Why All Buyers Should Care About the GE/Honeywell Misfire: The message in the EC’s rejection of the aerospace megadeal is that Europeans have the muscle to make or break mergers with global dimensions.

General Electric Co. and Honeywell International Inc. rebounded from the European Commission’s (EC) rejection of their megamerger by going about their business – albeit in strikingly different ways. GE agreed to a $5.3 billion buyout of Heller Financial Inc. to strengthen its already formidable financial services business, sifted alternate acquisitions to expand its aircraft operations, and advanced plans to install Jeffrey Immelt as CEO to succeed the retiring Jack Welch. Former target Honeywell was, by contrast, in turmoil. CEO Michael Bonsignore was ousted and replaced by predecessor Lawrence Bossidy, the company split into four operating segments – portending a breakup in the view of many analysts – and earnings plunged 92%. But as the two ex-partners put the setback behind them, the specter of the EC’s early July blackball haunted scores of other companies planning deals with global dimensions – whether cross-border or, like GE/Honeywell, between two firms based in the same country. By shooting down the big merger, the EC underscored the reality that combining firms of size inevitably must serve antitrust masters both in the U.S. and abroad and left companies groping for ways to navigate the dual regulatory tracks. Striking the right balance may be tough, say antitrust lawyers and other veterans of international business. Stripped of political and philosophical rhetoric that erupted after GE/Honeywell collapsed, the EC veto drove home the very basic point that U.S. and European regulators take divergent paths in weighing the competitive effects of mergers, and it can be tricky, as European review becomes increasingly essential in deals involving American companies, to get both approvals at the same time. The demarcation surfaced in the divergent handling of the deal. Two months after the U.S. Justice Department (DOJ) waved the $42 billion combination through with modest demands – notably the sale of Honeywell’s helicopter engine business – the EC killed the deal. In a nutshell, the DOJ and the Federal Trade Commission (FTC) don’t get hung up much on sheer size but key on potential abuse of dominant positions, general effects on competition, and the impact on customers of merging firms. While corporate heft bothers the EC only a bit more than the Yanks and the commission’s gauge of the competitive impact on customers is not dissimilar, the big point of departure is the Europeans’ fear that competitors may be gored by the transaction. Indeed, a major reason that GE/Honeywell bombed in Europe was the EC’s fear that the merged firm would hammer aerospace competitors, say observers who point out that regulators on the Continent want customers to have alternate choices in any marketplace. That was the basis for the EC’s attack on the “bundling,” or virtual one-stop shopping for plane manufacturers and airlines that the deal promised. In the commission’s view, competitors may not have been able to stand up to a powerhouse offering a diverse array of engines, avionics, and other types of aircraft equipment, as well as the power to finance the purchases or plane leases. Kevin J. Arquit, an antitrust lawyer at Clifford Chance Rogers & Wells, says that the irony is that bundling rarely draws a challenge in the U.S. and would be considered an efficiency, “in other words, a reason to let the deal proceed.” “What it says is that when you are putting together your arguments for one jurisdiction, you have to be aware that the very argument that gets you off the hook in one jurisdiction may put you on the hook in another,” he adds. A former director of the FTC’s Bureau of Competition, Arquit says that the regulatory schism poses a challenge in shaping future deals. “This was a clear example of the Europeans applying a different theory than the U.S. authorities and many other global authorities,” he notes. “That’s what makes it significant for future deals. To the extent that there had been some predictability in terms of what regulators look to in deciding whether or not to challenge a deal, the GE/Honeywell case kind of throws in a curve ball.” Veteran international antitrust hand Douglas E. Rosenthal says that while the product bundling was important, he thinks that the stopper was GE’s powerful in-house financing capability that competing equipment manufacturers lacked. He says that the EC noted that GE’s General Electric Capital Aviation Services (GECAS) subsidiary enjoys a massive share in financing or leasing planes utilizing GE engines. “A major strength of GE Capital and the GE Capital leasing program is to provide targeted financial solutions to airline companies and mainframe manufacturers,” says Rosenthal, a partner at Sonnenschein Nath & Rosenthal in Washington. “So they can leverage their financial strengths to preferentially market GE engines at the expense of competitors, particularly of Pratt & Whitney and Rolls-Royce.” In the commission’s view, Rosenthal adds, that put competitors at a significant disadvantage. “The intention of the commission is not to protect competitors but to maintain competitive alternatives,” he says. “The competitors are not failing, but the commission thought they could if the deal was allowed. That is different from the U.S., where the position is to let the market decide.” Peter Alexiades of the Brussels office of Squire Sanders & Dem-psey agrees with Arquit that the European view could threaten the synergies that acquirers envision in large transactions. They “might die on the vine,” he says, if the Europeans require the merging firms to shed a lot of businesses. Compounding the buyers’ problem is that in the wake of the demise of GE/ Honeywell, determining what “you will need to give away” is highly speculative. “It makes it hard to predict what the down side will be on these deals, what divestitures will be required to resolve the commission’s problems,” he adds. In striking down the huge deal, the EC concluded that GE already enjoyed a dominant position in jet engines for large commercial and large regional aircraft based on