China Law Insight : China Law Insight: China Commercial and Intellectual Property Lawyers and Attorneys, Full Service Law Firm: King & Wood

Relevant Market 

According to the Announcement, the relevant market is the worldwide HDD market. Although MOFCOM found that the HDD market could be further divided into narrower market segments based on the end use application (such as desktop computers, mobile computers), it considered the HDD market as a whole and carried out competition analysis only in the HDD market.

Competitive Assessment 

MOFCOM mainly considered the following factors in its analysis:

Market Structure. MOFCOM noted that the worldwide HDD market is highly concentrated with only five players, i.e. Seagate (33%), Western Digital (29%), Hitachi (18%), Toshiba (10%) and Samsung (10%), whose market shares are similar in China. It found that the HDD market is very transparent. Since the HDD products are homogenous and large computer manufacturers as the main downstream customers are relatively few in number, it is easy for HDD manufacturers to gain competitor’s information.

Purchasing Pattern. MOFCOM emphasized the importance of the current purchasing pattern on the maintenance of competition in HDD market. In order to ensure stable supply, large computer manufacturers procure through a confidential bidding process and split the order among two to four HDD manufacturers based on the competitiveness of their prices. This model incentivizes HDD manufacturers to compete for larger orders.

Buyers'Bargaining Power. MOFCOM found that large computer manufacturers generally will not oppose price increases and will instead shift such price burden to end consumers that have little countervailing buyer power. As pragmatic evidence, MOFCOM cited an example indicating how the recent price increases by Western Digital due to its impaired production by the floods in Thailand were passed on to end consumers.

MOFCOM also found that the capacity utilization rate of the HDD manufacturers are very high (90% in the fourth quarter of 2010), entry barriers are significant (no new entry into the worldwide HDD market in the past 10 years) and that innovation is quite important for HDD manufacturers to obtain competitive advantages.

Taking into account the above, MOFCOM was of the view that this merger will cause negative impact on Chinese consumers. It is likely to restrict competition by removing an important competitor from the market, undermining the effect the purchasing pattern has on bringing competitive pressures on HDD manufacturers and increasing the possibility of coordination among the remaining players considering the relative transparency of the HDD market.

Remedies
 
According to MOFCOM's decision, Seagate shall have the following obligations:

(1) Seagate shall adopt measures to keep Samsung's brand as a separate competitor, such as establishing an independent subsidiary for independent pricing and sales of Samsung products, creating firewalls to avoid information exchange etc.;

(2) Seagate shall keep its promise to expand the Samsung production capacity within six months of the decision, and reasonably determine and report the production capacity and volumes of Samsung's products thereafter;

(3) Seagate shall not materially change its current business model, forcing customers to buy HDDs exclusively from Seagate or its controlled entities;

(4) Seagate shall not force TDK (China) Investment Co. to supply magnetic pickup head for HDDs to Seagate or its controlled entities exclusively or restrict the quantity TDK sells to other HDD manufacturers; and

(5) Seagate shall invest at least USD800 million per year for three years in R&D.
 

It is interesting to note that Seagate is entitled to apply to MOFCOM for release of the first two of the above obligations after the elapse of 12 months from the date of the decision. MOFCOM will then decide whether to approve based on the market conditions.

Comments

The decision is the most comprehensive decision MOFCOM has published to date. Whereas MOFCOM still relies heavily on market share and market structure, it also takes in account a comprehensive set of factors as well as pragmatic evidence in its analysis.

Moreover, this deal was also notified in the U.S. and the EU. But MOFCOM is the only authority that has imposed remedies, showing that MOFCOM is getting increasingly independent in reaching its own decision. This raises another interesting issue: how and to what extent would antitrust authorities in different jurisdictions cooperate with each other in the face of a cross-jurisdictional merger filing if significant divergence is likely to happen?  

In relation to the remedies, it is also interesting to note that for the first time, MOFCOM included a periodic review clause in its clearance.  Western Digital/Hitachi, the other major transaction in HDD market, obtained conditional approval from the European Commission in November. MOFCOM may have considered that the Western Digital/Hitachi transaction and the divesture commitments made by Western Digital may eventually change the competitive landscape of the HDD market and therefore Seagate’s obligations may merit review at a later stage.

