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Tongaat-Hulett Group Limited and Transvaal Suiker Beperk Middenen Ontwikkeling (Pty) Ltd / Senteeko (Edms) Bpk / New Komati Sugar Miller's Partnership TSB Bestuursdienste (83/LM/Jul00) [2000] ZACT 47 (27 November 2000)

.RTF of original document


IN THE COMPETITION TRIBUNAL
REPUBLIC OF SOUTH AFRICA



Case No: 83/LM/Jul00

In the large merger between:

The Tongaat-Hulett Group Limited

and

Transvaal Suiker Beperk, Middenen Ontwikkeling (Pty) Ltd, Senteeko (Edms) Bpk, New Komati Sugar Miller’s Partnership, TSB Bestuursdienste




Reasons for the Competition Tribunal’s Decision



APPROVAL/PROHIBITION

1.      
We prohibit the transaction between the Tongaat-Hulett Group Limited and Transvaal Suiker Beperk. The reasons for our decision are set out below.


BACKGROUND

2.      
In this section we first describe the transaction. Secondly, we provide a brief overview of the major players in the South African sugar industry. Thirdly, we identify key features of the regulatory regimes that characterize the sugar industry both in South Africa and abroad.

The Transaction

3.      
The proposed transaction involves the acquisition of the Transvaal Suiker Beperk (TSB) group of companies by the Tongaat-Hulett Group Limited (THG).

4.      
The TSB group of companies include:
 •         Transvaal Suiker Bpk,
 •         Middenen Ontwikkeling (Pty) Ltd,
 •         Senteeko (Edms) Bpk,
 •         New Komati Sugar Millers Partnership and
 •         TSB Bestuurdienste (Pty) Ltd.

5.      
THG will acquire the sugar, molasses and animal feed business of TSB as a going concern. Tongaat will also acquire the issued share capital of TSB Bestuurdienste (Pty) Ltd.

6.      
THG is controlled by Anglo South Africa (Pty) Ltd, which, in turn, is controlled by the Anglo American Corporation of South Africa Ltd and, ultimately, by Anglo American PLC. Tongaat Hullett Sugar (THS) is the South African sugar division of THG and is involved in a wide range of activities in the sugar industry. Apart from its mills in South Africa it also owns 100% of Triangle Sugar Ltd in Zimbabwe and its parent, Anglo American PLC, owns 51% of Hippo Valley Estates Ltd in Zimbabwe. The group has recently invested in packaging operations in Namibia and has also acquired interests in two sugar mills in Mozambique.

7.      
The Rembrandt Group Ltd, through Hunt Leuchars & Hepburn Holdings Ltd (HL&H), ultimately controls the TSB group of companies. TSB primarily conducts business within the sugar industry and, to a lesser extent the citrus industry. It is not selling its citrus business. TSB does not have sugar producing assets in any other country.

8.      
Rembrandt informed the Tribunal that it was selling TSB because it has not achieved satisfactory returns on investment due to, inter alia, its inability to achieve economies of scale, the deregulation of the sugar industry since 1994 and a drop in the world sugar price. It has therefore decided to disinvest from sugar because it believes that TSB is too small to obtain the critical mass necessary to achieve acceptable returns. The Tribunal was informed that HL&H had, over the past decade, unsuccessfully attempted to merge TSB with other sugar companies.

9.      
THS, for its part, informed the Tribunal that the reason for the transaction was that for a number of years it has been implementing a strategy to expand and rationalize its production base to achieve lower costs of production. In line with this strategy it has, via its land sale program and long-term cane supply agreements, reduced its exposure to cane growing in South Africa by 30% since 1996. However, the major milling assets remain within the same geographic area (Kwa-Zulu Natal North Coast) and cane supply is largely rain fed. The acquisition of TSB therefore gives rise to further opportunities for THS to shift its production base to lower cost areas, whilst at the same time realizing value for redundant assets to part-fund the acquisition and reducing the risks of dry-land farming.





