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Private Equity: A new enforcement priority for the UK competition & markets authority?


Increased scrutiny of private equity investment is firmly on the radar of US antitrust enforcers. Both the Federal Trade Commission (FTC) and U.S. Department of Justice's Antitrust Division (DOJ) have expressed concern, through various speeches, interviews and their own cases, over the degree of leverage and market power that private equity firms have, in their view, amassed in certain sections of the US economy.

Here in the UK, the Competition & Markets Authority (CMA) has thus far taken a broadly neutral stance to the ownership of parties involved in its investigations (whether that be a trade buyer, private equity fund or other financial investor). However, recent comments made by the CMA's Chief Executive, Sarah Cardell, at the Spring 2023 Enforcers Summit in Washington D.C. suggest the dial may be shifting. In the M&A space, Cardell made clear that 'roll up' acquisitions (whereby private equity firms buy up, and merge, multiple smaller or independent players in the same industry to benefit from economies of scale and valuations at higher multiples) will, consistent with enforcement priorities in the US, "come in for very close scrutiny" here in the UK.

Cardell's comments are the strongest to date on the CMA's approach to the growth of PE investment in the UK economy. They follow questions posed by a government committee back in July 2021 to the then CMA Chief Executive over whether the CMA had sufficient ability to investigate acquisitions of high street brands by private equity firms.

In this briefing we discuss the metrics used to inform the CMA's approach to private equity investment in recent years. We then consider whether there has in fact been a shift in the competition-law risk profile of PE investment in the UK already, or whether the position has remained business-as-usual so far.

In brief, Cardell's comments, and the recent enforcement action taken by the CMA, certainly appear to signal a warning shot to the private equity industry that their actions are under scrutiny from a competition law perspective. Ultimately, however, the CMA's competition and merger control functions are based on competition-related tests and, in this respect, PE deals are subject to the same rules as any other owner or investor. Nevertheless, the CMA's flexible tools mean that it would be prudent for the industry to anticipate some prioritisation of PE activity in the way in which the CMA focuses its resources, at least in the short term.

Leveraged equity 

So where does the CMA's debate over private equity begin? The answer lies in its 'market studies' work: i.e. its ability to investigate whole market sectors that do not appear to be working well for consumers. In two such studies the CMA expressed concerns over the prevalence of highly-leveraged PE business models and the way in which high debt may impact the resilience of particular industries.

The CMA's 2021 market study into children's social care referred to high debt levels, with PE owned providers having "particularly high levels". The CMA considered this level of indebtedness, all else being equal, "likely to increase the risk of disorderly exit of firms from the market". However, when assessing traditional indicators of competition, in this case prices and profits, the CMA did not find strong evidence of any systematic difference between PE and non-PE owned providers.

Perhaps unsurprisingly, given the proximity in time to the 2021 market study, a recent (March 2022) economics working paper, co-authored by the then CMA Chief Executive Andrea Coscelli, highlighted a shift over the past decade to more highly-leveraged capital structures: a shift which the CMA views as having been accelerated by the growth of private equity acquisitions during the pandemic. In Coscelli's view, higher leverage is generally likely to make businesses more vulnerable to changes in their trading climate, leading to more firm failures.

The CMA's concern over PE leverage is relatively new. When conducting a market study of the UK care homes sector back in 2017, the CMA found debt levels to be "not particularly high" and that PE owned providers were not taking on particularly higher debt levels than other providers. However, the views later expressed in Coscelli's 2022 paper appear to take a different view: referencing the failure of PE owned Southern Cross (the UK's then-largest care home provider). In the CMA's view, Southern Cross had entered into 'sale and leaseback' arrangements in the early 2000s that had led it to become highly leveraged and less resilient to changes in trading conditions.

For each of these studies, it is worth highlighting that the CMA's role was to assess the markets in question through the lens of the 'customers' they serve. In each case, the studies focused on some of the most vulnerable in society, and therefore the consequences of disorderly failure were, in the CMA's words, "particularly severe".

In any event, neither study resulted in action against PE owned businesses (or indeed any business) on the basis of leverage. By way of example, the findings over debt levels in the children's social care market were dealt with by recommendations to introduce monitoring and contingency plans for market exit.

So how do these concerns over leverage and resilience feed into Cardell's recent comments on the CMA's priorities, if at all?

