Completed acquisition by Air France Finance S.A.S / City Jet Ltd of VLM Airlines N.V.

Affected market: Passenger air transport services

No. ME/3535/08

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, jurisdiction, third party views, assessment and decision.

The OFT's decision on reference under section 22(1) given on 9 May 2008. Full text of decision published on 10 June 2008.

Please note that square brackets indicate text or figures which have been deleted or replaced with a range at the request of the parties and third parties for reasons of commercial confidentiality.

PARTIES

Air France KLM S.A. (AFKL) is active principally in air transportation (passengers and freight) but also in ground services (for example, passenger handling). AFKL owns over 92 per cent of the economic rights in KLM Royal Dutch Airlines (KLM), a Dutch registered international carrier operating scheduled cargo and passenger services to more than 90 destinations principally from Amsterdam. AFKL is a founding member of the SkyTeam Alliance and has two international hubs at Amsterdam Schiphol and Paris CDG airports. AFKL's vehicles for this acquisition are its wholly-owned subsidiaries, Air France Finance S.A.S., and the latter's subsidiary, City Jet Ltd (City Jet), a regional European airline serving ten of its current seventeen routes from its hub at London City Airport.

VLM Airlines N.V. (VLM) is a Belgian-registered regional airline. VLM is active in the supply of scheduled short-haul point-to-point passenger air transport services, primarily focused on business customers. For the IATA summer 2008 season, VLM operates eight routes on a reverse-hub basis at London City Airport, with most of its aircraft and personnel based in The Netherlands and in Belgium.

TRANSACTION

The transaction comprises the acquisition by Air France Finance S.A.S. ([…]) of the entire issued share capital of VLM together with […] Fokker 50 aircraft for €[…].

The transaction was completed on 14 February 2008. The OFT's statutory deadline in the present case is therefore 14 June 2008. The parties submitted an informal merger notification on 22 February 2008. The OFT's extended administrative deadline expires on 9 May 2008.

JURISDICTION

As a result of this transaction, AFKL and VLM have ceased to be distinct. In the year ended 31 December 2006 (last financial year for which audited financial information is available), VLM generated a UK turnover of £[…], which, accordingly, does not satisfy the turnover threshold set out in Section 23(1)(b) of the Enterprise Act (the Act).

However, the transaction qualifies as a relevant merger situation on the share of supply test set out in Section 23(4) of the Act as the parties' combined share of supply in the UK for scheduled air transport services between Amsterdam and LCY (in which both parties are active) exceeds the 25 per cent threshold.

THIRD PARTY VIEWS

From twelve questionnaires sent to competing airlines, eight responded to the OFT. One other airline sent unsolicited comments. Five respondents express concerns essentially about the merged entity servicing over half the slots operated at LCY which is capacity constrained at peak times.

Another respondent, not active at LCY but operating services to AMS from LHR, reports not having any meaningful views on the merger. It confirms however that LCY might be constraining LHR.

Two other unconcerned respondents form the view that the London market is sufficiently competitive and that passengers have enough alternatives to turn to. One of them notes that increasingly, airlines are using all the London airports to provide services.

The OFT also contacted 21 of the parties' customers: their largest corporate customers and the major travel agencies working with the parties. From the four responses collected by the OFT, one agency, unconcerned, indicates that customers might accept a price rise implemented by the merged entity as a price for convenience of location.

Two other respondents say that they would be in a position to react to a price rise, due to length of relationship and volume spent with the merged entity. Nevertheless, one of them indicates that the monopoly position arising as a result of the merger will inevitably affect its negotiation position.

Finally, another respondent expresses its concern mainly driven by the expected price increase due to the monopoly situation arising as a result of the merger.

ASSESSMENT

The OFT's competitive assessment in this case focuses on (i) direct, scheduled leisure passenger air transport services on LON-AMS, (ii) direct, scheduled business passenger air transport services on LCY-AMS, (iii) direct, scheduled leisure passenger air transport services on LON-RTM. The transaction does not give rise to any horizontal overlap for direct, scheduled business passenger air transport services to RTM, however, the OFT also evaluates (iv) the issue of potential competition on the non-overlap LCY-RTM (business) route.

On LON-AMS (leisure), the OFT considers that the merged entity, whose combined share of supply ([0-10] per cent increment) amounts to [20-30] per cent, faces sufficient competitive constraints not to give rise for concerns over unilateral effects on this route.

On LCY-AMS (business), the transaction creates very high combined shares of weekly capacity and frequency in excess of 70 per cent. Notwithstanding BA's recent entry, the merging parties are closest competitors on LCY-AMS: KLM and VLM remain by a large margin the top two choices for business passengers requiring morning and evening peak outbound and inbound flights between LCY and AMS; they will uniquely provide UK business passengers with a schedule of multiple peak-time departures and arrivals and the schedule flexibility that such time-sensitive customers require.