Key players in the South African Sugar Industry

The primary sugar industry – the sugar cane growers

10.     
In South Africa sugar is produced almost exclusively from sugarcane. The high bulk/low value of sugar cane and the fact that the cane must be milled immediately after cutting creates a regional relationship between cane growers and millers. Growers, the parties assert, are bound to a single regional miller thus eradicating competition at the level of cane procurement.

11.     
In South Africa primary cane production is undertaken by more than 53 000 registered cane growers comprising approximately 2000 large-scale farmers, farming on freehold land, and approximately 51 000 small scale growers. South Africa has 15 mills with a total milling capacity of more than 2.5 million tons. The small-scale growers are responsible for 18% of the total average cane production of 22,2 million metric tons.

12.     
Milling companies currently own about 16% of the land under cane. It appears that most of this land was purchased defensively to avoid it being lost to timber production. Two of the milling companies have already introduced schemes to dispose of portions of their land to create new opportunities for the development of medium-scale black farmers.

13.      The South African sugar industry alone employs about 130 000 people directly and a further 110 000 indirectly.

The secondary sugar industry – the millers

14.     
Illovo is the largest of the South African sugar producers and produces 1,2 million tons of raw sugar per annum. The geographical spread of Illovo’s mills in South Africa range from Pongola in the north of Kwazulu-Natal to Umzimkulu on the lower south coast. Illovo operates seven sugar mills, four of which have refining facilities. Approximately 15% of Illovo’s cane is irrigated and 85% is rain-fed. Illovo has significant access to preferential markets in the EU and USA, by reason of its investments in Swaziland, Malawi, Mauritius and Tanzania.

15.     
THG’s sugar division, THS, is the second largest in South Africa and produces approximately 900 000 tons of raw sugar per annum in five mills all located on the Kwa-Zulu Natal north coast between Durban and Richards Bay. It has a central refinery based in Durban with a capacity of 650 000 tons of refined sugar per annum. Like Illovo its cane supply is largely rain-fed with some 13% of its supply being irrigated. THS is internationally cost competitive due to the scale of its refinery and its predominantly larger sized mills. However it faces a higher exposure to world market prices than Illovo. Less than 1% of THS’s production receives preferential market prices compared with Illovo’s 21%. Less than 1% of TSB’s output receives preferential market prices. THS has recently acquired interests in two mills in Mozambique and it owns 100% of Triangle Sugar Ltd in Zimbabwe. It is also invested in packing operations in Botswana and Namibia.

16.     
TSB is the third largest sugar producer in South Africa and has two sugar Mills in Mpumalanga, Malelane and Komati, together producing 440 000 tons of sugar per annum i.e. 17% of South African production. Its entire cane supply is irrigated and after the Maguga dam is completed in 2002 it will have two years water security from dams on all the major rivers in the area. The Malelane mill has an annexed refinery with a capacity of 320 000 tons including off-crop refining. It also farms 8000 ha of cane land, producing 850 000 tons of cane.


The Regulatory Framework

17.     
Across the world, the production and consumption of sugar is subject to massive regulatory intervention. In evaluating this merger considerable attention has been given to the interplay between regulation and competition, between regulation in the rest of the world and regulation in South Africa, and between competition in the rest of the world and competition in South Africa.

General Characteristics

18.     
The sugar industry, internationally, is influenced by the following:

•         75% of sugar produced worldwide is consumed in the countries in which it is produced with only the balance, or surplus, entering world trade. As such, the world sugar market is considered to be a residual market, that is, a market into which only sugar surplus to domestic needs is sold, and from which sugar is bought only if domestic production falls short of domestic requirements. The residual nature of the market combined with the vagaries of agricultural production makes sugar the most volatile of all commodity markets;

•         The domestic markets of net-exporter sugar producers are regulated and protected from the volatility of residual world market prices by tariff and/or non-tariff barriers. World prices are below average production costs in the majority of sugar producing countries;

