China Approved Western Digital and Hitachi Storage Deal on Conditions
On 2 March 2012, MOFCOM published its conditional approval to the $4.5 billion acquisition of Viviti Technologies Ltd (a company directly holding Hitachi Global Storage Technologies Netherlands B.V. ,which holds Hitachi Global Storage Technologies Singapore Pte. Ltd.) (“Viviti”) by Western Digital Corporation (“Western Digital”).
This is the twelfth transaction MOFCOM approved on conditions since China launched its antitrust review regime under the Anti-Monopoly Law (“AML”) effective from 1 August 2008, and the second transaction it approved in the hard disc drive business (“HDD”) within three months. Previously, MOFCOM had approved conditionally Seagate’s acquisition of the HDD business assets of Samsung in December 2011.
The Western Digital/Viviti acquisition was also notified to the European Commission (“EC”) and Fair Trade Commission of United States (“FTC”) for antitrust clearance in April 2011. The EC and FTC cleared the transaction respectively on 23 November 2011 and on 6 March 2012. The EC approved the transaction upon the conditions of divestment of production assets for 3.5-inch hard disk drives, including a production plant, and accompanying measures. The EC also ruled that the acquisition will not take effect until Western Digital finds a suitable purchaser approved by the EC. The FTC approved the transaction after reaching a settlement agreement to resolve the competitive issues raised by the transaction. The settlement enables Toshiba to replace Hitachi Global Storage Technologies in the market for the desktop HDD, according to Bloomberg.
MOFCOM was notified of the transaction on 2 April 2011 and accepted it formally on 10 May 2011. MOFCOM later extended its review into phases II and III, ending on 6 November 2011. On 1 November 2011, Western Digital and Viviti notified MOFCOM that the deal had significant changes, therefore they applied to withdraw the filing. Upon the approval of MOFCOM, the review process ceased. On 7 November 2011, the parties applied to restart the review process. The review later entered into phase II with the review time ending on 6 March 2012. MOFCOM published its decision prior to the end of the phase II review. Due to the delay caused by the withdrawal, the review process lasted 286 days in total, exclusive of the time for preparing for the filing.
In the decision, MOFCOM outlined the issues it considered and provided a brief analysis underlying the decision. It has considered and examined the competitive effect of the transaction from the following aspects:
The Definition of the Relevant Market
MOFCOM first defined the nature of the deal, the product market and geographic market relevant to its review. The transaction was defined as an equity purchase deal among a number of parties engaging in production and distribution of HDD products or other digital storage device business. MOFCOM went on to identify the market relevant to the antitrust review of this transaction. It noted that the HDD market can be further divided according to the attributes of different HDD products and their various uses. It also noted that the buyers often source HDD supplies globally. MOFCOM found then that it is the entire HDD product market that constitutes the product market relevant to its review and the worldwide HDD market makes the relevant geographic market. MOFCOM repeated its finding in the Seagate/Samsung case.
The Structure of the Relevant Market
Against the background set by the definition of the relevant market, MOFCOM further analyzed the structure of the market. It recited the four key characters in the HDD market addressed in the Seagate/Samsung case. First, the market is a highly-concentrated market. MOFCOM noted that the worldwide HDD market is completely divided by five competitors, including Seagate (33%), Western Digital (29%), Hitachi (18%), Toshiba (10%) and Samsung (10%), who also control similar shares of the market in China. Secondly, the HDD products are highly homogenous and substitutable, which therefore makes consumers and purchasers easy to switch to other manufacturers at a relatively low cost. Thirdly, the HDD market is transparent, and therefore it is easy for HDD manufacturers to gain competitors’ information. Fourthly, the downstream purchasers of the products are mainly those large computer manufacturers and HDD distributers, therefore the product prices between the major purchasers and the manufacturers are able to determine the price in the market.
Current Purchase Model
Like the Seagate/Samsung case, the current purchase model of HDD products was again found important to determine the competitive effect of the transaction. MOFCOM repeated its findings and comments in the former case that large computer manufacturers (main purchasers) normally do not conduct bidding publicly when selecting HDD suppliers, rather they engage in bilateral negotiations with specific HDD suppliers each season. MOFCOM found that computer manufacturers normally will buy from two to four HDD suppliers according to competitiveness of their offers. It held that keeping this purchase model is important to maintaining competition in the HDD market. This finding is a key basis for MOFCOM later ruled that the two competitors must continue their current model of sales and be kept independent after the transaction at least for a period of time.