Furthermore, the OFT has seen insufficient evidence to suggest that competitive responses by BA (from LCY and LHR), bmi (from LHR), or new entrants, could replicate the lost competition between the parties, because all such players would face the binding airport capacity constraints that limit the addition of flights at peak times from LCY (or indeed from LHR). Nor is the available evidence on buyer power or efficiencies such as to resolve these concerns.

Accordingly, the OFT is under a duty to refer on the basis of the serious unilateral effects concerns arising on the LCY-AMS route (business) as a result of the transaction.

On LON-RTM (leisure), pre-merger the parties were the only airlines operating services between LON and RTM (VLM operated a service from LCY, AFKL operated a service from STN via its subsidiary Transavia and KLM operated a service from LHR). Accordingly, the merger prima facie leads to a monopoly on LON-RTM. When testing against the pre-merger conditions, the OFT considers that entry would be unlikely to constrain the merging parties post-merger. However, the OFT believes that the parties arguments on the correct counterfactual meet the high evidentiary threshold required to demonstrate that AFKL would have exited the STN-RTM and LHR-RTM routes with or without the merger. Consequently, the OFT finds no lessening of competition between existing, actual services caused be the merger on LON-RTM (leisure).

On LCY-RTM (business), the OFT considers whether AFKL could have been regarded as well or best placed as a potential entrant onto a new LCY-RTM route. Although the possibility of entry onto LCY-RTM has been raised within AFKL, the OFT however considers that the capacity constraint at LCY during peak times renders the likelihood of entry by AFKL low. In addition, the OFT finds AFKL to be no better placed than BA to obtain the necessary additional slots to commence a new service or flex its existing slot portfolio at LCY. Consequently, the OFT concludes that the removal of AFKL as a potential entrant (actual or perceived) does not give rise to a realistic prospect of a substantial lessening of competition on LCY-RTM.

UNDERTAKINGS IN LIEU

Where the duty to make a reference under section 22(1) of the Act is met, pursuant to section 73(2) of the Act, the OFT may, instead of making such a reference, accept from such of the parties concerned undertakings as it considers appropriate for the purpose of remedying, mitigating or preventing the substantial lessening of competition concerned or any adverse effect which has or may have resulted from it or may be expected to result from it.

Pursuant to section 73(3) of the Act, in considering whether to exercise its discretion to accept such undertakings, the OFT is required, in particular, to have regard to the need to achieve as comprehensive a solution as is reasonable and practicable to the substantial lessening of competition and any adverse effects resulting from it.

The OFT's guidance states that in order to accept undertakings in lieu of reference 'the OFT must be confident that the competition concerns identified can be resolved by means of undertakings without the need for further investigation. Undertakings in lieu of reference are therefore appropriate only where the competition concerns raised by the merger and the remedies proposed to address them are clear cut, and those remedies are capable of ready implementation.'[see footnote 1]

AFKL's offer of undertakings in lieu of reference

AFKL has indicated during the course of the OFT's investigation that, notwithstanding its arguments as to why the test for reference is not met, to the extent that the OFT did find competition concerns on the LCY-AMS route, AFKL is prepared to resolve these by means of the provision of suitable undertakings in lieu. Given AFKL's constructive approach to this question, the case team has been able to give AFKL its view as to what undertakings in lieu would be likely to be acceptable (or not acceptable) in the event that the decision maker ultimately concluded that the test for reference was met.

AFKL submits the following undertakings in lieu to resolve the OFT's concerns in respect of the overlap on LCY-AMS by allowing a purchaser to replicate the constraint provided pre-merger by AFKL on the LCY-AMS route:

• to the extent that the purchaser is unable to secure the appropriate slots at LCY from LCY's slot coordinator ACL, divestment [see endnote 1] of up to three slots at LCY during the morning peak period [^ see footnote 2] and up to four slots at LCY during the peak evening period [see footnote 3] to be used by the purchaser for LCY-AMS
• divestment of a parking stand for an early flight at LCY to the extent ACL was not able to make an overnight parking stand available to the purchaser, and
• to the extent that the purchaser is unable to secure the appropriate slots at AMS from the slot co-ordinator, divestment of the necessary corresponding slots at AMS.

In line with guidance from the case team, AFKL offers to make the required slot divestments to an up-front buyer, that is to a purchaser approved by the OFT in advance of the acceptance of undertakings in lieu. However, AFKL specifies that the number of slots offered for divestment will be reduced to the extent that the identified purchaser already operates a service between LCY-AMS in the relevant time periods (that is, effectively, where BA was the relevant purchaser [see footnote 4]).