 1. A copy of MOFCOM’s Announcement [2011] No. 90 could be found here(in Chinese): http://fldj.mofcom.gov.cn/aarticle/zcfb/201112/20111207874274.html
 
2. The Extended Phase II lasted 62 days in this case.The statutory Extended Phase II should be 60 days; however, since the last day of the review period was a Saturday, MOFCOM extended the period for another 2 days.

Parties and Transaction. The proposed transaction was announced as early as January, 2011 as part of President Hu Jintao's state visit to the United States ³.  GE China and CSCLC are to establish a 50/50 JV mainly to license coal-water slurry (CWS) gasification technology to industrial and power projects in China. GE Infrastructure Technology, another subsidiary of GE will license GE's CWS gasification technology to the proposed JV.

The parent company of CSCLC - Shenhua Group Corporation Limited (Shenhua Group) is a State-owned mining and energy company in China. Its core businesses include production and supply of coal, electricity and heat, as well as rail and port transportation services.

Relevant Market. MOFCOM paid close attention to the market in which the proposed JV will be active, and found that this transaction might exclude or restrict competition in the CWS gasification technology licensing market. Considering the significant differences between CWS gasification technology and other coal gasification technologies, MOFCOM was of the view that CWS gasification technology licensing market constitutes a separate relevant product market.

Since the propose JV will only be active in China and the Chinese licensees only acquire such technology on the China market, MOFCOM found that the relevant geographic market is China.

Competitive Assessment. Apparently, market share, market concentration level and market entry are still the major factors MOFCOM considered in its competitive assessment process.

MOFCOM indentified that China's CSW gasification technology licensing market is highly concentrated with only three major players – CWS gasification technology provided by GE Infrastructure Technology, multi-nozzle-mounted CWS gasification technology jointly developed by Yankuang Group and East China University of Science and Technology, and multi-component slurry gasification technology provided by the Northwest Research Institute of Chemical Industry. It was noted by MOFCOM that GE's CWS gasification technology has the highest share in this market.

MOFCOM further looked into an adjacent market involved in this transaction. Since CWS gasification technology has specific requirements for the properties of the raw coal, operators of CWS gasification projects need to have a reliable supply of the specific coal. MOFCOM noted that in 2010, Shenhua Group was the largest supplier of raw coal that is suitable for CWS gasification projects.

MOFCOM also found that there are significant barriers for entry into the CWS gasification technology market due to the complexity of the technology, high investment cost, existing IP rights and long R&D and industrialization cycles. 

In light of the above, MOFCOM concluded that the proposed JV is likely to restrict competition in the CWS gasification technology market by making use of the dominant position of Shenhua Group in the raw coal market.

Remedies.  In order to solve the competition concerns, MOFCOM requested CSCLC and Shenhua Group not to compel licensees of CWS gasification technology to use JV's technology by restraining the supply of raw coal, or by conditioning such supply on licensing of JV's technology, nor to raise the cost of such supply for those using other technologies.

Comments
 
There are a few points about this decision that are worth mentioning. As mentioned above, it is the first conditional merger control decision where an SOE is involved. If read together with the recent antitrust probe of China Telecom and China Unicom by the National Development and Reform Commission⁴, it appears that contrary to protectionism accusations from overseas, Chinese antitrust enforcement agencies are indeed increasing their antitrust scrutiny of SOEs.

It is also the first conditional clearance of a joint venture project. Whether JV is caught by China's merger control regime is not expressly stipulated in the AML. However, based on our experiences, MOFCOM considers joint ventures to be a type of notifiable transactions under the AML. This decision officially affirmed MOFCOM's position in this regard.

Furthermore, this is the first time MOFCOM defined a technology licensing market. This decision (as well as the previous decision on Alpha V/Savio deal) has become more detailed in terms of competitive analysis. It is also interesting to note that MOFCOM imposed behavioral remedies in this case after it requested divestiture in the Alpha V/Savio case. All these suggest that MOFCOM is getting increasingly sophisticated and holds a flexible and pragmatic approach towards merger remedies.

