of buyer power were it to concentrate its requirements with a single brewer. This eventuality too appears unlikely given that Enterprise along with other pub companies has a policy of multi-sourcing beers to ensure that tenants have a wide range of drinks from which to choose. In any case, price reductions, if they are passed on to consumers through competition, are to be welcomed.

Third party views

Views expressed by third parties have been mixed. Some competitors and suppliers have expressed concern about the degree of buyer power that Enterprise will gain through this transaction and its possible subsequent acquisition of the Voyager/Unique pubs. Other competitors and suppliers have indicated that they do not believe the transaction will have any impact on the UK market. Most third parties did not believe that the number of pubs in each PSD was the correct market definition in every case, but could not identify a more suitable proxy for analysis.

UNDERTAKINGS IN LIEU

Following discussions with OFT officials, Enterprise has indicated that it would be prepared to consider giving undertakings that, in those PSDs where the merger increases its share of pubs to 25% or more, it will within an agreed period dispose of or free from tie as many pubs as is necessary in order to reduce its local shares to 25% or the pre-merger level (whichever is the higher). As with previous similar cases, Enterprise would be entitled to select which of its pubs it would divest under the terms of the undertakings. This freedom of choice is not without concern. First, Enterprise could select only smaller, lower value pubs, and retain all of its larger more profitable venues in each area. Second, by calculating share of pubs by number in each PSD and not by revenue in a PSD, a pub company's true position - and the effect on competition - in a PSD may be understated. I see no immediately practicable way to address these issues (which are not new) given that accurate PSD share data may not be available on a revenue basis.

The form of undertaking offered by Enterprise has been used in several previous pub merger cases following the MMC's 1990 recommendations on Elders/IXL. We have considered whether this is a case where similar undertakings in lieu are appropriate, and whether the undertaking proposed is appropriate to remedy the potential adverse effects on competition that we have identified. In this connection, we considered: (i) concerns over the appropriateness of the '25% of pubs in a PSD' basis for calculation; (ii) the fact that the available share of pubs data might not accurately reflect the strength of the merging parties; and (iii) the substantial number of pubs that Enterprise would have to divest to comply with the 25% threshold. On balance, and subject to the important proviso below, we have concluded in this case that the proferred undertakings in lieu are an adequate remedy for the competition concerns arising from this merger, which would therefore avert the need for a reference.

The proviso is this: following the MMC's report in Elders/IXL, undertakings in lieu have been accepted to divest the relevant number of pubs or free them from tie. The industry has changed significantly in the last decade, however, with many pubs being owned by pub companies such as Enterprise rather than brewers. In this context, it may no longer be appropriate to accept undertakings merely to free pubs from tie. This remedy originally freed a pub from purchasing from its brewer-owner: where the remedy is applied to free pubs from a tie to their pub company (not a brewer), the remedy may not address the adverse competitive effects of local pub concentrations that are identified above. The pub company may still be able to affect retail pricing by raising wholesale beer prices or increasing rents/other costs to the tenant in the expectation that such cost increases could be passed through to consumers given weakened local competition.

In these circumstances, it is doubtful whether giving Enterprise the option to free pubs from their supplier tie would adequately address the potentially adverse competitive effects of the merger identified above. We therefore believe that it would be more appropriate to require Enterprise to divest the relevant pubs. This is a matter on which Enterprise and others will be able to comment at the consultation stage.

Absent undertakings that squarely address the local competition concerns set out above, we believe that a reference to the Competition Commission would be warranted. There is indeed a case for saying that in view of the concerns about the 25% benchmark discussed above it would be desirable for the Competition Commission to revisit the question of local pub concentration by examining this merger. However, an undertaking to divest the pubs in question would in my view be sufficient in this case to tilt the balance of consideration against reference.

CONCLUSION

I therefore conclude and recommend that you refer the merger to the Competition Commission unless the parties give suitable undertakings in lieu of reference to remedy the adverse effects that have been identified.

NOTES

1. A pub is defined as a full publican on-licence

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