Proposed acquisition by Group 4 Falck a/s of the Wackenhut Corporation

No. ME/1154/02

A report under section 125(4) of the Fair Trading Act 1973 on the advice of the Director General of Fair Trading, given on 1 May 2002, to the Secretary of State for Trade and Industry under section 76 of the Act

[17 July 2002 - interim undertakings published]

Jurisdiction

The merger satisfies the gross assets test of the FTA. It also satisfies the share of supply test for custodial services let by HM Prison Services.

The parties

Group 4 Falck A/S (Group 4) is a company listed on the Copenhagen Stock Exchange [and the New York Stock Exchange] (see note 1). It was created following the merger of Falck A/S and Group 4 Securitas BV in May 2000. Group 4 provides safety and security services to the public and private sectors. The company operates through three main business divisions: (1) security services; (2) safety services; and (3) Global Solutions (public-private partnership). In the year ended 2001, Group 4 reported pre-tax profits of £71 million (DKK 864 million), turnover of £1,738 million (DKK 21,040 million) and gross assets of £801 million (DKK 9,713 million).

The Wackenhut Corporation (TWC) is a Florida corporation listed on the New York Stock Exchange. Its principal businesses are (1) security services; (2) correctional services; and (3) flexible staffing services. TWC is the majority shareholder (57 per cent) in Wackenhut Corrections Corporation (WCC) which is listed on the New York Stock Exchange and a global leader (see note 2) in privatised corrections. In the year ended 2001, TWC reported turnover of £1,935 million ($2,809 million) and gross assets of £433 million ($619 million) (see note 3). WCC provides custodial services and the transportation of prisoners and asylum seekers in the UK via a joint-venture - Premier Custodial Group Ltd (Premier) - which is owned 50:50 by WCC and Serco, a logistics company.

ASSESSMENT

Relevant markets

The parties' activities overlap in the provision of manned security services, transportation services and custodial services. The manned security sector is reasonably fragmented and this overlap does not raise any competition concerns: accordingly, this segment is not further discussed.

Transportation services

Transportation and escort services involve moving persons from one secure location to another. HM Prison Service currently has let nine transportation contracts (one national and eight regional contracts) which require vehicles meeting detailed security standards set by the Home Office. IND has let three transportation contracts for the movement of asylum seekers and immigration detainees. IND security standards are not as high as for HM Prison Service contracts.

On the demand side, there is no substitute for secure, escorted transportation services. HM Prison Service and IND requirements are very precise and it would be difficult for them to substitute another type of transport.

On the supply side, there is a significant overlap in the firms bidding for the two sets of contracts. Thus, the relevant product market for transportation services may be all Home Office transportation contracts or there may be separate markets for contracts from each unit of the Home Office. There is no need to come to a firm view on this as the competition issues are similar irrespective of the market definition adopted.

Custodial services

Custodial services are purchased by three units of the Home Office. Since the start of tendering HM Prison Service has tendered for 15 contracts, including DCMF (design, construction, management and finance) contracts and management-only contracts. Three management-only contracts were won by HM Prison Service so a total of 12 facilities are currently under contract (either management-only or DCMF) to private-sector firms. The Youth Justice Board has tendered three DCMF contracts to private-sector firms. Finally, six IND facilities are under contract to private sector firms. These are a mixture of management-only contracts and design, build and operate contracts that are financed by the public sector.

On the demand side, each contract let by the Home Office has a different set of specifications, so there is no substitute for a particular contract. The issue is competition for contracts.

On the supply side, there is a degree of substitutability between capacity available to meet contracts for the different types of unit. Similar firms are involved in tendering for HM Prison Service, IND and Youth Justice Board custodial contracts. There is also a self-supply alternative for custodial contracts as HM Prison Service can determine whether construction and management of a facility will be contracted out or whether it will be built and operated by the public sector. In the past, HM Prison Service has bid for and won management-only contracts. However, new facilities are currently commissioned using private finance only and HM Prison Service is not permitted to bid for such contracts. It has also made a policy decision not to allow HM Prison Service to compete against private sector firms for management only contracts. Therefore, HM Prison Service is not a credible future bidder for custodial contracts.