•         Domestic market prices in net-export sugar producing countries are higher than the world market price;

•         Preferential trade agreements distort the market. The EU and the US operate the largest preferential access arrangements. South Africa does not benefit at all from the European agreement and it has a token preferential allocation into the US market;

•         Farmer support, such as the Common Agricultural Policy (CAP) in the EU, the Farm Bill in the USA and the fuel alcohol program in Brazil, together with high domestic prices, enable high cost producers to sustain export production – one of the largest exporters (the EU) is also one of the highest cost producers;

•         Government sanctioned export quotas exist in one form or another in all net-exporting sugar producing countries. Many achieve this via single-channel export regulations.

General Features of the South African Regulatory Regime

19.     
The South African industry is a world class, cost competitive producer of high quality raw and white sugar. It is a diverse industry combining the agricultural activities of sugar cane cultivation with the production of sugar, syrups, specialty sugars, and a range of by-products. It has sophisticated research and training facilities that are available to other SADC sugar producers.

20.     
Sugar cane is grown in fifteen cane producing areas extending from Northern Pondoland in the Eastern Cape Province through the coastal belt and Midlands of Kwa-Zulu Natal to the Mpumalanga Lowveld. Of the 424 444 hectares currently under sugar cane production, about 68% is grown within 30 km of the coast, 17% in the Midlands of Kwa-Zulu Natal and 15 % is grown in the northern irrigated areas that comprise Pongola and the Mpumalanga Lowveld.

21.     
There are 16 mills, 8 are owned by Illovo Sugar Ltd, 5 by Tongaat-Hulett Sugar Ltd, two by Transvaal Suiker Beperk and 1 by a co-operative. Four of the Illovo mills and one TSB mill have refineries attached to them. Tongaat-Hulett Sugar owns a stand-alone refinery in Durban.

22.     
According to 1998 International Sugar Organization figures, South Africa is the eleventh biggest producer of sugar, the eighteenth biggest consumer of sugar and the ninth lowest cost exporter in the world, with sugar mills currently attaining the highest capacity utilization by international comparison. Two of its neighboring industries, Zimbabwe and Swaziland, are respectively ranked second and third lowest-cost exporters in the world.

23.     
The South African Sugar Industry is protected against sugar imports from:

•         Swaziland, by an inter-governmental accord on access by Swazi producers to the South African market as members of the Southern African Customs Union (SACU).

•         Zimbabwe, by an import tariff on direct imports of sugar, and via value addition criteria in respect of sugar imported from that country into Namibia and Botswana (both members of SACU) under bilateral trade agreements with those two countries.

•         The rest of the world, by an import tariff. South African sugar producers are not protected from imports by non-tariff barriers as is the case with many other producer nations. Consequently, for as long as domestic sugar is priced at or below the cost of imported sugar – being the sum of the world price, the tariff and various other transport and transaction costs, in other word, the import parity price - it will not be economically viable for any person to import sugar into South Africa. However this is the ceiling price, that is, should the domestic sugar price exceed import parity, South African producers will be acutely vulnerable to international competition.

24.     
Swaziland is in a unique position in the context of the South African Sugar Industry. Swaziland forms a part of SACU and as such Swaziland’s sugar exports to South Africa are not subject to duties or other importation restraints. The South African and Swaziland sugar industries have reached an accord in terms of which Swaziland sugar enjoys access to the South African market, achieving a share of 18,2% of the SACU market in 2000/01 sugar season, equal to some 243 000 tons sugar sales into South Africa.

25.     
The South African Sugar Association (SASA) is an autonomous organization and operates in terms of the Sugar Act and Sugar Industry Agreement. It administers the interface between the Cane Growers’ Association and the Sugar Millers’ Association, each of whom have 11 members on the council of SASA. It provides specialist services to the industry and determines the notional price, used in calculating the equitable sharing of proceeds, as well as the quantities of sugar required for the local market and the export market.

