Can consolidation create sustainable long-term value, or will it prove seductive but, ultimately, disappointing to shareholders, employees, customers, and management alike?
Do regulatory and economic trends favor industry mergers?
at FERC whose proposed combination otherwise would exceed the guidelines’ safe-harbor market concentration screens, typically have proposed to divest sufficient generating capacity to bring the transaction within these safe harbors to avoid a hearing. The stringency of the existing market-concentration screens, and the consequent divestiture requirement, has limited the scope of realistically viable merger combinations.
The proposed new federal merger guidelines make significant changes in the market concentration screens. Under the guidelines, mergers resulting in unconcentrated markets would pass the screens; mergers resulting in moderately or highly concentrated markets would exceed the screens if they cause significant increases in market concentrations as measured by the Herfindahl-Hirschman Index (HHI) (see Figure 1) . The new merger guidelines would revise the threshold for defining unconcentrated and concentrated markets and raise the level of HHI increases that can occur without exceeding the safe-harbor screening criteria.
If FERC adopts these new DOJ and FTC merger guideline standards, it will make a significant difference. 6 For example, the new guidelines would change the definition of an unconcentrated market from an HHI of 1,000 to an HHI of 1,500. According to FirstEnergy’s recent FERC filing, the post-merger HHI in PJM-wide energy markets currently would be below 1,000, except for two off-peak periods when it would be no higher than 1,029. This means that the FirstEnergy-Allegheny merger largely would pass the current safe-harbor market-concentration screens, but that any significant subsequent mergers in PJM may not, absent divestiture. However, under the revised market-concentration screens in the proposed new guidelines, some potential future transactions that would exceed the current screens might be able to obtain timely FERC approval without divestiture. Similar effects would be seen in other geographic markets.
Notably, because the FirstEnergy-Allegheny transaction would raise the market concentration level in PJM, this would reduce the headroom for subsequent mergers within PJM to fit under the market-concentration screens. Thus, as can be seen, there’s a first mover advantage to firms considering large mergers. It will be easier for them to consummate consolidations of generating assets than for subsequent merger applicants.
The new proposed guidelines are expected to be adopted sometime this year. If FERC amends its merger policy statement to mirror the new guidelines, this will facilitate merger regulatory review. Even if FERC doesn’t immediately revise its criteria, the more lenient standards in the new guidelines will permit merger applicants before the agency to argue for greater flexibility in approving merger proposals.
A second development affecting competition analysis can be seen in the Department of Justice’s recently announced final judgment regarding the KeySpan-Morgan Stanley swap. 7
The Justice Department charged that KeySpan violated the Sherman Act by entering into a financial hedge that gave KeySpan an incentive to exercise market power in the capacity market in New York City. Under this arrangement, KeySpan bought a financial derivative from Morgan Stanley, whereby Morgan Stanley paid Key Span a guaranteed revenue stream if prices rose above a specified value. It was alleged that this arrangement gave KeySpan, a pivotal supplier in the in-City market, the ability to profitably raise prices.
This recent DOJ