1. See our article entitled MOFCOM's 8th Conditional Clearance - Alpha V/Savio Deal.    

2. A copy of MOFCOM's Announcement [2011] No. 74 could be found here (in Chinese): http://fldj.mofcom.gov.cn/aarticle/zcfb/201111/20111107824342.html.

3. See the press release of the deal on GE's website:

http://www.genewscenter.com/Press-Releases/GE-and-Shenhua-Announce-Formation-of-Cleaner-Coal-Technology-Joint-Venture-in-China-2ddd.aspx.

4.See our article entitled Earlier Rumor Confirmed: China Telecom and China Unicom under Antitrust Investigation  on details of this incident.

Parties. The acquirer, Alpha V is a private equity fund, whose investments mainly relate to non-ferrous metal recycling, supply of household textile, and production and supply of textile machinery.  Specifically, Alpha V holds 27.9% shares of Uster Technologies Ltd (Uster),the global leader in textile testing and quality control machines. 

The target, Savio, is a manufacturer of textile machinery, and its main products include automatic cone winders, yarn clearers, rotor spinning machines, and double twisters. 

Relevant market. MOFCOM found that Uster and Leopfe (a wholly-owned subsidiary of Savio) are the only two suppliers of yarn clearers in the world. Since there are no other machines that are substitutable, MOFCOM considers that yarn clearer is the relevant product market here. In the yarn clearer market, Uster has 52.3% market share of the global market while Leopfe has the remaining market share. Their performance in China largely resembles their performance in the global market. 

MOFCOM did not specify the relevant geographic market but indeed looked into both the global market and the China market.

Competition concerns. MOFCOM paid a lot of attention on whether Alpha V may influence Uster's operations and management.  For this purpose, MOFCOM reviewed, among other things, Uster's shareholding structure, voting mechanism of the shareholders' meetings, meeting minutes of the shareholders meetings, composition and the voting mechanism of the board of directors.  After the review, MOFCOM decides that it can not rule out the possibility that Alpha V may influence Uster's operations.

In light of the above, MOFCOM considers that after the transaction, it is likely that Uster and Leopfe can coordinate with each other through Alpha V to restrict and/or eliminate the competition in yarn clearer market; on the other hand, it is also likely that Alpha V can restrict and/or eliminate competition through its control and/or influence over Uster and Leopfe. 

Barriers to entry. In order to fully assess the potential anti-competitive effects of the transaction, MOFCOM also carried out a detailed study of the barriers to entry in the yarn clearer market. The result shows that there are significant entry barriers to new entrants due to the existing IP rights, importance of the economies of scale, and customer recognition.  MOFCOM specifically notes that there has been no successful new entrant for the past three years. 

Remedies. In light of the above, MOFCOM was of the view that the transaction is likely to restrict or exclude competition in the yarn clearer market. In order to counter these anticipated anti-competitive effects, MOFCOM imposed the following four conditions on Alpha V:

(1) Alpha V shall divest its shares in Uster to an independent party within 6 months upon MOFCOM's approval of the transaction;

(2) Alpha V shall notify MOFCOM of the transferee of the shares of Uster, the transaction amount, and the estimated closing date of the transaction, to make sure such transfer would not raise any new competition concerns;

(3) Alpha V shall not participate in or influence Uster's operations and management before completion of the divesture process; and

(4) Alpha V shall entrust a monitoring trustee to supervise the divestiture.

Comments

This is the first conditional clearance decision MOFCOM issued after the promulgation of the Interim Rules on the Assessment of the Impact of Concentrations on Competition (see our article entitled MOFCOM's New Antitrust Rules Shed Light on Its Competitive Assessment Process).  In line with the Interim Rules, in its competitive assessment process, MOFCOM considered, in particular, market shares, market structure, market entry, and examined both the unilateral effects and coordinated effects that may arise from the transaction.