Assessment of the undertakings in lieu

The OFT's starting point in approaching undertakings in lieu is that it will seek to ensure that competition is restored to pre-merger levels. This straightforward approach is consistent with the broad margin of assessment bestowed upon the OFT by sections 73(2) and 72(3) of the Act. It is incumbent on the merging parties to satisfy the OFT (without requiring the OFT to conduct a detailed investigation) that any alternative proposed remedy clearly and comprehensively removes the substantial lessening of competition even though it does not restore competition to pre-merger levels. [see footnote 5]

In this case, the OFT's starting position is therefore that the undertakings in lieu should replicate the competitive constraint lost through the merger. In this case, the substantial lessening of competition in question is derived from the importance to business passengers of being able to rely on a frequent LCY-AMS service operating at peak times of the day. Given that, pre-merger, KLM operated a fewer number of services during peak times than VLM did, the constraint lost by the merger is therefore most clearly resolved by a remedy in which a carrier other than the merging parties provided the same number of daily services from LCY-AMS, operating at times equivalent to those operated pre-merger by KLM.

The parties' offer to divest up to three slots during the morning peak and up to four slots during the evening period is therefore, in principle, a clear-cut solution to the competition concern identified. To the extent that the required number of slots are divested to an existing carrier that is already present during the early morning and early evening peak (that is, in this case, to BA), it is clear that AFKL would need to divest one less slot in each time period to replicate KLM's pre-merger frequency.

The OFT does not have information on the availability of free slots at corresponding times of the day at AMS. However, the undertakings in lieu offer provides that, to the extent that free slots are not available from the AMS slot co-ordinator, AFKL is also prepared to divest suitable slots in order for the purchaser in question viably to operate an equivalent LCY-AMS service to that operated pre-merger by AFKL.

The OFT has considered carefully whether it would be sufficient for AFKL to make the relevant number of peak-time slots at LCY available to a carrier that wished to operate on the LCY-AMS route, without actually requiring that those slots be immediately transferred. Holding the slots open in this manner would address the issue of capacity constraints at LCY during the peak periods, thereby removing the principal entry barrier for any carrier that wished to enter the LCY-AMS route. However, KLM provided direct actual competition on the route and the OFT seeks to restore that constraint via undertakings in lieu by safeguarding that there will be actual competition on the route post-divestment, not merely perceived potential competition.

In the circumstances of this case, the OFT considers that a necessary requirement to suspend the duty to refer and consider undertakings in lieu is that divestment of the slots described above should be to a suitable purchaser provisionally approved by the OFT before the OFT publicly consults on the undertakings prior to acceptance.

Given the nature of slot divestments remedies, and the need for a prospective purchaser to plan its future timetable and to advertise its future new services sufficiently far in advance, the OFT recognises that a carrier acquiring the divested slots from AFKL will not be able to begin its services immediately. However, the OFT considers that such an operational delay does not undermine the importance of AFKL securing a contractual agreement with an up-front buyer such that the buyer will commit to acquire the slots before the OFT accepts undertakings in lieu. In this regard, the OFT can be certain that, notwithstanding any operational delay, competition will be restored on the LCY-AMS route to pre-merger levels within the short term.

On the basis that AFKL offers to divest the number of slots necessary to restore the pre-merger competitive constraint provided by KLM to an upfront buyer, the OFT is currently of the view that the proposed undertakings in lieu-assuming they are capable of being implemented-will restore competition to pre-merger levels. It considers that the undertaking offered is sufficiently clear cut to remedy the concerns identified, namely the substantial lessening of competition in the supply of airline services for business passengers on the LCY-AMS route.

Therefore, the OFT has decided to exercise its discretion under section 73(2) of the Act to suspend its duty to refer to consider whether to accept undertakings in lieu of a reference.

DECISION

The OFT's duty to refer the completed acquisition by Air France Finance / City Jet of VLM Airlines to the Competition Commission pursuant to section 22 of the Act is suspended because the OFT is considering whether to accept undertakings in lieu of reference from the AFKL group pursuant to section 73 of the Act.

ENDNOTE

1. Given that slots in the sense of the EU slot regulation do not exist at LCY, AFKL may have to seek permission from LCY to be able to divest slots held at LCY to another carrier.

FOOTNOTES

1. See paragraph 8.3 of OFT Mergers Substantive Assessment Guidance.

2. This was defined as being 06:30-10:00.

3. This was defined as being 16:00-20:00.

4. In the IATA summer season 2008, BA operates a service to AMS at 08:55 during the morning peak period and at 18:55 during the evening peak period.

5. See Co-operative Group (CWS) v OFT [2007] CAT 24.

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