Geographic market

Some of the custodial and transportation contracts let by the Home Office are regional in nature, although this would just appear to indicate that the product specification has a geographic dimension rather than any geographic limitation on the location of potential suppliers. In fact, the firms bidding for UK-based contracts can be based anywhere in the world: many of the main bidders are US-based companies.

Horizontal issues

Current contracts for both transportation and custodial services are held by a small number of firms. The proposed merger will result in further concentration of this business. Although existing shares of supply do not necessarily provide a reliable guide to the existence of future competition in bidding markets, they may provide a useful guide to the relative strengths of competing bidders.

Regarding transportation and escorted services for the HM Prison Service, Group 4 currently holds the national contract and four of the eight regional contracts whereas Premier has two regional contracts. The merger would give Group4/Premier a combined share of supply of 78 per cent (by number of contracts). Regarding IND's transportation contracts, Wackenhut has two out of the three contracts.

The parties also hold a large number of contracts for the management of HM Prison Service, the IND and the Youth Justice Board facilities. They manage respectively 67 per cent, 83 per cent and 100 per cent of privately-operated facilities.

However, the aggregation of these contracts in the hands of the parties is unlikely by itself to allow them to exploit their existing position because there is limited opportunity to raise prices in the existing contracts. Rather, it is important to consider whether competition for future transportation and custodial services contracts will be lessened as a result of the merger.

Experience is a strong advantage in bidding for these contracts, and the competitiveness of bidding may be influenced by the number of experienced bidders. Post-merger, there will be only two firms other than the merged entity (see note 4) that have experience of fulfilling the requirements of each of the two types of Home Office contracts. For transport contracts, Securicor and Reliance each currently holds one of the regional HM Prison Service transport contracts. For custodial contracts, the two other existing contract holders are Securicor (with one facility) and UKDS (with one existing facility and preferred bidder status on two further contracts). The number of likely bidders for each type of contract will therefore fall from four to three and will bring together the two most experienced and successful bidders. HM Prison Service has also identified Correctional Services Corporation as a potential bidder but they have not been successful in winning any of the contracts they have bid for so far in the UK.

Although there are other potential bidders, past bidding history suggests that competition between Group 4 and Premier is an important competitive factor in this industry. Indeed, the Home Office expressed its concern that the merger would lead to a reduction of bidding competition. Absent rivalry between Group 4 and Premier, there is a possibility that competition for future Home Office contracts will be substantially reduced, particularly with regard to custodial contracts. Barriers to entry make it unlikely that new entrants will easily replace Premier as a competitor to Group 4. Finally, HM Prison Service was a bidder for management contracts in the past but is not now bidding for contracts against private-sector firms. Self-supply does not therefore appear likely to guarantee strong bidding for Home Office contracts.

Barriers to entry

Encouraging new bidders for custodial and transportation contracts has proved difficult. The cost of preparing a bid is substantial in comparison to the value of the contract. Some past bidders decided to withdraw because of their lack of success or because of the high bidding costs. Others, despite expressing an interest, withdrew at the pre-qualification stage. On several occasions, HM Prison Service has tried without success to encourage new bidders.

Given Group 4's and Premier's already detailed knowledge of the Home Office's custodial and transportation requirements, the merger may discourage entry by concentrating this informational advantage in the hands of one bidder. This informational advantage appears to be more important for transportation contracts than for custodial contracts. However, the Home Office could help new bidders overcome this barrier by giving them sufficient information to launch an effective bid. We were told that the Home Office has done this in the past to promote new entry.

The nature of the contracts may discourage some potential entrants. The transportation of prisoners and immigration detainees involves a different set of risks than other logistical transportation services and reputation risks are very high.

Buyer power

The Home Office is the only purchaser of transportation and custodial services for prisoners, immigration detainees and juveniles. However, despite an apparently strong bargaining position, its ability to utilise that buying power depends on the degree of competition between bidders and its ability to play off bidders against each other. The Home Office was concerned that the merger would eliminate one of the already small number of potential bidders for its custodial and transportation contracts, thus reducing bidding competition and its buyer power.

