Ardent Mills Merger Completes After Finding Upfront Buyer for Divestiture

June 2, 2014 at 3:18 pm

On May 20, 2014, the Department of Justice (“DOJ”) announced that it will require Ardent Mills, a proposed merger of the wheat milling operations of the companies ConAgra, Cargill, and CHS, to divest four competitively significant mills to an upfront buyer before clearing the deal for approval.

These four mills are located in regions encompassing major metropolitan areas, such as Los Angeles, San Francisco/Oakland Bay, Dallas, and Minneapolis-St. Paul, and the DOJ believes the divestitures will retain competition for wheat millers in those regions after the merger, and result in lower prices to consumers for wheat flour and related products, such as bread, cakes, and crackers.

The merger was announced on March 5, 2013 by a joint press-release from ConAgra, Cargill and CHS. The merger will combine ConAgra Mills, a subsidiary of the food-giant ConAgra, and Horizontal Milling, a joint-venture of Cargill and CHS, to form the largest wheat milling company in the United States with a combine market share of 30%. While the merger was initially planned for the last quarter of 2013, regulatory hurdles and anti-trust concerns from both the DOJ as well as non-government organizations (“NGOs”) delayed it completion until May 29, 2014, shortly after the DOJ announcement of the divestiture requirements.

Background

Wheat is possibly the first agricultural crop to be farmed intensively by humans—the earliest samples of wheat grains from the Middle East dates back over six thousand years. Wheat’s popularity as a staple food has continued into the present day, and, in its grain form—flour, it is used in a myriad of modern foodstuffs, such as bread, cakes, cookies, pasta, and crackers. Different types of flours produce different types of food items, and a wheat mill generally turns wheat grains into specific types of flour.

Wheat flour is generally separated into two types: hard or soft. Hard flour has higher gluten content. It is primarily used to make tougher and chewier foods such as pasta, pizza dough, and bread. Soft flour, in contrast, has lower gluten content, and it is primarily used in lighter and flakier foods such as cake, crackers, and cookies. Hard and soft flour are generally non-substitutable due to their aforementioned characteristics, and a small, but significant and non-transitory increase in price for one type of flour will not lead to a substitution effect in terms of consumer demand for the other type. Most wheat mills, which process raw wheat grains into flour, specialize in producing either hard or soft flour. Aside from “swing mills” that has the equipment to produce both types of flour, processing the opposite type of flour will usually result in a large drop of efficiency at the mill.

The price of a mill’s flour is generally determined by the following five factors: the price of wheat, which is usually determined by the price on an organized wheat market; the “basis,” which accounts for the difference between the organized wheat market price and the local price for a miller; the “millfeed credit,” which is based on the price at which a miller can sell wheat middlings, milling by-products that are used as animal feed; transportation costs, i.e., the cost of delivering flour from the mill to the customer; and finally the “block,” which covers the cost of converting wheat into flour. The first four factors are heavily dependent on the geographical location of the particular mill or forces beyond the control of the mill owner, and they form by far the largest component of the price of a mill’s flour. Mills compete primarily through the “block” cost, even though it is a small part of the overall price of the flour. Given that millers compete over such a minute part of their overall cost, lower transportation costs become an important advantage for certain millers, even though transportation costs are also a relatively small part of the overall cost of producing flour. As a result, a mill typically serves an area that stretches 150-200 miles from its location. If there are multiple mills within a geographic market of that size, customers will play the mills off of each other to obtain the best prices.

Existing Market Share and Concentration

The DOJ identified four relevant markets for the merger—Northern California (containing the San FranciscoBay metropolitan region), Southern California (containing the Los Angeles-San Diego metropolitan region), Northern Texas (centered on the Dallas-Fort Worth metropolitan region), and the Upper Midwest (centered on the Minneapolis-St. Paul metropolitan region). The proposed Ardent Mills would control approximately 70 percent of hard wheat flour milling capacity within 200 miles of San Francisco. In Southern California, it would own more than 40 percent of hard wheat flour milling capacity, and approximately 70 percent of soft wheat flour milling capacity, within 200 miles of Los Angeles. In Northern Texas, it would own more than 75 percent of hard wheat flour milling capacity, and 100 percent of the soft wheat flour milling capacity, within 200 miles of Dallas-Ft. Worth. In the Upper Midwest, it would own more than 60 percent of hard wheat flour milling capacity within 200 miles of Minneapolis-St. Paul. The DOJ recognized that Ardent has significant market power, and can raise its price by a small, but significant and non-transitory amount without repercussions, due to the local nature of mill operations and the inelasticity of the demand for wheat.