product sales and financing activities. Honeywell was described as the “leading supplier” of avionics (instrumentation for operating planes), non-avionics (including braking and heating systems), engines for corporate jets, and engine starters. That mix, the EC statement said, “would enable the merged entity to leverage the respective market power of the two companies into the products of one another. This would have the effect of foreclosing competitors, thereby eliminating competition in these markets, ultimately affecting adversely product quality, service, and consumers’ prices.” GE proposed selling off operations with revenues of $2.2 billion a year and taking in a minority partner at GECAS to placate the commission. But the remedy was described as “insufficient” by the EC, which, among other demands, wanted GE to cut its ties completely with GECAS. GE had said that meeting the EC’s conditions would have cut the heart out of the deal’s advantages. The commission, Rosenthal says, just “talks about GE as a juggernaut and is not concerned that it might turn out a superior product that is sold and serviced more effectively,” which could be telling in U.S. screenings. “They were not focused on technology,” he adds. “They were just concerned about GE being a juggernaut.” With the EC’s hard-nosed position, required divestitures “may gut the central rationale for doing the deal,” Arquit says. “You may do it to solve a problem but leave no reason for doing a deal.” Arquit had little use for the EC’s tilt toward competitors, noting that the reason for doing a deal “is that you want to get a step ahead of the competitors and want to do it in a way that offers more choice. Our antitrust law suggests that should be allowed. The Europeans have thrown a monkey wrench into it.” Although GE’s financing prowess injected a unique joker into the deck, an international dealmaking expert suggests that the rough treatment of the deal might be indicative of a harder regulatory line on consolidating industries in general. Robert A. Filek, who heads up cross-border advisory activities for PricewaterhouseCoopers’ transaction services unit, notes that GE/Honeywell was “a very large transaction in an industry that has already seen a lot of consolidation.” “For those industries that have completed the early stages of consolidation over the course of the last few years, the next stages, where you really have the mega-players coming in, are going to receive a lot more scrutiny,” he says. “The rules change, and the regulators may say, this is about where we draw the line.'” From a strategic standpoint, Filek cautions, it may be difficult to execute mergers in the later stages where mega-players are being formed. “Your options need to be changed,” he says. “You can’t use the merger process you used earlier in the consolidation. You really have to change the process to anticipate that this is going to be an issue and you have to position yourself for it.” Virtually underscoring Filek’s assessment was the scrubbing of a high-profile airline deal after a challenge not by the Europeans but by American regulators. UAL Corp., owner of United Airlines, the second-largest carrier, and sixth-ranked US Airways Group Inc. called off their merger after the DOJ declined to allow more consolidation in an industry in which the number of competitors has contracted markedly over the last several years through m&a. US Airways, whose survival as an independent has been placed in doubt, immediately was targeted for a bid by Global Airlines Corp., a little-known New York-based private holding company. The offer was quickly turned down. Global Airlines surfaced earlier in the year when it bid for Trans World Airlines Inc. in an unsuccessful try at beating out AMR Corp.’s American Airlines Inc. Several antitrust experts had predicted that the UAL/US Airways hookup was in jeopardy after a federal appeals court delivered a potentially significant decision against further contraction in a highly concentrated industry, even though it had nothing to do with airlines. The U.S. Court of Appeals ruled against H.J. Heinz Co.’s acquisition of Milnot Holding Corp., owner of Beech-Nut baby foods, which would have cut the three-player field to two. Meanwhile, merger-makers continued to watch regulatory developments in a variety of industries that involved strategic trappings of the GE/Honeywell deal. One transaction in the spotlight was a cross-border megadeal in the pet food industry that was being given a lengthy going-over by the EC. Nestle SA was awaiting a decision on its $10.3 billion acquisition of St. Louis-based Ralston Purina Co. It offered to sell off brands in Spain, Greece, and Italy – which some observers considered a significant concession – to get European regulators to sign off on the deal. The success of PepsiCo Inc. in completing its $14 billion acquisition of Quaker Oats Co. after a long and checkered review in the U.S. also was considered part of the competition policy mix. Although the FTC staff had recommended that the deal be opposed, it went through when the commission deadlocked 2-2 on whether to mount a formal challenge. The case offered a variation on bundling. Quaker’s star product is the sports drink Gatorade. PepsiCo has a small competing sports drink, which it plans to sell. But the primary flash point was PepsiCo’s ability to leverage its vast soft drink bottling network for widening sales and distribution of Gatorade, historically not a product that vies directly with soda in the beverage market. While lawyers and dealmakers sorted the regulatory fallout, once-burned GE regrouped to plot its next moves for growing and diversifying its engine-dominated aircraft equipment business with antitrust implications very much on its mind. Rich Kennedy, a spokesman for the aircraft group, says that it’s a company strongpoint that is ripe for future development. “It’s safe to say that this business has created an enormous amount of cash for the company,” he says. It’s likely that “growth would involve additional acquisitions,” he adds. “The strategy of growing via acquisitions hasn’t changed.” Exact plans have yet to be determined, he says, but the company is expected to work on piecemeal augmentation of the