Vertical issues

No substantive vertical issues arise as a result of this merger.

Undertakings in lieu

The parties are ready to offer some behavioural undertakings to address any competition concerns. Their intention was to build up information exchange safeguards between WCC/Premier and the rest of Group 4. The following safeguard covenants agreed by the parties (see note 5) are intended to separate Group 4 from WCC's decision-making processes: (1) WCC board is to be composed of five directors independent of TWC and Group 4, which are entitled to a maximum of two each (see note 6); (2) no director or employee of Global Solutions (Group 4 subsidiary operating in the UK) is to be a WCC director; (3) neither Group 4 nor TWC is entitled to any directorship on a WCC subsidiary outside the US; (4) WCC management are to report to the WCC board and not via any member of Group 4 or TWC management; (5) Group 4 and TWC directors cannot access information on any business in which they compete with WCC; and (6) any Group 4 representative on the WCC board is subject to a strict confidentiality agreement.

The parties set up these safeguards under Florida state laws protecting minority shareholders to ensure that WCC and Group 4 Global Solutions operate as separate bidders. They have argued that these provisions could be formalised as undertakings in lieu of reference in the UK and would be sufficient to ensure that Premier and Group 4 remain separate bidders for Home Office contracts. The parties also explained that the same Florida legislation prevents them from divesting WCC's interest in Premier (see note 7). Considerations (see note 8) also prevent them from divesting TWC's 57 per cent stake in WCC at this time. Group 4 has told us that it intends to make such a divestment by the end of 2003 although there is no guarantee that this will happen.

We are concerned about the effectiveness and enforceability of the proposed behavioural undertakings. The complexity of the corporate relationships between TWC, WCC and Group 4 make it difficult to be certain that the proposed undertakings would clearly remedy the competition concerns. Further, behavioural remedies of the type proposed raise serious questions regarding monitoring and enforceability, especially as WCC is not based in the UK.

THIRD PARTY VIEWS

The Home Office (the parties' principal customer) was concerned by the transaction which it thought would have a negative impact on competition for future bids. Other third-party reactions were mixed. There was a general concern that the merging parties would have no, or at least less, incentive in the future to bid aggressively against each other, as they would continue to operate on the market with distinct identities but under the control of the same parent company (see note 4).

CONCLUSION

The merger would result in a substantial increase in concentration for the supply of transportation and custodial services contracts since Group 4 and Premier are leading suppliers of these services in the UK. It is by no means certain that the remaining credible bidders will be sufficient to maintain adequate bidding competition for future contracts. In addition, there is evidence that barriers to entry are substantial, and that new entry is difficult. There would therefore appear to be a clear possibility, requiring fuller investigation, that the merger would substantially lessen competition for future contracts. The Home Office, the principal UK customer, shares this concern.

The behavioural undertakings proposed by the parties are not sufficient for me to conclude that WCC/Premier will, in the future, operate independently from Group 4. Nor, given the parties' statements regarding structural remedies, have I been able to conclude that there are alternative structural remedies available that you might be able to seek from the parties in lieu of reference.

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

NOTES

1. The parties erroneously stated in the Merger Notice dated 15 March 2002 that Group 4 Falck A/S was listed on the New York Stock Exchange.

2. This term was taken from the parties' press release. They have since told me that, for the purpose of this advice, they consider that the term 'principal business' is more appropriate.

3. At the parties' request, it is pointed out that these figures include WCC's turnover and gross assets.

4. The parties have asked for it to be pointed out that only Group 4 and Premier are active in the UK.

5. The parties wish to stress that they negotiated and agreed these covenants in parallel with the merger agreement, i.e. prior to the merger notification.

6. The parties have, by way of clarification, pointed out that the covenant states that the majority (five of nine) of the WCC's directors are to be independent of TWC and Group 4 – Group 4 and TWC having only two directors each.

7. The parties have pointed out that it is not Florida law but the contractual safeguards secured by the WCC board that require a decision by the board in order to divest.

8. The nature of these considerations has been omitted at the parties' request.

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