Category: mergers & acquisitions

Why Sen. Warren is Wrong on Trust-busting Big Ag

Several Democratic presidential candidates courted rural voters in Iowa at last weekend’s Heartland Forum. Both Sen. Amy Klobuchar (D-MN) and Sen. Elizabeth Warren (D-MA) decried the plight of farmers, with Warren promising trust-busting policies to break up Big Ag. But Warren’s call for aggressive antitrust is more populist politics than sound economic policy.

Warren claimed that, “A generation ago, 37 cents out of every food dollar went into a farmer’s pocket. Today, it’s 15 cents. And one of the principal reasons for that has been concentration in agribusiness. You’ve got these giant corporations that are making bigger and bigger profits for themselves, for their executives and for their investors, but they’re putting the squeeze on family farms.” But there are several problems with that argument.

First, the farmer’s share of the food dollar is a pretty worthless measure of how well-off farmers are in the food economy. From an economic perspective, it is completely meaningless. In response to the perennial reactions by farmers’ lobbies to the USDA’s “Farm Dollar” report in 2018, Jayson Lusk provided a nice example of how focusing on farmers’ share of the food dollar actually can lead to very poor conclusions. Even more to the point, Gary Brester, John Marsh and Joseph Atwood demonstrate what agricultural economists have long understood:

“[S]ome have argued that decreases in FS (farmer share) statistics…are indicators of anti-competitive behavior in the food processing industry. Agricultural economists have long noted that such relationships cannot be justified on theoretical grounds. … We have empirically demonstrated that FS statistics and, by construction, farm-to-retail marketing margins, are not reliable measures of changes in producer surplus (welfare)… Consequently, these data should not be used for policy purposes.”

Brester, et al., “Evaluating the Farmer’s-Share-of-the-Retail-Dollar Statistic,” 34 Journal of Agricultural and Resource Economics 213 (2009)

Second, even if one could make any reasonable inferences from the farmers’ share numbers, they do not support the story Warren is trying to sell. While farmers’ share of the food dollar has declined over the past 24 years, the decline is not near as big as Warren suggests: from 16% to 12% of the real (2009) dollar value of domestic food sales, as shown in the nearby Table 1. But a closer look at the numbers reveals what is driving the overall decline: when people eat away from home, the share of the dollar that goes to the farmer is much smaller, because more of the dollar is going to the people that add additional value by processing and preparing the food away from home. And eating away from home has become more and more prevalent.

Table 1: Farmer Share of Total Domestic Food Dollar, 1993-2016

Truth be told, the microcosm of food eaten at home or away from home illustrates the larger issue: as consumers choose foods that have been further processed and prepared, more of the dollar goes to the people that add the additional value in the form of preparedness, packaging, convenience, etc., that consumers value. That’s why, over the last century, the farmers’ share of the food dollar has dropped from near 50% to only 12%.

But what about the big bad ag companies that Warren blames for this problem? Doesn’t the consolidation of Big Ag share some of the blame? Warren blames mergers of companies like Bayer-Monsanto on the farm inputs side or large multinationals like JBS on the farm output side for squeezing farmers’ share of the food dollar. What about them?

As it turns out, firms in the farm inputs industry (like Bayer or Corteva (the offspring of Dow-Dupont)) and firms in the food processing industry (like JBS or Tyson) also have seen their share of the food dollar decline, as shown in the nearby Table 2. For farm inputs, the share has dropped over 40%, even more than the farmers’ share; and food processing companies’ share has dropped over 20%, almost as much as farm shares. Not even the banking industry, another of Warren’s favorite regulatory targets, has seen an increase in its share of the food dollar. In fact, the only food industry segments experiencing any appreciable increase in food dollar share are retail sales and food service–again, where more of value-adding convenience and food preparation are being contributed.

