Affected market: Rail franchises
No. ME/4151/09
Please note that the full text of the decision can be downloaded by using the link on the right. What follows are extracts regarding the parties, the transaction, jurisidction and decision.
The OFT's decision on reference under section 22(2)(a) given on 6 August 2009. Full text of decision published 17 August 2009.
PARTIES
Govia Limited (Govia) is a joint venture company owned by the Go-Ahead Group plc (Go-Ahead) and Keolis (UK) Limited (a wholly owned subsidiary of Keolis SA). Go-Ahead and Keolis own 65 and 35 per cent of Govia respectively.
Go-Ahead is a UK based transport group. It operates train services through its joint ownership of Govia, which currently operates the London Midland franchise and the Southeastern franchise. Go-Ahead also operates bus services, primarily in urban locations, including the wholly owned subsidiaries Brighton & Hove, Metrobus and Go-Ahead London.
Southern Railway Limited is a wholly owned subsidiary of Govia, and was established specifically for the purpose of pre-qualifying for, bidding for, and operating the South Central franchise (the Franchise).
Govia is the incumbent franchisee. Govia is currently operating the South Central Passenger Rail franchise via its wholly owned subsidiary New Southern Railways Limited. The necessary assets and liabilities will be transferred from New Southern Railway Limited to Southern Railway Limited according to a 'Transfer Scheme' negotiated between Govia and the Department for Transport (DfT) in advancement of the Franchise.
TRANSACTION
Govia signed the Franchise agreement on 8 June 2009 and will start operating the Franchise on 20 September 2009. It will continue to operate it until 25 July 2015. If performance targets are achieved, or if the DfT exercises its discretion, the Franchise may be extended to 22 July 2017. The OFT received a satisfactory submission by Govia on 18 June 2009 and the administrative deadline is 13 August 2009. The statutory deadline is 7 October 2009.
JURISDICTION AND PROCESS
The award of the Franchise to Govia does not constitute a concentration under the European Merger Control Regulation (ECMR) since Govia is already operating the franchise. The acquisition of the Franchise will not therefore result in a change of control under Article 3 ECMR.
The award of the Franchise to Govia constitutes an acquisition of control of an enterprise by virtue of section 66(3) of the Railways Act 1993. Govia and the Franchise have therefore ceased to be distinct. As the anticipated turnover from the first year of operating the Franchise is expected to exceed £70 million (turnover for 2008 on the Franchise was approximately £560 million) the turnover test in section 23(1)(b) of the Enterprise Act 2002 (the Act) is met. The OFT therefore believes that it is or may be the case that a relevant merger situation has been created.
During the course of the OFT's investigation, the parties submitted that they would be willing to forego the receipt of an issues paper, in the event that the OFT found that its duty to refer was triggered but that it would exercise its discretion not to refer given that the market is of insufficient importance. Since the OFT did decide that it would exercise its discretion, it did not send an issues paper to the parties. In addition, given that on a 'worst case scenario' analysis the OFT decided that it would exercise its discretion not to refer, the OFT did not consider that survey evidence (in order to determine whether bus and rail compete on particular flows) was necessary.
THIRD PARTY VIEWS
No third parties raised any competition concerns in relation to this merger.
ASSESSMENT
Govia will commence the operation of the Franchise on 20 September 2009. The merger resulted in a large number of overlaps between the Franchise and Govia's existing rail franchises and Go-Ahead's existing bus services. As in previous cases, the OFT considered the effect of the transaction on a flow by flow basis, on the basis that the degree of substitutability between different modes can vary from flow to flow.
The acquisition results in 31 rail-on-rail overlaps, four of which raise no competition concerns due to the limited pre-merger competition between the Franchise and other Govia services, or due to the presence of effective competitors.
The acquisition also resulted in 32 rail-on-bus overlaps, four of which raised no competition concerns due to the continuing presence of effective bus and rail competitors.
In line with previous decisions, the OFT considers that generalised cost arguments are not always sufficient to exclude competition concerns. However, for four flows in this case, generalised cost arguments in relation to off-peak journeys, where the OFT would expect bus and rail to compete more vigorously, were sufficiently strong to exclude the possibility of the acquisition giving rise to a substantial lessening of competition.
Taking all of the above factors into account, the OFT was not able to exclude the possibility of competition concerns arising on 27 rail-on-rail overlaps and 24 bus-on-rail overlaps. However, the OFT has not needed to reach a definitive conclusion as to whether it is or may be the case that the merger may be expected to result in a substantial lessening of competition because - even if the duty to refer is triggered - the OFT will apply its discretion not to refer the merger to the Competition Commission.
Consequently, the OFT believes that it is or may be the case that the merger has resulted or may be expected to result in a substantial lessening of competition within a market or markets in the United Kingdom pursuant to section 22(1) of the Act.