MOFCOM found that the current utilization of production capacity of the HDD manufacturers is relatively high due to the increase in market demand since 2008. MOFCOM noted that such a high utilization of production capacity leaves limited unused production capacity in the market. MOFCOM cited particularly that the capacity utilization rate reached approximately to 90% in the fourth quarter of 2010, and the flood in Thailand in 2011 further worsened the HDD supply. The high production capacity utilization probably was viewed as an indicator of limited strength the market itself has to counteract the additional market control power gained by the parties through the transaction. In light of the difficulty for new players to enter in the market, MOFCOM considered that this is another reason to impose the behavioral remedies on the transaction such as a requirement for the two parties to continue production and supply in the current volume and scale.
Impact of a transaction on innovation in the market is a factor often considered by MOFCOM in merger review where the innovation is a drive for market competition. Like in the Seagate/Samsung case, MOFCOM considered that innovative ability is important to the competitiveness of the HDD suppliers. It commented that such innovation power, on the one hand, enables the manufacturers to gain higher margin for their products, and thus commonly used by the manufacturers in maintaining their competitiveness in the market. On the other hand, maintaining the innovation in the HDD market can promote competition in the market. MOFCOM was concerned that the transaction can adversely affect innovation in HDD industry, if the parties reduce their investment or efforts in R&D, which will affect the competition in the entire market. As a remedy, the decision required Western Digital and Viviti not to reduce the investment in the R&D of HDD to ensure that they will continue providing innovative products and solutions to consumers.
Strength of the Buyers and Impact on Customers
MOFCOM studied respectively the positions of the HDD distributors, large computer manufacturers and end customers in negotiating price. It found that HDD distributors do not have the power to counter the HDD price fluctuation, and the large computer manufacturers are generally not willing to oppose to any price increase. MOFCOM studied the incident of notable HDD price increase caused by the 2011 Thai flood and the corresponding price increase of personal computers. It found that the computer manufacturers are simply passing the increased price through to their end consumers. MOFCOM also note that the end consumers are highly dispersed, they therefore have no power to oppose to the price increase either. Finally, it came to the view that the weak position of the purchasers or customers in reacting to price increase highlights the needs of maintaining competition in the supplier’s market.
MOFCOM found that the HDD market is difficult to enter into due to some intellectual property right or high technology barriers and the huge investment required to reach the survival scale economies in production. MOFCOM particularly noted that there has been no new competitor entered into the relevant market in the past 10 years.
Conclusion of the Reviews
On all the possible impact on the relevant product market and consumers, MOFCOM came to the conclusion that:
The deal would remove an important competitor from the market, and thereby increase the chance of other HDD manufacturers to gain more market. It could also de-motivate the parties to continue product and technology innovation. Given the high market transparency, which enables HDD manufacturers to predict the behaviors of other competitors, the deal could increase the possibility of HDD manufacturers coordinating their activities to eliminate or restrict competition in the HDD market. Eventually, it could restrict competition in the HDD manufacturer market without attaching certain remedies. Notably, MOFCOM also added that this deal could adversely affect the interests of the Chinese consumers, as China is one of the largest consumers of personal computers in the world. For the reasons, MOFCOM decided to impose the following restrictions on the transaction after discussing with the parties involved:
1. After the transaction is implemented, Viviti’s HDD business must operate as if it is an independent competitor to Western Digital. For this purpose, MOFCOM has specifically required that, both parties take effective measures to keep Viviti’s independence in the aspects, such as R&D, procurement, sales, after-sale services, finance, human resources, management, etc.; Viviti must continue manufacturing and sales of its HDD products in the manner as it is before the transaction takes place, and the parties must take necessary measures to prevent exchange of competitive information between them; Western Digital must not exercise its rights as a shareholder of Viviti in a way harmful to the independence of the parties or the competitive relationship between them; The parties must maintain independent R&D departments. To monitor the implementation of these measures, MOFCOM required Western Digital to appoint an independent trustee. If the parties wish to cooperate in respect of R&D, the cooperation plan must be reported to the trustee and approved by MOFCOM.