In addition, Ardent would also remove consumer’s ability to lower prices by playing competing mills off of each other. The DOJ found that Horizon and ConAgra are major competitors, especially in the aforementioned geographical markets. Horizon and ConAgra mills tend to offer the lowest prices compared to other millers and compete aggressively among themselves. The formation of Ardent Mills would eliminate that competition, resulting in higher hard wheat flour prices for customers in Northern California, Southern California, Northern Texas, and the Upper Midwest, and higher soft wheat flour prices for customers in Southern California and Northern Texas.

The merger may also lead to other anti-competitive effects, such as mill closures, lowering the supply of hard and soft flour to the market leading to higher prices, as well as price coordination opportunities due to the reduction in competing mills. The former is likely, because Ardent will be in control of a wide array of mills operating on various levels of cost. It may choose to shut down high-cost mills, which would have the added effect of reducing the supply, and increasing the price of flour. The latter is likely because the reduced number of players in highly concentrated market would make coordination easier. The transparency of the wheat market also means most millers already know their competitors costs, capacity utilization, output and prices. In addition, since Cargill and CHS also supplies mills outside of Ardent with wheat, the combined entity is likely to also know competitors’ costs and strategies based on their purchasing patterns. Ardent, as a result, is likely to be armed with a high level of information that it can use to make any coordination attempts more likely and more durable.

Finally, the DOJ does not believe market entry is sufficient, likely or timely to offset the potential anticompetitive effects of the merger. Wheat milling is a stable industry in terms of both demand and margins, which reduces the incentive of investments into new milling capacity. It also is unlikely that entry by more distant mills will be timely, likely, or sufficient due to the additional cost and inconvenience associated with transportation of flour, which renders it an unacceptable option for many customers.

Remedy Required a Divestiture to an Upfront Buyer

As a result, the DOJ ordered Ardent to divest four mills in each of the relevant geographical markets upfront, before the completion of the merger, to Miller Milling Company LLC, a subsidiary of the Japanese firm, Nisshin Foods.  The four mills are: ConAgra Mills’ Oakland, California; Saginaw, Texas; and New Prague, Minnesota mills; and Horizon Milling’s Los Angeles mill.

What makes this antitrust review interesting is that the Antitrust Division required an upfront buyer. Unlike the Department of Justice’s Antitrust Division, the FTC historically has required merging parties to identify buyers of assets to be divested before the agency will accept a consent agreement. This approach requires the acquiring firm to execute a divestiture agreement and all ancillary agreements with a divestiture buyer before the parties formally present that buyer to the FTC for approval. The FTC staff then reviews the qualifications of the upfront buyer and the definitive divestiture agreement and, once satisfied, submits the identity of the buyer and agreement along with the consent agreement and decision and order to the Commissioners, who must vote whether to approve the package. Generally, the FTC requests parties to delay the closing of their transaction until the Commission approves the package.

The FTC posits that the upfront buyer requirement minimizes the risk that a remedy will fail to preserve competition in cases where the agency is concerned about the adequacy of the divestiture package, the lack of acceptable buyers or the deterioration of the assets pending divestiture. An upfront buyer is likely to be required when the parties seek to divest a package of assets comprising less than an autonomous, ongoing business.

The Antitrust Division, however, generally believes that “an acceptable buyer should be forthcoming” if the Division has properly specified “in the decree the appropriate set of assets to be divested quickly” after the transaction closes. See U.S. Dep’t of Justice, Antitrust Div., Antitrust Division Policy Guide to Merger Remedies, Part IV.D n.42 (Oct. 2004). While the DOJ has required upfront buyers in a few cases in the past, it is unusual but not unprecedented.

Lesson Learned

Has the DOJ changed its policy with regards to requiring upfront buyers? We don’t think so. In discussing the proposed final judgment requiring the sale of the four mills, the DOJ explained that an “upfront buyer” was needed to be sure the new owner had the wherewithal to be “an effective, long-term competitor in the production and sale of flour.” A specific concern the consent judgment seeks to address along these lines was ensuring the buyer of the mills would be able to assemble an effective management team and other personnel. Therefore, we do not believe that the Antitrust Division is signaling a change in policy rather the remedy required in this investigation demonstrates that when the circumstances warrant an upfront buyer, the Antitrust Division will require one.

 

Andre Barlow
202-589-1838
abarlow@dbmlawgroup.com

Mark Ye
202-589-1834
mye@dbmlawgroup.com