engine lines with the avionics and non-avionics equipment that Honeywell would have brought in mass. GE’s 60% share in engine production and 50% penetration in engine services virtually precludes expansion by acquisition in those areas, requiring the company to forage elsewhere. “We are always looking for opportunities to grow the business, but we probably will have to look at other aerospace-related businesses,” Kennedy says. Nobody has a quick-fix remedy for companies doing deals with global dimensions that may find themselves in GE’s and Honeywell’s shoes. But the experts say that the experience has generated a number of tips for skippering deals through regulatory shoals, especially for American firms that might be unfamiliar with foreign waters. Don’t Take the Europeans for Granted As deals get bigger and companies go farther afield, the EC, by definition, will get into the picture. It is prepared, moreover, to flex its muscles based on the approach that differs from the U.S. direction. The GE/Honeywell fizzle “emphasizes that deals are becoming more and more multi-jurisdictional in regulatory focus,” notes William G. Lawlor of the Philadelphia-based law firm of Dechert. “In the past, most deals were focused on the U.S. from an antitrust standpoint,” he says. “The EC was a sideshow. That’s not the case anymore.” International Regulatory Alliance Expect greater coordination of merger regulation by American and foreign authorities. EC Competition Commissioner Mario Monti and Charles James, head of the DOJ’s antitrust division, have noted that the agencies already work together and that GE/Honeywell was a rare case in which they clashed on a deal. However, Rosenthal expects “coordination to happen much more extensively than before.” Arquit hopes that the regulators will talk more extensively “so you get close to what is one set of antitrust policies.” But at the same time, he believes that the GE/Honeywell rejection continues a “kind of distressing pattern” in the European outlook, marked by differences with Americans on specific deals. He cites such precursors as the EC demands for more scaling down than the U.S. wanted in the mergers of Boeing Co. and McDonnell Douglas Corp. and America Online Inc. and Time Warner Inc. The problem of reaching a semblance of uniformity is exacerbated, he adds, by the addition of merger reporting machinery in a host of countries to the point where more than 60 countries now look at deals. “There is way too much at stake politically in many of these jurisdictions for people to realistically think that they are going to give up that authority,” he says. “In fact, right now the trend is in the other direction.” Tighter Deal Management Across Borders Slipups in communications between deal teams in the U.S. and abroad can be fatal. Advisers warn that the teams must work together and tell a coherent story. “There has to be a lot of communication among the lawyers,” says Rosenthal, who also decries a tendency for the acquirers’ counsel to freeze out the target’s attorneys in handling regulatory affairs. The target’s lawyers, he says, can give “additional perspective” if given the chance. In Arquit’s view, “companies must have a global strategy” in regulatory affairs. “If they just send in completely unrelated teams to deal with each jurisdiction, they may unwittingly find that the team that is satisfying one regulator is, by definition, getting them in the soup with another set of regulators,” he states. Lawlor says that the stakes in fundamental blocking and tackling are on the rise, with the seller often having to take the lead in spotting problems that may mar a deal completion. In up-front due diligence, for example, “it becomes particularly important for the seller to assess potential overlapping markets and specifically address potential remedies in the transaction documents.” Additionally, it’s no longer good enough to rely on “vague covenants” in the contracts, such as “you will use your reasonable efforts to get a deal through,” Lawlor says. “If there are specific areas of concern and you are a seller, you want to make sure that you address those specifically. You will commit to divest X, or you will agree to litigate Y, and you will not rely on broad contractual language that you will simply do your best to try to get a deal done,” he adds. Watch the Competition Customers of GE and Honeywell were quiet about the combination, but competitors howled, literally playing into the European Union’s (EU) concerns. Complaints were lodged by engine makers United Technologies Corp., Rolls-Royce PLC, and Rockwell Collins Inc. American firms may be caught off guard when the competition beefs. In the U.S., Arquit points out, regulators give the opposition short shrift. “They think that if competitors are complaining, they probably are worried that the deal is too competitive, not too anticompetitive,” he says. Mike Lovdahl, a consultant at Mercer Management Consulting who has ex-tensive European ex-perience, warns merger partners to scope out the competitors’ complaints early and be prepared to fight back. This is especially critical in bundling deals in which the competitors may not have a “set of offerings in their kit bag.” “It is doubly important in global matters, particularly in the EU where opposition will come from competitors, to be armed with the kind of objections they will make, in advance, and to think about logical responses,” he adds. Fallback Positions Acquirers may have to show more give on divestitures and other cutbacks to please regulators who are concerned about overlaps, market positioning, and bundling. Filek says that buyers should know what they can shed up front and still engineer a value-creating deal. “You need to spend a lot of time, if not more than before, thinking about how you want to deal with regulators, and that includes the way you talk about a transaction, the way you structure a transaction, and your alternatives – your potential mitigating strategies,” he notes. “Well-thought-out plans are going to more successful with regulators than the proposals by people who haven’t invested the time to show the appropriate respect for the process.” Brent Shearer contributed to the preparation of this article.