2. Western Digital and Viviti must arrange their production capacity and volumes in light of the demand in the market. Their production capacity and volumes are required to be reported to the trustee on a monthly basis.
3. Western Digital and Viviti must not change their current business models substantively. They must not use any means to coerce customers to purchase HDD products from them.
4. Western Digital and Viviti must not reduce investment in the R&D of their HDD business.
5. MOFCOM agrees to the proposal made by the parties that Western Digital must within 6 months from the decision date divest its 3.5-inch HDD manufacturing business to an independent party, as so required by the EC.
At the end, MOFCOM permitted the parties to apply to waive the above requirements 1 and 2 after a 24-month period from the implementation of the decision.
This is the second MOFCOM decision on a merger transaction in the HDD industry following its ruling of Seagate/Samsung acquisition in December last year. Both the transactions took place in one market and around the same time. Both the transactions’ competitive effects were examined by the FTC and the EC, as well as by MOFCOM. For these common characters, some new issues arise from the MOFCOM review and decisions:
1. As recalled, both the FTC and the EC approved the Seagate/Samsung transaction unconditionally and cleared the Western Digital/Viviti acquisition conditioned on some divestment obligations. In contrast, MOFCOM imposed some significant behavioral remedies on both the transactions, as well as a divestment requirement on the Western Digital/Vivti transaction. MOFCOM included the divestment of the assets of 3.5-inch HDD, a remedy from the EC, in its decision as a part of its conditional approval. However, MOFCOM did not reason, but simply accepted it as “a proposal from the parties” for settlement. The different rulings show that MOFCOM wishes its review to stand independently from the regulators in the US and EU. The name it efforts to build is an important regulator in the global antitrust system, but is willing and able to use a different set of approaches in the review of the same transaction. This position has highlighted the need to understand MOFCOM’s practice and special approaches in conducting the antitrust review. It certainly has added uncertainties to the global deals.
2. MOFCOM gave significant weight in both decisions to the impact of the transactions on the interest of the Chinese consumers of personal computers. As China is the largest consumer of HDD products in the world, it thus is especially concerned on the impact of the deal. Apparently, this is another example of MOFCOM’s application of Article 27 of the AML, which authorizes it to consider the factors such as “effect of the concentration on national economy” and “other factors the anti-monopoly enforcement authority may consider relevant”. Similar consideration had been taken in the Coca Cola/Huiyuan case and the Uralkali/Silvinit case where MOFCOM respectively found that the transactions can harm China’s domestic small and medium-sized manufacturers and the healthy development of the Chinese fruit-juice drink industry and China’s agriculture and agricultural industries. Both the decisions remind that MOFCOM will not reluctant to take into account such a kind of factors in antitrust review, if it believes necessary. However, this will raise concerns in preparing China merger filings with MOFCOM, as there actually can virtually be no parameters in using such a consideration.
3. In both decisions, MOFCOM allowed the parties to apply, after a period of time, to waive a series of the behavioral remedies it imposed on, including the parties must exist and operate independently and continue their sales or production as usual. After the given time, the parties are expressly allowed to apply for a waiver of the remedies, subject to MOFCOM’s approval. This is a new practice, which perhaps is related to the special structure and purchasers’ power in the HDD market as MOFCOM so noted. It indicates that the remedies were imposed as an interim measure and MOFCOM is prepared to limit its intervention to certain extent, as they would significantly affect the parties’ interests in the transaction. MOFCOM will still be able to decide after the period of time whether to remove the remedies. The period of time is given to the market, particularly to the Chinese purchasers, to prepare for the transaction. However, it remains to be seen under what circumstances MOFCOM will remove these remedies.
ABOUT THE AUTHOR: Wei (Steven) Su
Mr. Wei (Steven) SU is a senior partner of Guo Lian PRC Lawyers. His practice focuses on cross-border investment, transactions and operations. Dr. Su has significant experience in advising foreign investors and funds on the China-focused mergers and acquisitions, investment and transactions, onshore fund formation and placement, commercial dispute settlement, general corporate matters, etc.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.