GE’s Aborted Attempt to Merge with Honeywell Many observers anticipated significant regulatory…

GE’s Aborted Attempt to Merge with Honeywell

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 Many observers anticipated significant regulatory review of
GE’s attempt to merge with Honeywell because of the size of the transaction and
the increase in concentration it would create in the markets served by the two
firms. Nonetheless, most believed that after making some concessions to
regulatory authorities, the transaction would be approved due to its widely
perceived benefits. Although the pundits were indeed correct in noting that it
would receive close scrutiny, they were completely caught off guard by
divergent approaches taken by the U.S. and European Union (EU) antitrust
authorities. U.S regulators ruled that the merger should be approved because of
its potential benefits to customers. In marked contrast, EU regulators ruled
against the transaction based on its perceived negative impact on competitors.

Background

Honeywell’s avionics and engines unit would add significant
strength to GE’s jet-engine business. The deal would add about 10 cents to GE’s
2001 earnings and could eventually result in $1.5 billion in annual cost
savings. The purchase also would enable GE to continue its shift away from
manufacturing and into services, which already comprised 70% of its revenues in
2000 (Business Week, November 6, 2000). The best fit is clearly in the
combination of the two firms’ aerospace businesses. Revenues from these two
businesses alone would total $22 billion, combining Honeywell’s strength in jet
engines and cockpit avionics with GE’s substantial business in larger jet
engines. As the largest supplier in the aerospace industry, GE could offer
airplane manufacturers “one-stop shopping” for everything from engines to
complex software systems by cross-selling each other’s products to their
biggest customers. Honeywell had been on the block for a number of months
before the deal was consummated with GE. Its merger with Allied Signal had not
been going well, and it had contributed to deteriorating earnings and a much
lower stock price. Honeywell’s shares declined in price by more than 40% since
its acquisition of Allied Signal. While the euphoria surrounding the deal in
late 2000 lingered into the early months of 2001, rumblings from the European
regulators began to create an uneasy feeling among GE’s and Honeywell’s
management.

Regulatory Hurdles Slow the Process

Mario Monti, the European Competition Commissioner,
expressed concern about possible “conglomerate effects” or the total influence
a combined GE and Honeywell would wield in the aircraft industry. He was
referring to GE’s perceived ability to expand its influence in the aerospace
industry through service initiatives. GE’s service offerings help differentiate
it from others at a time when prices of many industrial parts are under
downward pressure from increased competition, including low-cost manufacturers
overseas. In a world in which manufactured products are becoming increasingly
commodity-like, the true winners are those able to differentiate their product
offering. GE and Honeywell’s European competitors complained to the EU
regulatory commission that GE’s extensive service offering would give it entrée
into many more points of contact among airplane manufacturers—from
communications systems to the expanded line of spare parts GE would be able to
supply. This so-called “range effect” or “portfolio power” is a relatively new
legal doctrine that has not been tested in transactions the size of this one
(Murray, April 5, 2001).

U.S. Regulators Approve the Deal

 On May 3, 2001, the U.S. Department of Justice approved the
buyout after the companies agreed to sell Honeywell’s helicopter-engine unit
and to take other steps to protect competition. The U.S. regulatory authorities
believed that the combined companies could sell more products to more customers
and therefore could realize improved efficiencies, although it would not hold a
dominant market share in any particular market. Thus, customers would benefit
from GE’s greater range of products and possibly lower prices, but they still
could shop elsewhere if they chose. The U.S. regulators expressed little
concern that bundling of products and services could hurt customers, since
buyers can choose from among a relative handful of viable suppliers.

Understanding the European Union Position

 To understand the European position, one needs to
understand the nature of competition in the EU. France, Germany, and Spain have
spent billions subsidizing their aerospace industry over the years. The
GE–Honeywell deal has been attacked by their European rivals from Rolls-Royce
and Lufthansa to French avionics manufacturer Thales. Although the EU imported
much of its antitrust law from the United States, the antitrust law doctrine
has evolved in fundamentally different ways. In Europe, the main goal of
antitrust law is to guarantee that all companies should be able to compete on
an equal playing field. The implication is that the EU is just as concerned
about how a transaction affects rivals as it is about consumers. Complaints
from competitors are taken more seriously in Europe, whereas in the United
States it is the impact on consumers that constitutes the litmus test.
Europeans have accepted the legal concept of “portfolio power,” which argues
that a firm may achieve an unfair advantage over its competitors by bundling
goods and services. Also, in Europe, the European Commission’s Merger Task Force
can prevent a merger without taking a company to court. By removing this
judicial remedy, the EU makes it possible for the regulators, who are political
appointees, to be biased.