Merger Control: Roll-up, Roll-up

Cardell's recent comments centre on the CMA's powers to investigate M&A activity and to remedy any harm to competition arising from a particular transaction. Their focus is the impact of 'roll-up' deals in consumer facing markets. Cardell's comments appear to stem from a number of ongoing merger investigations by the CMA into transactions in the UK veterinary space. Multiple cases have been opened into completed deals by IVC (Independent Vetcare Limited) and Medivet, both under private equity ownership. The CMA has highlighted the acquisitive nature of private equity, increased consolidation in the veterinary industry (with a reduction in the number of independent players) and increased vertical integration.

The particular nature of the UK's merger control regime affords the CMA significant discretion to investigate so-called 'roll-up' and 'bolt-on' deals. Regardless of the level of target turnover, the UK 'share of supply' test enables the CMA to take jurisdiction over transactions where the purchaser group and target have a combined share of 25% or more of any plausible description of goods or services in a 'substantial part of the UK'. The CMA is not required to follow a formal market definition analysis in delineating the set of goods or services to be considered. The CMA is also afforded a wide discretion in setting the relevant geographic boundaries: in the IVC cases, its 'local area analysis' found that areas with a population of no less than 100,000 people represented a 'substantial part of the UK' for the purposes of the CMA's jurisdiction. Cardell's comments should therefore be taken as a firm indicator as to the CMA's likely action going forward.

It is also worth noting that the CMA, in the IVC cases, considered whether different market players should be given different weighting in its analysis, depending on the competitive constraint that they pose in practice. Whilst these comments were not targeted at private equity owners per se, they serve as a useful reminder that deal makers should remain cognisant of the state of wider competition in an industry when considering the CMA's likely interest in a given deal.

Coming back to leverage: debt levels do not feature as a driver in the documents published to date in the veterinary cases. However, it is worth noting that whilst a failure of a portfolio business may well impact competition in its given market, the CMA can only take action under its competition-focused merger control powers if it is demonstrated that the transaction in question would lead to a substantial lessening of competition in one or more markets in the UK. In practice, in order to intervene in a transaction solely on leverage concerns, the CMA would likely need to show that:

  • The levels of debt being taken on as a result of the transaction are such that the target would be likely to fail post-merger; or

  • At least, that the target's financial position would be affected to such a degree that it would likely become a significantly weaker competitor (for example, because it would not be able to make significant investments of the kind needed to continue to be an effective competitor).

As acknowledged by the CMA, it is difficult to assess at the time of a merger whether 'high gearing' would affect a target’s competitiveness (and over what time frame): and even more difficult to evidence this to the requisite legal standard. The extent to which the CMA is likely to intervene in an M&A deal on the basis of high leverage is therefore limited, although cannot be ruled out.

Leverage may, however, potentially play a role in another aspect of the CMA's mergers work: divestitures. The CMA's Remedies Notice (CMA87) highlights the importance of a divestiture package continuing to develop as an effective competitor. It states that a "highly-leveraged acquisition of the divestiture package which left little scope for competitive levels of capital expenditure or product development is unlikely to satisfy" the test for an appropriate purchaser. Nevertheless, a divestiture package is yet to be formally turned down on the basis of a PE acquiror identity, and the CMA would of course be required to substantiate any concerns over a particular divestment purchaser in a given case.

Liability for competition law breaches: UK CMA follows EU hard-line

Moving away from the transactional space, the CMA's recent moves to attribute liability to PE owners for competition law fines imposed on their portfolio companies are also noteworthy. As discussed in our earlier briefing, the private equity industry is now acutely aware that regulators may seek to impose liability on private equity firms for infringements of competition law by their portfolio companies – even where they had no knowledge of, or involvement in, the offending behaviour and even if the portfolio company concerned had been sold years before the infringement decision is reached and fines imposed.

At the EU level, the well-publicised Goldman Sachs (GS)/Prysmian case led to the imposition of a €37million fine on GS for the conduct of Prysmian, its former portfolio company, in participating in a market sharing and customer allocation cartel. Prysmian was acquired by GS private equity funds in 2005, but was divested several years before the European Commission's 2014 decision (although the Commission's dawn raid of Prysmian took place in 2009, around a year before GS' final exit from the investment).

Here in the UK, the CMA has reached three antitrust decisions (Hydrocortisone, Liothyronine and Prochlorperazine) for the first time imposing liability on private equity firms for competition law infringements committed by former portfolio companies during the period of ownership. Each relate to the pharmaceutical sector, in which the CMA has been very active in recent years.