Table 2. Share of Domestic Food Dollar by Industry Segment, 1993-2016

Antitrust is currently seeing a lot of renewed interest in political circles because big, bad corporations make easy populist political targets. And it may be true that increased concentration in some industries could stand more antitrust scrutiny, possibly even in agriculture. But broad antitrust enforcement is a very blunt, and potentially dangerous, policy tool that shouldn’t be invoked carelessly. Nor with as little understanding of an industry as Sen. Warren appears to have of the food system.

 

Innovation trends in agriculture and their implications for M & A analysis

This is a repost from the Mergers in Ag-Biotech blog symposium over at Truth on the Market. If you’re interested in more perspectives on the topic, I encourage you to read the other posts there.  If you’d like to comment, please do so on the TOTM version so it’s part of the general discussion.

The US agriculture sector has been experiencing consolidation at all levels for decades, even as the global ag economy has been growing and becoming more diverse. Much of this consolidation has been driven by technological changes that created economies of scale, both at the farm level and beyond.

Likewise, the role of technology has changed the face of agriculture, particularly in the past 20 years since the commercial introduction of the first genetically modified (GMO) crops. However, biotechnology itself comprises only a portion of the technology change. The development of global positioning systems (GPS) and GPS-enabled equipment have created new opportunities for precision agriculture, whether for the application of crop inputs, crop management, or yield monitoring. The development of unmanned and autonomous vehicles and remote sensing technologies, particularly unmanned aerial vehicles (i.e. UAVs, or “drones”), have created new opportunities for field scouting, crop monitoring, and real-time field management. And currently, the development of Big Data analytics is promising to combine all of the different types of data associated with agricultural production in ways intended to improve the application of all the various technologies and to guide production decisions.

Now, with the pending mergers of several major agricultural input and life sciences companies, regulators are faced with a challenge: How to evaluate the competitive effects of such mergers in the face of such a complex and dynamic technology environment—particularly when these technologies are not independent of one another? What is the relevant market for considering competitive effects and what are the implications for technology development? And how does the nature of the technology itself implicate the economic efficiencies underlying these mergers?

Before going too far, it is important to note that while the three cases currently under review (i.e., ChemChina/Syngenta, Dow/DuPont, and Bayer/Monsanto) are frequently lumped together in discussions, the three present rather different competitive cases—particularly within the US. For instance, ChemChina’s acquisition of Syngenta will not, in itself, meaningfully change market concentration. However, financial backing from ChemChina may allow Syngenta to buy up the discards from other deals, such as the parts of DuPont that the EU Commission is requiring to be divested or the seed assets Bayer is reportedly looking to sell to preempt regulatory concerns, as well as other smaller competitors.

Dow-DuPont is perhaps the most head-to-head of the three mergers in terms of R&D and product lines. Both firms are in the top five in the US for pesticide manufacturing and for seeds. However, the Dow-DuPont merger is about much more than combining agricultural businesses. The Dow-DuPont deal specifically aims to create and spin-off three different companies specializing in agriculture, material science, and specialty products. Although agriculture may be the business line in which the companies most overlap, it represents just over 21% of the combined businesses’ annual revenues.

Bayer-Monsanto is yet a different sort of pairing. While both companies are among the top five in US pesticide manufacturing (with combined sales less than Syngenta and about equal to Dow without DuPont), Bayer is a relatively minor player in the seed industry. Likewise, Monsanto is focused almost exclusively on crop production and digital farming technologies, offering little overlap to Bayer’s human health or animal nutrition businesses.

Despite the differences in these deals, they tend to be lumped together and discussed almost exclusively in the context of pesticide manufacturing or crop protection more generally. In so doing, the discussion misses some important aspects of these deals that may mitigate traditional competitive concerns within the pesticide industry.

Mergers as the Key to Unlocking Innovation and Value

First, as the Dow-DuPont merger suggests, mergers may be the least-cost way of (re)organizing assets in ways that maximize value. This is especially true for R&D-intensive industries where intellectual property and innovation are at the core of competitive advantage. Absent the protection of common ownership, neither party would have an incentive to fully disclose the nature of its IP and innovation pipeline. In this case, merging interests increases the efficiency of information sharing so that managers can effectively evaluate and reorganize assets in ways that maximize innovation and return on investment.