The most notable issue in this case is MOFCOM's reading of Alpha V's potential influence in Uster's operations through its minority interest. It appears to be the major reason underlying MOFCOM's concern over this Transaction and MOFCOM appears to consider that this concern can only be properly addressed by divestiture of Alpha V's entire interest in Uster.  The fact that the relevant market is a highly concentrated oligopoly market may partly explain MOFCOM's approach. The takeaway for funds with portfolio companies is that even if they believe they do not have control over portfolio companies in which they only hold a minority interest, MOFCOM may think otherwise.    

It is also interesting to note that MOFCOM did not specify whether the geographic market in this case is worldwide or China-wide. In practice, MOFCOM would look into both the global market and China market, and would require the parties to provide the market data of both.

 
According to the announcement, during the review process, MOFCOM sought opinions from the following third parties: government agencies, trade associations, competitors, downstream undertakings and industry experts.

For a more detailed analysis of MOFCOM's decision, please see our article entitled MOFCOM's 8th Conditional Clearance – Alpha V/Savio Deal.
 

¹A copy of MOFCOM's Announcement [2011] No. 73 could be found here (in Chinese):  http://fldj.mofcom.gov.cn/aarticle/zcfb/201111/20111107809156.html.

According to Mr. Shang, from 1 August 2008 (when the Anti-Monopoly Law was enacted) till the end of May 2011, the Anti-Monopoly Bureau of MOFCOM cleared 240 merger control filings, among which 233 (97%) were approved without conditions, 1 rejected, and 6 were approved with conditions.  [Note: On 2 June 2011, MOFCOM announced that a transaction between two Russian potash producers was cleared with conditions, bringing the conditional clearance figure from 6 to 7 (see our article entitled The Russian Potash Deal - first conditional clearance of 2011)].

During the Symposium, Mr Shang also said that amongst these 240 cases, 119 cases (about 50%) were cleared before or by the end of the Phase I review period (30 calendar days); and 117 cases (about 49%) were cleared before or by the end of the Phase II review period (90 calendar days).  Only 4 cases entered the extended Phase II review period (which spans for a maximum of an additional 60 calendar days).

Some Historic Data

• By the end of June 2009, MOFCOM accepted 58 merger control filings, among which 46 were closed without conditions, 2 closed with conditions and 1 prohibited.
• By the end of June 2010, MOFCOM accepted about 150 merger control filings, among which 120 were closed without conditions, 5 closed with conditions and 1 prohibited.
   

• MOFCOM officially accepted the Parties' merger control submission on 14 March 2011.  This filing entered into Phase 2 review on 12 April 2011.  MOFCOM decided to clear this transaction with conditions on 2 June 2011.
• During the merger control review, MOFCOM requested that the Parties submit the following information:  information to do with overlaps in relation to the types of quantity of potash products produced by the parties; information to do with pricing and the sales model of both parties; market share information (both Chinese and worldwide market shares); information to do with the potash industry.
• MOFCOM sought opinions from the following third parties: government departments, trade associations, suppliers, traders and industry experts in order to obtain a better understanding of the relevant products, distribution of potash, market definition, market structure as well as the production, operation and trading patterns of the potash industry.
• MOFCOM held that the relevant product market was the market for potassium chloride.   MOFCOM took into consideration that China is one of the largest importer of potassium chloride in the world, relying on import for nearly 50% of its domestic consumption.  MOFCOM  further noted that more than 50% of China's import of potassium chloride is derived from Uralkali, Silvinit and their affiliates. 
• MOFCOM noted that potassium chloride is a natural resource concentrated in a few jurisdictions.  The top 3 potassium chloride jurisdictions in the world possess more than 80% of the world's potash resources.  Global production and sales of potassium chloride are concentrated in the hands of a few companies.  The Parties' concentration would result in the world's second largest export supplier of potassium chloride.  The Parties' combined global market share will exceed 1/3 of the world's supply of potassium chloride.