GE Walks Away from the Deal

 The EU authorities continued to balk at approving the
transaction without major concessions from the participants, concessions that
GE believed would render the deal unattractive. On June 15, 2001, GE submitted
its final offer to the EU regulators in a last-ditch attempt to breathe life
into the moribund deal. GE knew that, if it walked away, it could continue as
it had before the deal was struck, secure in the knowledge that its current
portfolio of businesses offered substantial revenue growth or profit potential.
Honeywell clearly would fuel such growth, but the transaction made sense to
GE’s management and shareholders only if it would be allowed to realize
potential synergies between the GE and Honeywell businesses. GE said it was
willing to divest Honeywell units with annual revenue of $2.2 billion,
including regional jet engines, air-turbine starters, and other aerospace
products. Anything more would jeopardize the rationale for the deal.
Specifically, GE was unwilling to agree not to bundle (i.e., sell a package of
components and services at a single price) its products and services when
selling to customers. Another stumbling block was GE Capital Aviation Services
unit, the airplane-financing arm of GE Capital. The EU Antitrust Commission
argued that this unit would use its clout as one of the world’s largest
purchasers of airplanes to pressure airplane manufacturers into using GE
products. The Commission seemed to ignore that GE had only an 8% share of the
global airplane leasing market and would therefore seemingly lack the market
power the Commission believed it could exert. On July 4, 2001, the EU vetoed
the GE purchase of Honeywell, marking it the first time a proposed merger
between two U.S. companies has been blocked solely by European regulators.
Having received U.S. regulatory approval, GE could ignore the EU decision and
proceed with the merger as long as it would be willing to forgo sales in
Europe. GE decided not to appeal the decision to the EU Court of First
Instance, knowing that it could take years to resolve the decision, and withdrew
its offer to merge with Honeywell.

The GE–Honeywell Legacy

In an attempt to defuse criticism, particularly from U.S.
corporations, the EU’s powerful Competition Department is considering radically
changing its M&A review process. While no final decision has been made, the
proposed changes include establishing an oversight board to scrutinize the team
of officials charged with reviewing a merger and appointing a chief economist
to play a key role in M&A analysis. The Competition Department would also
allow companies under review to be able to request a two-week “cooling off”
period. This period is intended to find ways of addressing regulatory concerns
to avoid disallowing the merger. Without reforms, companies may be unwilling to
go to the lengths GE did in subjecting its proposal to the intense review of
the EU regulators. The issues raised in this deal could discourage big mergers
by making their likelihood of receiving regulatory approval less predictable.
To the extent that cross-border transactions contribute to improved
efficiencies, the EU’s decision could reduce efficiency not only in Europe but
also around the world. It is more important than ever for government
policymakers in different parts of the world to confer to resolve fundamental differences
in antitrust policies if the full economic benefits of globalization are to be
realized. If global antitrust policy is made consistent across countries,
cross-border mergers could contribute to improved efficiency, lower prices, and
higher living standards.

Case Study Discussion Questions

1. What are the important philosophical differences between
U.S. and EU antitrust regulators? Explain the logic underlying these
differences. To what extent are these differences influenced by political
rather than economic considerations? Explain your answer.

2. This is the first time that a foreign regulatory body has
prevented a deal involving only U.S. firms from occurring. What are the
long-term implications, if any, of this precedent?

 3. What were the major stumbling blocks between GE and the
EU regulators? Why do you think these were stumbling blocks? Do you think the
EU regulators were justified in their position?

 4. Do you think that competitors are using antitrust to
their advantage? Explain your answer.

 5. Do you think the EU regulators would have taken a
different position if the deal had involved a less visible firm than General
Electric? Explain your answer.

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