On this basis, the OFT is under a duty to make a reference to the Competition Commission. However, the OFT has considered whether it would be appropriate to exercise its discretion to apply the exception to the duty to refer pursuant to section 22(2)(a) of the Act to the facts of this case.
EXCEPTIONS TO THE DUTY TO REFER
Introduction
The OFT's duty to refer under section 22(1) is subject to the application of certain discretionary exceptions, including the markets of insufficient importance or 'de minimis' exception under section 22(2)(a), and the undertakings in lieu exception under section 73(2).
Undertakings in lieu of reference and 'de minimis'
For the reasons explained in full in the OFT's Dunfermline Press/Trinity Mirror decision, the OFT believes that it would be proportionate to refer a problematic merger (that is, not to apply the 'de minimis' exception) where the OFT considers that it is 'in principle' clearly open to the party (or parties) to offer a clear-cut undertaking in lieu of reference - but they have in fact chosen not to do so - because the recurring benefits of avoiding consumer harm by means of undertakings in lieu in a given case, and all future like cases, outweighs the one-off costs of a reference.
The OFT did not consider, based on its objective evaluation of the transaction, that this case was a clear candidate for resolution by means of undertakings in lieu. The OFT has a strong preference for structural undertakings over behavioural commitments in a problematic horizontal case. Typically, structural undertakings consist of a divestiture of one of the overlapping businesses that have led to the competition concerns. The OFT does not consider the present case clearly to fit this profile, unlike, for example, divestiture of a stand-alone business that removes the overlap in a local market.
Moreover, the OFT does not consider that a package of behavioural remedies would, in principle, clearly be available as a first-phase remedy in this case. In horizontal mergers in particular, behavioural remedies substitute price regulation for competition. Behavioural remedies in this case, therefore, fail the clear-cut standard of undertakings in lieu because, for the OFT's purposes at Phase I, they are costly and yet of questionable effectiveness.
63. The OFT therefore considers that it would not be appropriate to rule out the application of the 'de minimis' exception at this stage of the analysis.
Application of the markets of insufficient importance exception to this case
64. In the absence of any clear-cut undertakings in lieu being, in principle, available to the parties, the OFT has considered in detail whether to apply the markets of insufficient importance exception to this case. The factors that the OFT considers in determining whether it should apply its discretion in respect of the 'de minimis' exception have been set out in detail in a number of recent cases. The relevant factors are:
The OFT has considered each of the above factors in determining whether to exercise its discretion in this case.
Market size - The OFT considers that the acquisition of the Franchise creates a realistic prospect of a substantial lessening of competition on 27 rail-on-rail overlaps and 24 bus-on-rail overlaps. For the reasons given in paragraphs 17 to 23 above, the OFT considers that any consumer detriment that may arise as a result of the acquisition would be as a result of Govia's increased ability and incentive to increase unregulated rail fares or bus fares. As such the OFT considers it reasonable to exclude regulated rail fares on the potential substantial lessening of competition flows from the market size for the purposes of its de minimis calculation.
As discussed in paragraph 43 above the OFT has considered that on bus-on-rail overlaps, where Govia faces a bus or rail competitor, Govia may still have the incentive to increase prices on that mode where it does not face intra-modal competition. Therefore, for the purposes of determining the size of the market for which there could be an impact on competition (and that would be therefore relevant to the exercise of its discretion in respect of its duty to refer) the OFT has only taken into account (a) the rail revenue on those bus-on-rail overlap flows where there is a bus competitor, and (b) the bus revenue on those bus-on-rail overlaps where there is a rail competitor.
The total revenue, therefore, of the 51 flows on which the OFT has found competition concerns in this case amounts to approximately £3.7 million per annum. This is clearly less than the £10 million threshold above which 'de minimis' will not be applicable; as such, it is appropriate to consider the additional 'de minimis' factors in detail.
Strength of OFT's concerns - in respect of rail-on rail overlaps, the OFT believes, on a balance of probabilities, that the transaction may be expected to result in a substantial lessening of competition. However, in respect of bus-on-rail overlaps, which account for approximately half of the revenue on the problematic flows in this case, the strength of the OFT's concerns would appear lower, given that bus entry (which on bus-on-rail overlaps is more likely to be an effective constraint to Govia than on a rail-on-rail overlap) would be possible. However, even on this lower probability of likelihood of harm, the OFT's overall belief that harm will result from the merger, although not in itself conclusive, tends to point away from the exercise of the 'de minimis' exception in this case.
Magnitude of competition lost - the OFT has, in past decisions in relation to rail franchises, noted the special nature of rail franchise awards. In most cases considered to result in a relevant merger situation under the Act, two or more enterprises - meaning business activities of any kind - cease to be distinct and the acquirer gains unfettered commercial control over the target business post-merger. However, rail franchise awards amount to a medium-term outsourcing agreement by the government of railway services in the Franchise area, subject to regulation and potential clawback by the government, and qualifying as an 'enterprise' within the meaning of section 23 of the Act pursuant to the express provision in section 66(3) of the Railways Act 1993. While by no means sufficient to remove any competition concerns in principle, the degree of regulation and other generic features of rail franchise awards relative to general private mergers and acquisitions activity do place limits on the scale and durability of merger effects on overlap flows - especially with respect to rail services - that are not applicable more generally.