26.     
The Sugar Act, 1978, provides for the establishment of a Sugar Industry Agreement that constitutes subordinate legislation and enables the industry to regulate itself and to take decisions on key marketing questions such as the volume of sugar to be exported in terms of the single channel export market. The Minister of Trade and Industry has approved a review of the Sugar Act, the aim of which is to ensure that the Sugar Act only provides for or enables government approved intervention in the sugar industry.

27.     
The Sugar Industry Agreement 2000, which was published in May 2000, addressed some deregulation and restructuring issues such as:

•         The replacement of the maximum industrial pricing system with a notional pricing system,

•         The replacement of a cane payment system based on sucrose content with a system based on the recoverable value of cane,
 •         The selling of sugar on an ex-mill basis instead of a free-on-rail Durban basis, which allows for competition based on geographical location and mill efficiencies; and

•         The limitation of sugar exports undertaken by the Sugar Association in terms of the single-channel export provision to indirect consumption raw sugar, with refined sugar being directly exported by refineries themselves.

28.     
The provisions of the Sugar Act are supported by three regulatory ‘pillars’. These are, firstly, the tariff that protects the domestic market against low world sugar prices. Secondly, the equitable proceeds arrangement that provides for the equitable sharing of industry proceeds, or, expressed differently, equitable exposure to the world market, as between cane growers and millers and between the various millers. Thirdly there is the single channel export arrangement. A maximum price arrangement was maintained until the end of September in order to prevent the industry from exploiting the market through inflated prices caused by artificially created shortages in domestic supply. It was, however, abandoned after the implementation of a new duty structure at the end of September 2000.

The Tariff

29.     
Before September 2000 the formula for determining the tariff was designed to achieve import parity at Durban free-on-rail for refined sugar. The world price indicator used was the London Futures Market No. 5 contract for refined white sugar. Added to this was an amount of $33 for freight and insurance. Any adjustment to the tariff level was triggered when the 20-day moving world price was changed by 10% - as world market prices declined, the duty would compensate by rising, and vice-versa. It was also triggered when the domestic price was changed by more than 4%.

30.     
The only limit to the level of the duty is South Africa’s agreed WTO commitments, set out in schedule XVIII of the Agreement. South Africa bound itself to a maximum ad valorem duty of 105% of the 20-day moving world price average.

31.     
The new tariff is a dollar-based reference price system to protect the industry against imports. The new system no longer caters for domestic price increases. The domestic sugar price is derived from the long-term average world price of sugar. The tariff is calculated in relation to a reference price of $330. The $330 is based on a long-term world price average of $300, adjusted upwards by $60 to compensate for perceived “distortions” in the world market, and adjusted downward by $30 for transportation costs. A trigger mechanism is employed, i.e. an adjustment occurs if the difference between the 20-day moving average of the London No. 5 world price for refined sugar and the 20-day moving average of the same price on which the previous trigger was based amounts to more than $20 for 20 consecutive trading days. The tariff is then the difference between $330 and the 20-day moving average price on which the duty was triggered, in ZAR, converted at the prevailing exchange rate on the day of the trigger.

The Equitable Proceeds Arrangement

32.     
The equitable proceeds arrangement refers to a formula through which revenue that accrues to the sugar industry is allocated to the millers and growers. The Division of Proceeds calculation is a notional calculation, and, whilst representing industry income, does not reflect actual revenues. Proceed-sharing is practised horizontally, between the millers based on their production, and vertically, between the millers and growers based on the ‘recoverable value for cane’ pricing system.

33.     
Export quotas are calculated by the industry and allocated to producers on the basis of their respective production capacities. Price competition in the domestic market is expressly dis-incentivised insofar as the equitable proceeds arrangement provides that increases above the allocated domestic market share are penalized through calculations based on the difference between the notional price, which is calculated by the industry, and the world price for sugar. Sugar producers selling more than their allocated quota on the domestic market have to pay the ‘under performing’ producers the difference between their ‘over performance’ and the world price. South Africa exports roughly 50 % of its national sugar production.

