The Pacific National Case – Current Issues in Non-Horizontal Mergers

Australian Competition and Consumer Commission v Pacific National Pty Limited (No 2) [2019] FCA 669

In May 2019, Pacific National succeeded against the ACCC in the Federal Court, in proceedings brought by the ACCC seeking (among other things) an injunction to prevent Pacific National from acquiring the Acacia Ridge intermodal rail terminal from Aurizon, the current owner of that terminal: Australian Competition and Consumer Commission v Pacific National Pty Limited (No 2) [2019] FCA 669. Although the case is on appeal, Beach J made some important general comments on the analysis of non-horizontal mergers which were not challenged on appeal.

Pacific National was the largest of two suppliers of interstate rail linehaul services. Aurizon, which had previously been the third (and second largest) of three suppliers of those services, had ceased supplying those services before the proceeding was commenced, separately from entering the transaction the subject of the proceeding.

The ACCC alleged that the Acacia Ridge terminal, located in Queensland, was a strategically significant asset, use of which would be essential for a new entrant to commence supplying interstate intermodal rail linehaul services. The ACCC alleged that Pacific National’s acquisition of that terminal would contravene s 50 of the Competition and Consumer Act 2010 (Cth), as it would give Pacific National control over access to the terminal, thereby conferring on Pacific National the ability and incentive to discriminate against potential new entrants in providing access to the terminal.

The ACCC also alleged that Pacific National would be perceived by new entrants to have that ability and incentive. The ACCC alleged that the acquisition of the terminal would therefore be likely to have the effect of substantially lessening competition in relevant markets for interstate intermodal rail linehaul services.

Accordingly, the case considered the application of s 50 to a vertical, or non-horizontal merger – that is, a merger of an upstream (terminal) and downstream (rail services) business, rather than a merger between competing businesses.

His Honour described the standard framework for assessment of non-horizontal mergers as taking into account:

1. the ability of the merged entity to engage in anti-competitive conduct;
2. the incentive of the merged entity to engage in anti-competitive conduct; and
3. the effect of the merged entity’s likely conduct on competition.

As to ability, which often overlaps with incentive, it typically concerns assessment of constraints that might prevent the merged entity from worsening the terms of access of a downstream rival to an important upstream input. The availability of alternative upstream inputs is particularly important.

Pacific National’s future ability and incentive to discriminate against new entrants were relevant to barriers to entry and the prospect of new entry. The issue was the commercial incentive of Pacific National to refuse a potential new entrant access to the Terminal, otherwise offering terms of use that would put them at a competitive disadvantage, or at least the risk that a potential new entrant would be deterred by a reasonable perception by a potential new entrant that Pacific National would engage in such behaviour.

As to perceived barriers to entry:

1. it is relevant to consider whether the view is based on detailed analysis and knowledge;
2. a widely-shared perception will tend to carry greater weight than an idiosyncratic one;
3. whether the perception as to likely future conduct arises from existing conduct within the industry may be relevant;
4. the genuineness and stability of the perception over time is relevant;
5. mistaken perceptions should not be considered; and
6. under ordinary market conditions, generally an entity’s perceptions of its competitors’ behaviour are informed by outward manifestations of their strategy through conduct.

As to incentive, the worsening of the terms of access of a downstream rival (say by foreclosing supply of an important upstream input) is likely to harm the revenues of the merged entity, so the assessment of incentive turns on whether any profits from diversion of downstream activity from the rival to the downstream operations of the merged entity would outweigh that harm. Pacific National, having downstream (rail) operations, had the opportunity to recoup its profits downstream to offset any lost profit associated with upstream (terminal) discrimination.

Amongst Pacific National’s arguments was that the acquisition would result in “internalisation of double marginalisation”, that is, efficiency resulting from vertical integration due to the ownership of both upstream and downstream operations, removing the profit margin that a third party downstream operator would seek. This raises an important distinction, in merger cases, between the efficiencies of vertical acquisitions and their effect on competition. His Honour considered that even if the acquisition were to increase efficiency by eliminating “double marginalisation”, that did not disprove a substantial lessening of competition flowing from the vertical integration. That is, while the outcome of competition may be to produce efficiencies, the relevant question for the Court was the effect of the proposed acquisition on the process of competition, which could be lessened even if the vertical integration resulted in greater efficiency.

As to whether the acquisition was likely to substantially lessen competition, his Honour addressed whether there was a “real chance” of that occurring, having regard to the future state of the market both with and without the proposed acquisition (that is, factual compared with counterfactual). His Honour preferred the view that this analysis required one composite evaluative judgment and did not require proof of the counterfactual on the balance of probabilities. However, the magnitude of any real chance of alleged future states coming to pass will practically affect the magnitude of the real chance of the alleged effects on competition.

His Honour considered that the acquisition was likely to substantially lessen competition, but that the competition issues were resolved by an access undertaking, offered unconditionally by Pacific National on the last day of the hearing, which put in place a regime which sought to prevent Pacific National from discriminating in providing access to other rail operators at the Terminal.

An appeal, and two cross-appeals, from the decision were heard in late February 2020, and judgment has been reserved. The matters addressed by the appeal and cross-appeals concerned the Court’s power to accept, and consideration of, an undertaking offered by a merger party; the approach to market definition adopted by the trial judge; the interpretation of s 50 of the CCA (including the appropriateness of the “real chance” test); and application of s 50 to the particular facts of this proceeding.