McDermott Will & Emery has a strategic alliance with MWE China Law Offices, a separate law firm based in Shanghai. This China Law Alert was authored by MWE China Law Offices lawyers Henry (Litong) Chen and James Jiang and McDermott lawyer Frank Schoneveld.
Recently China’s Ministry of Commerce (MOFCOM) approved Western Digital’s proposed acquisition of Hitachi’s hard disk drive business on a conditional basis. Containing the most comprehensive clearance conditions ever imposed by MOFCOM, this decision mirrors previous guidance issued by the European Commission and illustrates that at least two authorities in two of the world’s major economies are working toward imposing similar clearance conditions in their respective jurisdictions.
On 2 March 2012, China’s Ministry of Commerce (MOFCOM) published its conditional approval of the proposed acquisition of the hard disk drive (HDD) business of Hitachi by Western Digital (WD) through its wholly owned subsidiary of Viviti Technologies Ltd. The decision demonstrated how far Chinese anti-monopoly authorities are willing to go to restrain an approved merger that could impose substantial anti-competitive impact, but without refusing clearance altogether.
Scenarios in the European Union and United States
In November 2011 the European Commission approved the same transaction on the condition that WD divest essential production assets for the manufacture of 3.5-inch HDDs, including a production plant, the transfer or licensing of the intellectual property (IP) rights, the transfer of personnel and the supply of components to the divested business. The deal will not be closed until a binding agreement is reached for the sale of the divested business to a suitable purchaser approved by the European Commission. Given that the Seagate/Samsung merger was notified one day earlier than the WD/Hitachi case, but was approved unconditionally, it is worth noting, unlike China’s MOFCOM, the European Commission has applied the “first come first served” priority rule in reviewing the two similar cases and thus imposed stricter conditions for clearance of the latter case. The same concentration has also been notified to the US Federal Trade Commission (FTC), which has not made its final decision yet, but has publicly announced its intention to set divestment conditions on its clearance of the case.
The WD/Hitachi acquisition was first notified to MOFCOM on 2 April 2011, more than one month before the Seagate/Samsung notification. Having experienced an interruption of the case and withdrawal due to substantial changes, the acquisition was re-notified and accepted for review by MOFCOM on 7 November, 2011. The case then went through the statutory Phase I and Phase II review periods under China’s Anti-Monopoly Law (AML).
According to the AML, there are two circumstances that allow the withdrawal of a notification that has been officially accepted by MOFCOM for review. One is that the parties decide to abandon the proposed transaction and the other is that substantial changes have occurred, in which case withdrawal is subject to MOFCOM’s prior approval.
MOFCOM’s analysis of the competitive impact of the acquisition is similar to the one in the Seagate/Samsung case.
Defining Relevant Market
To define the relevant market, MOFCOM distinguished HDDs from other storage equipment, such as flash and hard drives, due to such factors as storage volume, price and function. But all segmentations of HDD were considered to constitute the relevant HDD market, even though there were different users and applications. The relevant HDD market was set geographically as the global market because of the nature of its worldwide supply and purchasing.
MOFCOM found there are five players in the worldwide HDD market, including Seagate (33 per cent), Western Digital (29 per cent), Hitachi (18 per cent), Toshiba (10 per cent) and Samsung (10 per cent), all of which have similar market shares in China. With regard to those market competitors, MOFCOM remarked in its decision that though the Seagate/Samsung merger was approved by MOFCOM in December 2011, Samsung was still an independent competitor in the HDD market and thus MOFCOM proceeded on the basis there were still those five major competitors. In its decision MOFCOM did not specifically discuss the possible cumulative effects of the Seagate/Samsung and WD/Hitachi transactions.
MOFCOM also found HDD products are similar, and downstream customers could easily switch to other suppliers with limited cost, and that the main downstream customers are large computer manufacturers. It also mentioned that the HDD market is relatively transparent and HDD manufacturers usually share distributors, therefore it is relatively easy for HDD manufacturers to gain competitors’ information. Transaction price between giant manufacturers and HDD manufacturers was found to be capable of determining the market price of HDD products.
MOFCOM recognized that large computer manufacturers usually negotiate with HDD manufacturers by launching non-public bidding processes. MOFCOM found that, to stabilize supplies, computer manufacturers purchase from two to four HDD manufacturers based on factors such as price. MOFCOM stated that such a purchase model facilitates price competition among HDD manufacturers.
MOFCOM concluded from its investigation that the five HDD manufacturers maintained very little unused production capacity due to the recent increase in market demand, noting that in the fourth quarter of 2010 capacity utilization rates were approximately 90 per cent.
MOFCOM found that innovation has a great impact on the HDD industry. Releasing initiative and successful products first will result in relatively high market share and profit. It was held that HDD manufacturers can reduce costs through innovation as a crucial competitive advantage.
