November 25, 2014 - For convenience, the full text of this article is below, or click here to view the article in our library.
Conclusion
Takeaways from Interview with Source Familiar with FTC’s Review. Given that Sysco is in advanced talks with a single buyer, Performance Food Group (PFG), a source familiar with the matter indicated that it is very likely that both staff and Bureau of Competition Director Deborah Feinstein have made positive comments to the parties regarding the overall contours of a proposed divestiture package.
Complexity Still a Hurdle. The source added that the complexity and cost of transferring customer and supply contracts continue to represent hurdles both to a deal between Sysco and PFG as well as to FTC clearance for Sysco/US Foods. Stakeholders should note that complexities around working out a deal more likely will contribute to questions on timing than on outcome. Complex details that still need to be worked out include: 1.) Transferring customer and supply contracts; 2.) The potential for renegotiation of contracts; and 3.) Data systems integration.
Reminder: Deal-making Posture at FTC Trumps Complexity. For stakeholders, the most important takeaway from recent developments appears to be that Ms. Feinstein has positioned the FTC in a deal-making posture rather than an aggressive, litigation-focused posture. Clearance of the Hertz/Dollar-Thrifty merger, despite subsequent criticism from the antitrust community, still holds up as a useful example of how even the most complex remedy packages can ultimately receive clearance at the FTC.
State AGs Still an Issue. Although both FTC staff and the front office may ultimately view a Sysco-PFG package as sufficient to transform PFG into a national competitor, the assets seemingly do little to address the concerns of investigating state Attorneys General. While state AGs are unlikely to significantly influence the Bureau of Competition’s decision making, state enforcers may continue to press Sysco to address state-level concerns regardless of the FTC’s ultimate disposition. State AGs will likely push for additional divestitures or state-level concessions, and are unlikely to sue independently of FTC action.
A Closer Look at Remaining Hurdles and Implications for Timing
Complex Negotiations. Although staff and the front office appear to have given implicit sign-off to the Sysco-PFG package’s broad contours, the nuts and bolts of actually winning ultimate Commission clearance will be extremely complex, and Sysco faces significant challenges in crafting the final package. In foodservice distribution, the ongoing customer business, rather than physical assets such as warehouses and trucks, drives profitability. To win ultimate staff and Commission approval, then, Sysco must transfer business, not merely physical assets. As Ken Davidson, a former FTC Compliance Division attorney told The Capitol Forum in an October interview, staff will likely require Sysco to position the divestiture buyer with a “flow through” arrangement that will immediately enable the buyer to match inventory supply with customer demand. This is especially challenging because Sysco is proposing to divest some, but not all, of US Foods’ assets.
The first issue is customer contracts. At the outset, Sysco and PFG, and ultimately FTC staff, must determine whether, and how, to transfer certain contracts to PFG to ensure PFG’s immediate competitive viability. A number of contracts that staff will push Sysco to transfer are likely non-assignable, and Sysco will therefore have to negotiate with individual customers to transfer service to PFG. This will be a time-intensive process, involving negotiations with a significant number of customers. Of course, if Sysco opens up customer contracts for re-negotiation, customers will have significant leverage, realizing that their consent to assignment, or lack thereof, could potentially hold up an $8.2b deal. And even customers whose contracts are assignable, aware that Sysco is re-negotiating contracts, may use the occasion to seek more favorable deal terms for themselves.
Customer contracts, however, are only one part of the equation—PFG will need supply contracts that position the firm to effectively fulfill its new customers’ requirements as well. These contracts must enable PFG to purchase competitively—and this is relative to an enlarged Sysco/US Foods that will be even better-positioned to drive down its own procurement costs. Although PFG has existing supply arrangements east of the Mississippi, it does not have such agreements on a national basis. With its newly increased scale, PFG may be able to negotiate new deals with its existing suppliers, or assume US Foods’ existing supply contracts under similar terms. But navigating this process will, at the very least, be a time-consuming ordeal.
Data systems are a final issue. Foodservice distribution is heavily dependent on ordering systems, both for managing DC inventory as well as customer ordering. In the process of taking a significantly enlarged footprint, PFG must somehow transition the divestiture DCs to its existing technology systems. Staff does not appear to view this as an insurmountable challenge. However, for Sysco and PFG to develop a workable integration plan will not be a quick or easy process. Both staff and Director Feinstein appear to view at least the proposed Sysco-PFG divestiture package’s broad outlines as sufficient to restore competition. In putting its proposal into action, however, Sysco faces a long, drawn out process fraught with numerous challenges. As Sysco negotiates with current US Foods suppliers and customers, as well FTC staff in the Compliance Division and elsewhere, stakeholders should, at the very least, expect a number of months to elapse between now and ultimate Commission sign-off.
State AG Concerns. Even if Sysco presents a divestiture package sufficient to drive Commission approval, the multiple state Attorneys General investigating the transaction represent an additional obstacle to close. While the FTC is primarily concerned with harm to national customers, state enforcers, including the Ohio, Florida, Indiana, Massachusetts, New York, Kansas and Tennessee AGs that are reportedly investigating Sysco/US Foods, are typically concerned solely with state-level issues. Although some state AGs appear to be participating in Sysco’s discussions with the FTC, those state AGs’ concerns do not appear to be totally aligned with the FTC’s. Specifically, the DCs Sysco reportedly proposes to divest to PFG, with at least some level of Bureau sign-off, are located west of the Mississippi, rather than in states with AGs investigating the deal.
While the FTC will accept state AGs’ input, at the end of the day, FTC staff will make an independent determination as to the divestitures necessary to address its concerns. Even if the Bureau eventually signs off on the PFG divestiture package, however, state AGs can continue to pursue cases and seek divestitures above and beyond what the FTC requires. In practice, state AGs investigating a merger in parallel with the FTC or DOJ will oftentimes close their investigations once the FTC or DOJ makes a decision, even if the federal enforcers’ conclusions do not fully address their concerns. That said, state AGs do retain the ability to challenge the Sysco/US Foods transaction in court. And with reports that divestitures are aimed at creating a new national competitor by enhancing PFG’s West Coast footprint, rather than addressing state-level issues in, for example, Ohio or Indiana, there is at least some risk that state AGs could push for additional divestitures. And although litigation is relatively unlikely, state AGs could even move to challenge the deal if Sysco is unwilling to negotiate.