The Single Channel Export Arrangement

34.     
Surplus production is removed from the domestic market via a single-channel export arrangement for raw sugar. This is effectively a component of the equitable proceeds arrangement. SASA is the single channel exporter of raw sugar, with sugar refiners being responsible for export of refined sugar. This is presently under review. It appears that government intends to assume responsibility for the export marketing of South Africa’s raw sugar surplus.




THE COMPETITION ANALYSIS

The relevant market

35.     
The identification of the relevant market always occupies a central place in anti-trust analysis. In this case the decision with respect to the relevant market, in particular the relevant geographic market, powerfully influences the outcome of the enquiry. As we shall outline, the relevant market enquiry is, in this matter, focused not on the impact of subtle segmentations within a broader market, not on nuanced enquiries regarding the substitutability of one similar product for another. It centers on the interplay between domestic producers and consumers of sugar, on the one hand, and, on the other hand, the production and consumption of sugar in the rest of the world. In short, we are required to decide whether South African sugar production and consumption takes place within an international market or whether it is contained within the boundaries of a domestic market effectively isolated from the vagaries of production and consumption elsewhere, from, in other words, the vagaries of international trade. Are South African producers properly viewed as proverbial big fish in a small pond, or tiny minnows in a veritable ocean?

The product market

36.     
The following sugar products have been identified: raw sugar, brown sugar, white sugar, specialty sugars, molasses, bagasse and animal feeds. However, since white sugar accounts for 90% of sugar produced and sold in South Africa, we accept the Commission’s view that it (white sugar) will act as an adequate barometer of the transaction’s impact on competition. We treat the white sugar supplied by the South African sugar millers/refiners as absolutely homogenous.

37.     
In the domestic market, white sugar is distributed to two customer groups, namely, industrial customers (notably carbonated soft drink and confectionary manufacturers) who only buy in bulk, and direct customers such as wholesalers and retailers who sell pre-packed sugar to ultimate consumers.

38.     
Retail customers trade in packages of 25 kg or smaller. In addition to the refiners’ brands – Huletts, Illovo and TSB’s Selati - sugar is retailed under a number of distributors’ and retailers’ brands such as Econo, Spar, Right Value, Woolworths, DB, Clarks, Cake Prides, Blue Crystal, Marathon and Makalani. These retail house brands are packed by one or other of the refiners.

39.     
Customers in the industrial sector trade in bulk (30-32 ton shipments) or in 1ton packages. Industrial users do not purchase 25kg packages of sugar even though the price per ton of 25kg packages is slightly lower than the price of a 1ton package because the handling costs of 25kg packages are too expensive. Similarly, wholesalers and retailers do not want bulk or 1ton packages of sugar because they would have to repackage it themselves.

40.     
The millers appear to view industrial and direct sales as separate product markets and SASA grants rebates to the bottlers and confectionary industry, the largest customers in the industrial market. It has never given rebates to the direct market.

41.     
High Fructose Corn Syrup, commonly referred to as HFCS, a sweetener product manufactured from maize is, according to the Objectors, a suitable substitute for sugar in its industrial usage. However, the cost of establishing a HFCS plant in South Africa is prohibitively high (capital expenditure in the order of R1.5 billion was suggested). Moreover, an HFCS plant would have to be built close to an adequate source of maize, which would be inconvenient for the supply of HFCS to many parts of South Africa. The barriers to entry by HFCS are accordingly viewed as prohibitive.

42.     
The Tribunal, therefore, defines the product market as the market for white sugar, which can be divided into two sub-markets, the industrial market for white sugar and the retail or direct market for white sugar. We note the Commission’s recommendation that the two sub-markets be viewed as separate relevant markets and the case law cited in support of this view.