Dow and DuPont each have a wide range of areas of application. Both groups of managers recognize that each of their business lines would be stronger as focused, independent entities; but also recognize that the individual elements of their portfolios would be stronger if combined with those of the other company. While the EU Commission argues that Dow-DuPont would reduce the incentive to innovate in the pesticide industry—a dubious claim in itself—the commission seems to ignore the potential increases in efficiency, innovation and ability to serve customer interests across all three of the proposed new businesses. At a minimum, gains in those industries should be weighed against any alleged losses in the agriculture industry.

This is not the first such agricultural and life sciences “reorganization through merger”. The current manifestation of Monsanto is the spin-off of a previous merger between Monsanto and Pharmacia & Upjohn in 2000 that created today’s Pharmacia. At the time of the Pharmacia transaction, Monsanto had portfolios in agricultural products, chemicals, and pharmaceuticals. After reorganizing assets within Pharmacia, three business lines were created: agricultural products (the current Monsanto), pharmaceuticals (now Pharmacia, a subsidiary of Pfizer), and chemicals (now Solutia, a subsidiary of Eastman Chemical Co.). Merging interests allowed Monsanto and Pharmacia & Upjohn to create more focused business lines that were better positioned to pursue innovations and serve customers in their respective industries.

In essence, Dow-DuPont is following the same playbook. Although such intentions have not been announced, Bayer’s broad product portfolio suggests a similar long-term play with Monsanto is likely.

Interconnected Technologies, Innovation, and the Margins of Competition

As noted above, regulatory scrutiny of these three mergers focuses on them in the context of pesticide or agricultural chemical manufacturing. However, innovation in the ag chemicals industry is intricately interwoven with developments in other areas of agricultural technology that have rather different competition and innovation dynamics. The current technological wave in agriculture involves the use of Big Data to create value using the myriad data now available through GPS-enabled precision farming equipment. Monsanto and DuPont, through its Pioneer subsidiary, are both players in this developing space, sometimes referred to as “digital farming”.

Digital farming services are intended to assist farmers’ production decision making and increase farm productivity. Using GPS-coded field maps that include assessments of soil conditions, combined with climate data for the particular field, farm input companies can recommend the types of rates of applications for soil conditioning pre-harvest, seed types for planting, and crop protection products during the growing season. Yield monitors at harvest provide outcomes data for feedback to refine and improve the algorithms that are used in subsequent growing seasons.

The integration of digital farming services with seed and chemical manufacturing offers obvious economic benefits for farmers and competitive benefits for service providers. Input manufacturers have incentive to conduct data analytics that individual farmers do not. Farmers have limited analytic resources and relatively small returns to investing in such resources, while input manufacturers have broad market potential for their analytic services. Moreover, by combining data from a broad cross-section of farms, digital farming service companies have access to the data necessary to identify generalizable correlations between farm plot characteristics, input use, and yield rates.

But the value of the information developed through these analytics is not unidirectional in its application and value creation. While input manufacturers may be able to help improve farmers’ operations given the current stock of products, feedback about crop traits and performance also enhances R&D for new product development by identifying potential product attributes with greater market potential. By combining product portfolios, agricultural companies can not only increase the value of their data-driven services for farmers, but more efficiently target R&D resources to their highest potential use.

The synergy between input manufacturing and digital farming notwithstanding, seed and chemical input companies are not the only players in the digital farming space. Equipment manufacturer John Deere was an early entrant in exploiting the information value of data collected by sensors on its equipment. Other remote sensing technology companies have incentive to develop data analytic tools to create value for their data-generating products. Even downstream companies, like ADM, have expressed interest in investing in digital farming assets that might provide new revenue streams with their farmer-suppliers as well as facilitate more efficient specialty crop and identity-preserved commodity-based value chains.