MOFCOM found that HDD manufacturers dominate the sale prices of downstream distributors that do not have bargaining power against HDD manufacturers. As large scale computer manufacturers have the power to increase computer prices and transfer the burden of the price increase of HDDs to consumers, they have no incentive to execute any counteracting purchasing power. As a result, consumers are highly dispersed and have no bargaining power with respect to HDDs and computers.
Due to IP and other technological thresholds, as well as scale effect, MOFCOM found there are significant barriers to entry, noting there has been no new entry into the market in the past 10 years.
Impact on the Relevant Product Market and Consumers
MOFCOM thereafter concluded the proposed concentration will eliminate one important competitor in the HDD market, will weaken the competitiveness between HDD manufacturers caused by the aforementioned purchase model, and thus is likely to encourage market competitors to eliminate or restrict competition by coordination with each other. It is emphasised that China as a country is one of the largest consumers of personal computers, and the concentration will cause adverse impact on Chinese customers.
Discussion for Restraints
During the review, WD held several rounds of discussion with MOFCOM, and submitted the European Commission’s conditional clearance decision together with several other proposed solutions to eliminate the anti-competitive effect by the transaction. Upon evaluation, MOFCOM believed WD’s final proposed solution, which contained the condition of divesting all production assets for manufacturing 3.5-inch HDDs, was capable of eliminating the transaction’s adverse effect on competition.
MOFCOM’s Decision Remedies
MOFCOM held that the merger would eliminate or restrict competition in the HDD market, and thus decided to approve the merger by imposing restrictive conditions as follows.
- Viviti shall exist as an independent competitor in the relevant market, which includes, but is not limited to:
- Viviti shall maintain its status as an independent legal person and its independent business operation in all aspects such as research & development (R&D), manufacturing, purchasing, marketing, after-sale, administration, financing and accounting, investment, HR management, etc.
- Viviti shall continue to sell HDD products under the name of HGST (Hitachi Global Storage Technologies) with its original brands based on its independent pricing mechanism.
- WD and Viviti shall establish a firewall to ensure no exchange of competitive information, in particular any information about cost, price, production volume, clients, bidding, etc.
- WD, in exercising its rights and performing its obligations as the shareholder of Viviti, shall not harm the independence of Viviti nor shall it exclude or restrain competition between them. WD, exercising its shareholding rights and performing its shareholding obligations, shall be reported in advance to the appointed Trustee on any matters that might harm the independence of WD and Viviti or exclude or restrain their competition, subject to MOFCOM’s prior approval.
- WD and Viviti shall independently maintain their R&D institutes. R&D cooperation between WD and Viviti with regard to hard disks is allowed, but the exchange of competitive information is not permitted.
- WD and Viviti are required to prepare safeguard measures for realising the above conditions, which are also subject to MOFCOM’s prior approval.
- WD and Viviti shall reasonably confirm their manufacturing capacity and quantities based on market demand, which shall be reported to the Trustee on a monthly basis.
- WD and Viviti shall not substantially change the current business model, and/or force, or force in disguised form, customers to exclusively purchase hard disk products from WD or Viviti.
- WD promises to divest all production assets for manufacturing 3.5-inch HDDs within six months upon the issuance of the decision, which shall be handled in accordance with the AML and relevant rules and regulations.
- WD shall entrust an independent Trustee to supervise WD’s performance of its obligations under the MOFCOM decision.
It is also noted that MOFCOM’s decision includes a review clause entitling WD to apply to MOFCOM for waiver of the first two of the above conditions two years after the decision, on which MOFCOM will make a decision after consideration of prevailing market conditions.
This case contains the most comprehensive clearance conditions ever imposed by MOFCOM. The Ministry requires Viviti not only to be de facto independent, which is the same as for the Seagate/Samsung, but also to be legally independent. Further, the requirement concerning exercise of shareholding rights and performance of shareholder obligations to be subject to MOFCOM’s prior approval will likely cause many interesting legal issues, such as corporate governance, under the corporation laws of China and the country of origin of WD and Viviti.
From another perspective, it is noted that MOFCOM, in this decision, expressly acknowledged the effectiveness of clearance conditions imposed by the European Commission by including the same conditions as part of its decision, which must nevertheless still be executed under China’s anti-monopoly legal regime. It can be seen then, that at least two competition/monopoly authorities in two of the world’s major economies are apparently working more closely toward imposing clearance conditions on the same transactions in their respective jurisdictions. Although it is not certain how much credit the Chinese authorities are willing to grant their European counterpart, the decision demonstrates the benefits of planning for globally concerted merger notifications before formally filing with any major merger control authorities.