Taking the example of Liothyronine, fines totalling £60 million were imposed on two successive private equity owners for the conduct of a portfolio group, Mercury Pharma. Mercury Pharma was divested from PE ownership a period of 6 years before the CMA's infringement decision and, in contrast to the GS/Prysmian case, a full 2 years before the former PE owners were contacted by the CMA about the competition investigation.

The traditional approach to parental liability in UK and EU competition law typically follows the chain of ownership from a directly infringing subsidiary, through intermediary holding companies and up to an ultimate owner. However, private equity fund structures do not easily lend themselves to such an approach. The CMA has thus demonstrated its appetite to look beyond complex structures and ownership chains in attributing liability to private equity structures.

The CMA's analysis rests on the PE owners having exercised 'decisive influence' in practice over the infringing portfolio group, even if they did not hold the entirety (or even near entirety) of the shares or voting rights. 'Decisive influence' was found on the basis of a number of factors, including control rights under a shareholders agreement to appoint and remove directors, veto rights over the budget, oversight of the portfolio group's commercial conduct and fragmented ownership stakes of other shareholders.

Whilst the CMA does not find that the relevant PE owners participated directly in the infringement (and nor, on its case, does it need to), the CMA does take the view that the PE owners' strategy for the portfolio group contributed to the price increases which formed the basis for the competition law infringement:

"[its] ‘active’ and ‘engaged’ ownership; its ‘targeted, systematic and on-going’ operational input; its instigation of ‘the transformative merger’ of two corporate groups; its success in generating a very substantial profit drawing on its knowledge of the pharmaceutical sector and in particular its understanding of the opportunities presented by the ‘little jewellery boxes’ of ‘unloved’ niche generic drugs such as Liothyronine Tablets, demonstrate that it was no pure financial investor."

So where does this leave private equity firms in the eyes of UK antitrust enforcers?

Arguments that PE investment equates to pure financial investment will likely face significant push-back when it comes to the CMA (or indeed other European competition authorities). The CMA has demonstrated its appetite to pierce the corporate veil on the basis of its view that "holding a parent jointly and severally liable with its former subsidiaries in these circumstances ensures that it and others like it take more care with their investments, in whatever sector, in future". However, this reasoning has been widely criticised in its application to financial investors, mainly because it does not rely upon any allegation or proof of wrongdoing on the part of the investor and, hence, "taking more care" would not appear to address the CMA's concerns.

Each of these cases is currently being appealed to the UK Competition Appeal Tribunal. However, for the time being at least, most private equity firms with majority investments, and certainly those with a significant stake and seats on the board, should proceed on the basis that they may well be assumed by the CMA to have 'decisive influence'.

Importantly, both the investor and the portfolio company would hold the primary responsibility to pay the fine. It is not the case that the private equity house would only have to step in to pay the fine where its portfolio company is unable to do so. Further, the actual burden of where a fine falls can be uncertain. Indemnity arrangements may, or may not, have been put in place for a specific investment  – and, where the relevant portfolio company is a former investment, any such indemnity to the benefit of the investor may have ceased to apply.

A new enforcement priority, or business as usual?

Cardell's comments, and the recent commentary and enforcement action taken by the CMA, certainly appear to signal a warning shot to the private equity industry that their actions are under scrutiny from a competition law perspective.

In the M&A space, PE firms should be acutely aware that the CMA will not hesitate to probe their 'roll-up' acquisition strategies, in particular in industries where competition may be increasingly concentrated in a smaller number of players. In assessing the risks of an acquisition, the totality of a PE firm's deals in a particular industry should be considered and the CMA's flexible 'share of supply' test borne in mind.

Ultimately, however, the CMA's merger review functions are based on competition-related tests. And, in this respect, PE deals are subject to the same rules as any other owner or investor. Any concerns, for example over the leveraged nature of PE business models, may come increasingly into play, but these will need to be viewed (and proven by the CMA) in terms of their impact on competition. Wider scrutiny of PE business models in the context of market studies or market investigations would be open to the CMA, although these have focused to date on sectors serving particularly vulnerable sections of society. That said, Cardell's comments certainly indicate some prioritisation of PE activity in the way in which the CMA focuses its resources, at least in the short term.

Once an acquisition is made, PE owners should bear in mind that (for most majority – or even significant minority – investments) the CMA may well seek to find the private equity house liable for any breaches of competition law by the portfolio business. The CMA's antitrust enforcement provides a reminder of the importance of funds taking steps to mitigate the antitrust risk of their investments. 

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