Despite its particular approach to the counterfactual in rail franchise cases the OFT had, in this case, the opportunity to assess the competitive effects of the Franchise acquisition, given that Govia is the incumbent operator and as such some of the bus-on-rail and rail-on-rail overlaps discussed above have been in place for a number of years. Where it can be demonstrated that under competitive conditions equivalent to those expected post-merger, the parties have not in fact been able to increase prices significantly, the OFT may lower its expectations of the magnitude of harm resulting from the merger.
Unregulated rail fares
In this case, Govia provided evidence that it has been constrained in raising unregulated rail fares under the current franchise agreement and submitted that this constraint may be expected to remain under the new Franchise where competitive conditions will be similar. Whilst it is theoretically possible for unregulated fares to be increased significantly by TOCs, in practice, the OFT considers for the reasons given below that regulated fares do provide at least some constraint on unregulated fares.
In the current franchise period Govia has faced a RPI+ one per cent price cap across a basket of regulated fares. Govia provided evidence which shows that the annual price rise across all unregulated fares has been the same as the annual fare increase across the basket of regulated fares, indicating that unregulated fares are to some extent constrained by regulated fares. Govia submitted that this is due to the need to maintain a price differential between peak (usually regulated) and off-peak (usually unregulated) fares, and indeed that the peak fares provide a 'ceiling' price for off-peak fares. This has also been supported by the OFT's market investigation (First Group, the ORR and the DfT have broadly confirmed this) (see Endnotes). The evidence provided suggests that even on overlap flows where there is less competition, price increases on regulated and unregulated fares have been similar (within a percentage point difference on a cumulative increase basis, with unregulated prices sometimes increasing less than regulated prices).
Given that from January 2010 each individual fare increase will be capped at RPI+ one per cent and that regulated and unregulated fares on the flows examined by the OFT in this case moved in a broadly similar manner, the magnitude of harm will not be expected to be significant as long as the RPI+ one cap is in place.
Bus fares
Govia also provided some pricing data on the relevant bus flows. [ ] As the number of flows within its network where Brighton & Hove buses does not face competition from another bus company is relatively small, the OFT considers that the constraints on the majority of flows would constrain City Saver fares across the network as a whole.
As a result of the above factors, the strength of the OFT's belief of the magnitude of harm resulting from the merger, although not in itself conclusive, tends to point towards the exercise of the 'de minimis' exception in this case.
Durability - while the duration of harm for a rail franchise would normally be expected to be over the whole duration of the Franchise (that is, six to eight years) a closer examination of the facts reveals that this is not necessarily the case. Firstly, as far as the London Victoria to Denmark Hill and the London Victoria to Peckham Rye flows are concerned, the Franchise will cease to operate these flows by May 2012 as part of the Thameslink redevelopment programme so the overlap will cease to exist. In addition, the London Midlands franchise will be retendered in six years and the Southeastern franchise in five years, so South Central overlaps with these franchises may cease to exist at that point. In addition, bus entry on routes where Govia would be able to charge higher prices due to lack of competition may be possible within the short term. The OFT therefore notes that the duration of harm could well vary for different flows and while in some cases duration of harm may point against exercising the discretion, in others, duration of harm will be limited, which may support the exercise of the 'de minimis' discretion.
Transaction rationale and value of deterrence - part of the purpose of any credible merger regime is not only to prohibit a certain class of anticompetitive mergers but to deter like transactions from being contemplated or pursued. In considering the rationale for acquiring the Franchise, the OFT discounted the notion that the acquisition of market power as a result of the problematic overlaps formed a part of Govia's rationale for its winning bid. The expected annual turnover of the Franchise clearly lies in the profit potential of operating the Franchise on an efficient fixed-term basis subject to various regulatory requirements and not in the exploitation of any lost competition on any one flow. In this context, the OFT believes that this case is particularly amenable to the application of the 'de minimis' exception because such a finding would not undermine deterrence by incentivising a similar acquisition whose motive is market power by merger.
Conclusion - overall, given the above, the OFT considers that the total impact of the merger on consumer welfare is likely to be limited, and that the costs associated with a Competition Commission inquiry are disproportionate to the prospect of benefits from such action. Accordingly, given that the OFT does not consider that undertakings in lieu are, in principle, clearly available, and taking into account all the relevant facts specific to rail franchise awards and this award in particular, the OFT exercises its discretion not to refer because the markets are of insufficient importance to warrant a reference.
DECISION
This merger will therefore not be referred to the Competition Commission pursuant to section 22(2)(a) of the Act.
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