The development of digital farming is still in its early stages and is far from a sure bet for any particular player. Even Monsanto has pulled back from its initial foray into prescriptive digital farming (call FieldScripts). These competitive forces will affect the dynamics of competition at all stages of farm production, including seed and chemicals. Failure to account for those dynamics, and the potential competitive benefits input manufacturers may provide, could lead regulators to overestimate any concerns of competitive harm from the proposed mergers.

Conclusion

Farmers are concerned about the effects of these big-name tie-ups. Farmers may be rightly concerned, but for the wrong reasons. Ultimately, the role of the farmer continues to be diminished in the agricultural value chain. As precision agriculture tools and Big Data analytics reduce the value of idiosyncratic or tacit knowledge at the farm level, the managerial human capital of farmers becomes relatively less important in terms of value-added. It would be unwise to confuse farmers’ concerns regarding the competitive effects of the kinds of mergers we’re seeing now with the actual drivers of change in the agricultural value chain.

TOTM Blog Symposium on Ag and Biotech M&A

My friends at Truth on the Market are hosting a blog symposium later this week including yours truly. It should be an interesting set of perspectives:

Agricultural and Biotech Mergers: Implications for Antitrust Law and Economics in Innovative Industries

March 30 & 31, 2017

Earlier this week the European Commission cleared the merger of Dow and DuPont, subject to conditions including divestiture of DuPont’s “global R&D organisation.” As the Commission noted:

The Commission had concerns that the merger as notified would have reduced competition on price and choice in a number of markets for existing pesticides. Furthermore, the merger would have reduced innovation. Innovation, both to improve existing products and to develop new active ingredients, is a key element of competition between companies in the pest control industry, where only five players are globally active throughout the entire research & development (R&D) process.

In addition to the traditional focus on price effects, the merger’s presumed effect on innovation loomed large in the EC’s consideration of the Dow/DuPont merger — as it is sure to in its consideration of the other two pending mergers in the agricultural biotech and chemicals industries between Bayer and Monsanto and ChemChina and Syngenta. Innovation effects are sure to take center stage in the US reviews of the mergers, as well.

What is less clear is exactly how antitrust agencies evaluate — and how they should evaluate — mergers like these in rapidly evolving, high-tech industries.

These proposed mergers present a host of fascinating and important issues, many of which go to the core of modern merger enforcement — and antitrust law and economics more generally. Among other things, they raise issues of:

  • The incorporation of innovation effects in antitrust analysis;
  • The relationship between technological and organizational change;
  • The role of non-economic considerations in merger review;
  • The continued relevance (or irrelevance) of the Structure-Conduct-Performance paradigm;
  • Market definition in high-tech markets; and
  • The patent-antitrust interface

Beginning on March 30, Truth on the Market and the International Center for Law & Economics will host a blog symposium discussing how some of these issues apply to these mergers per se, as well as the state of antitrust law and economics in innovative-industry mergers more broadly.

As in the past (see examples of previous TOTM blog symposia here), we’ve lined up an outstanding and diverse group of scholars to discuss these issues:

  • Allen Gibby, Senior Fellow for Law & Economics, International Center for Law & Economics
  • Shubha Ghosh, Crandall Melvin Professor of Law and Director of the Technology Commercialization Law Program, Syracuse University College of Law
  • Ioannis Lianos,  Chair of Global Competition Law and Public Policy, Faculty of Laws, University College London
  • John E. Lopatka(tent.), A. Robert Noll Distinguished Professor of Law, Penn State Law
  • Geoffrey A. Manne, Executive Director, International Center for Law & Economics
  • Diana L. Moss, President, American Antitrust Institute
  • Nicolas Petit, Professor of Law, Faculty of Law, and Co-director, Liege Competition and Innovation Institute, University of Liege
  • Levi A. Russell, Assistant Professor, Agricultural & Applied Economics, University of Georgia
  • Joanna M. Shepherd, Professor of Law, Emory University School of Law
  • Michael Sykuta, Associate Professor, Agricultural and Applied Economics, and Director, Contracting Organizations Research Institute, University of Missouri

Initial contributions to the symposium will appear periodically on the 30th and 31st, and the discussion will continue with responsive posts (if any) next week. We hope to generate a lively discussion, and readers are invited to contribute their own thoughts in comments to the participants’ posts.