MOFCOM was of the view that the transaction is likely to restrict or exclude competition.  In order to counter these anticipated anti-competitive effects, MOFCOM has imposed the following four conditions on the Parties:

a) the combined entity should continue to maintain its current sales practices and procedures.  The combined entity should continue to supply potassium chloride to China via direct trade.  In addition, the combined entity should continue to channel potassium chloride to China via rail or sea in a reliable and diligent manner;

b) the combined entity should continue to meet China's demands for potassium chloride (both in terms of volume and range of potassium chloride products), including potassium chloride containing 60% and 62% of potassium oxide.  In addition, the combined entity should continue to supply its customers in China the types and quantities of potassium chloride required for a variety of uses, including for agricultural use, industry use and "special industry" use;

c) in relation to price negotiations with Chinese customers, the combined entity should keep to the usual consultation processes (including taking into account the history of customer transactions and the unique features of the Chinese market).  The usual negotiations, including price negotiations in relation to spot trading or trading by contract (six months or a year) should apply;

d) every six months (or upon request), the combined entity should report to MOFCOM that it has complied to this list of conditions and commitments.  MOFCOM possesses the power to supervise and inspect the implementation of the above restrictive conditions.  MOFCOM also has the right to impose sanctions on the combined entity, should it fail to adhere to any of the above conditions.

Comments

The four conditions listed above are behavioral conditions drafted in very broad terms.  This leaves a lot of scope for MOFCOM to interpret these conditions as they see fit going forward. 

It is clear that the objective of these conditions are to ensure the stability of the adequate supply of potassium chloride into China. 

It is interesting to note that while MOFCOM has determined product market definition, they did not express a view on geographic market definition – however, in MOFCOM's decision, there are many references to the global nature of the potassium chloride industry – thus it is likely that MOFCOM analysed the deal from a global perspective.

Pursuant to the AML, if the combined entity does not adhere to the conditions listed above, they are at risk of facing a range of sanctions including: a fine of not more than RMB500,000; orders to cease implementing the transaction; and orders to divest within a stipulated period.
 

 Before the promulgation of the State-owned Assets Law, the Interim Regulations on Supervision and Administration of Enterprise State-Owned Assets ("Interim Regulations"), a set of administrative regulations promulgated by the State Council on May 27, 2003, had been the regulations governing state-owned assets with the highest authority since the establishment of the State-owned Assets Supervision and Administration Commission under the State Council ("SASAC") in 2003. The promulgation of the State-owned Assets Law fills the gap of state-level legislation on state-owned assets in China's legal regime and formalizes the mandatory administration and regulation of state-owned assets in China.

The promulgation of the State-owned Assets Law did not draw much attention compared with the Property Rights Law, which attracted extensive academic discussions, or compared with the Anti-monopoly Law, which caused panic among the industrial oligarchs. One of the reasons for such a subdued public reaction is that the State-owned Assets Law mainly focuses on summarizing existing regulations and rules regarding the administration of state-owned assets. It is silent on matters that the public is concerned about, such as the supervision of offshore state-owned assets and executive compensation at state-owned enterprises ("SOEs"). Nevertheless, the State-owned Assets Lawis important because it recapitulates the SOE reform and development of the last three decades. The law also amalgamates old regulations and suggests future directions for the administration of state-owned assets.

Impact on Mergers and Acquisitions by Foreign Investors

The separation of management and ownership in modern corporate structures is a persistent headache for SOEs and the state-owned equity and assets management system. The government management mechanism, which combines the ownership of macro-control and administrative power over state-owned assets, also causes problems. Furthermore, administrative regulations and rules regarding state-owned assets are of a lower jurisdiction than laws and are often enacted by different authorities. Such practicalities have made these regulations and rules inconsistent and inoperable. For these reasons, when merging or acquiring an SOE, foreign investors or private equity funds are often overburdened with complicated approval procedures with two or more authorities, even those that may not have the proper legal authority. Foreign investors and private equity funds are also concerned about the potential difficulties in restructuring the SOE upon merger or acquisition due to the intervention of the government, and therefore, tend to avoid or react negatively to the acquisition of SOEs.

The State-owned Assets Law improves the supervision of state-owned assets by refining the rules for SOE reforms, related party transactions, appraisal, and transfer of state-owned assets. The State-owned Assets Law also clarifies the responsibilities of SASAC and its local branch offices, and prohibits(10) the state-owned assets investor's interference with the operation of SOEs. All of these changes may increase the attractiveness of SOEs as acquisition targets for foreign investors.

For further insight, please read the full article, located here.