The symposium posts will be collected here.

We hope you’ll join us!

 

 

How mergers affect innovation…maybe?

Justus Haucap and Joel Stiebale with the Düsseldorf Institute for Competition Economics (DICE) at the University of Düsseldorf have a recent paper analyzing the effects of mergers on innovation in the European pharmaceutical industry. The develop a model that suggests mergers reduce innovation not only in the merged firms, but among industry competitors as well. Their data bear this out, as explained in the abstract:

This papers analyses how horizontal mergers affect innovation activities of the merged entity and its non-merging competitors. We develop an oligopoly model with heterogeneous firms to derive empirically testable implications. Our model predicts that a merger is more likely to be profitable in an innovation intensive industry. For a high degree of firm heterogeneity, a merger reduces innovation of both the merged entity and non-merging competitors in an industry with high R&D intensity. Using data on horizontal mergers among pharmaceutical firms in Europe, we find that our empirical results are consistent with many predictions of the theoretical model. Our main result is that after a merger, patenting and R&D of the merged entity and its non-merging rivals declines substantially. The effects are concentrated in markets with high innovation intensity and a high degree of rm heterogeneity. The results are robust towards alternative specifications, using an instrumental variable strategy, and applying a propensity score matching estimator.

While I haven’t yet read the paper in detail, a cursory examination suggests they have ignored another possibility: mergers in high-intensity R&D industries could be a leading indicator of decreased innovation productivity (i.e., lower returns to investment in R&D). Consider that as research advances, the “low hanging fruit” are collected first before the more difficult (and lower return) investments are pursued. As companies in a high-intensity R&D industry exploit all of the low hanging fruit, particularly internally, one might expect mergers as a way of expanding the available set of lower-cost/higher-return R&D investment opportunities. Since firms are competing in the same science space, a slow-down in one firm is likely to be spuriously correlated with slowdowns throughout the industry.

“Affect” is a word of causation. To suggest that mergers cause a reduction in innovation is a strong statement–especially when paired with a merger policy implication. This may be something that bears more scrutiny since, as the authors note, the entire subject is one on which relatively little light has thus far been shed.

"Dish"ing It Out To Softbank

A student in my contracts course asked today about Dish’s hostile bid for Sprint and the implication for Sprint’s existing deal with Softbank. Great question! If only Dish had held off on their bid another couple weeks until when we are scheduled to talk about termination fees in M&A deals.

Turns out the Softbank-Sprint deal does have a break-up fee, to the tune of $600 million (as reported in the WSJ Online and confirmed in the actual deal). But Softbank went one step further than just including a termination fee. Concurrent with the original M&A agreement, Softbank also purchased a $3.1 billion convertible bond from Sprint. The conversion rate implies a price of $5.25 per share. That’s close to 600 million shares that Softbank can convert and sell back to any hostile bidder, capturing the additional value of the hostile tender offer. In the case of Dish’s $7/share bid, that’s roughly a $1 billion pay-off for losing the bidding war…in addition to the $600 million termination fee.

That’s a pretty sweet deal for sour grapes. It also illustrates that there are multiple ways bidders can protect their interests in an M&A deal.

Side note: the WSJ headlines report a potential $4 billion benefit to Softbank if Sprint bolts to Dish, but most of that is a windfall resulting from devaluation of the yen and it’s effect on the cash Softbank had set aside to effect the deal. It’s a nice windfall, but it’s not directly related to the terms of the deal itself.