DISTILLERS CORPORATION (SA) LIMITED and STELLENBOSCH FARMERS WINERY LIMITED (08/LM/Feb/02) [2003] ZACT 36 (18 June 2003)

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DISTILLERS CORPORATION (SA) LIMITED and STELLENBOSCH FARMERS WINERY LIMITED (08/LM/Feb/02) [2003] ZACT 36 (18 June 2003)

.RTF of original document

COMPETITION TRIBUNAL

REPUBLIC OF SOUTH AFRICA

Case No: 08/LM/Feb02

In the large merger between:

Distillers Corporation (SA) Limited Primary Acquiring Firm

And

Stellenbosch Farmers Winery Group Ltd Primary Target Firm

______________________________________________________________

Reasons for Tribunal Decision - Non-Confidential
______________________________________________________________

Finding

We have found that a substantial lessening of competition is likely in the proprietary spirits market, one of several markets implicated in this transaction. For the reasons outlined below we find that a consideration of the claimed efficiency gains is not pertinent. We have found that there are no consequences for the public interest that influence our finding.

A further hearing will be convened in order to determine an appropriate remedy in respect of that market in which we have found the likelihood of a substantial lessening of competition.

The Parties

Primary acquiring firm

Distillers Corporation (SA) Limited (“Distillers”) was a listed investment holding company, involved, through its subsidiaries, in the production and wholesale distribution of branded spirits, wine and ready to drink / flavoured alcoholic beverages (‘RTDs’ or ‘FABs’). Distillers produced, marketed, sold and distributed various brandy brands (including Oude Meester, Richelieu, Viceroy, Klipdrift), whisky (Harrier), vodka (Count Pushkin), cane (Seven Seas), premium wines (including Fleur du Cap, Le Bonheur, Neethlingshof and Grunberger), sparkling wines (J.C. le Roux) and liqueurs (Amarula Cream). The FABs manufactured and distributed by Distillers included Bacardi Breezer, Bernini and Castello. Distillers also acted as the South African agent and distributor of international brands such as Gordon’s gin, Martini, Bacardi rum, and Glenfiddich whisky.

Primary target firm

SFW was a producer and wholesaler of wine, spirits and alcoholic fruit beverages within South Africa. As a leading wine producer, it boasted names such as Nederburg, Zonnebloem, Graca, Chateau Libertas and Plaisir de Merle. Its spirit brands included Mellow-Wood brandy, Old Buck gin, Mainstay cane spirit and Romanoff vodka. It had the distribution rights in SA for Martell brandyand Bols brandy. It was the market leader in the FABs market with brand names such as Hunter’s Dry, Hunters Gold, Crown, Savannah, Esprit, Montello and Manhattan.

Shareholding structure

SFW and Distillers were both controlled by the same trio of shareholders. The two companies had an identical shareholding structure:

· Rembrandt-KWV Investments (“RemKWV”) held 60% of the shares of both parties. RemKWV is a joint holding company of Rembrandt and KWV, in which each holds a 50% interest. KWV’s interest in RemKWV is held through a listed subsidiary, KWV Investments Limited in which KWV owns approximately 54%;

· SAB held 30% of both companies through its wholly owned subsidiary Other Beverages Industries (Pty) Ltd (“OBI”);

· The general public held the remaining 10% of both companies.

Other significant participants in the production and distribution of alcoholic beverages

The merged entity’s most significant competitors in the production and distribution of spirits are GUDV and E. Snell & Co. GUDV is the South African subsidiary of multinational spirit producer Diageo, which was established out of the merger between Guinness and Grand Metropolitan. GUDV has the largest market share in whisky (including the J&B, Johnny Walker and Bell’s brands) and vodka (Smirnoff). It has smaller stakes in brandy, gin, and FABs. GUDV thus competes primarily with Distell in the middle and upper segments of the spirits markets. As elaborated below these are commonly referred to as the ‘proprietary’ or ‘prop’ and ‘premium’ spirits.

E. Snell & Co is a smaller South African company, which produces mainly, although not entirely, ‘value-for-money’ spirits – the low-price end of the market - including brandy (Wellingtons and Bols), whisky (Two Keys and Firstwatch), vodka (Absolut), cane (Cape to Rio), Gin (Strettons Deluxe Gin) and an alcoholic fruit beverage or ‘FAB’ (Snapper).

Douglas Green Bellingham (DGB), a long established South African company, is mainly a wine merchant, but its portfolio does encompass some well-know spirits brands in whisky (Balantine Finest) and brandy (Connoisseur). Brown and Forman, a major international liquor company, also distributes some of its important proprietary and premium spirits, notably Jack Daniels whiskey. The South African licensee of Brown and Forman brands is the Really Great Brand Company, which also performs distribution and related sales functions for E. Snell & Co. Other competitors include Seagrams (whose brands were subsequently acquired by Pernod Ricard), African Wines & Spirits and a large number of wine producers. The UK-based Bulmer, which has substantial international interests in cider, entered the South African market in 1999, when it acquired certain cider brands from Gilbeys. Bulmer exited the local market in 2002.

South African Breweries has a near-monopoly in beer where it enjoys a market share of approximately 95%. It has also recently begun producing FABs.

The Merger

The transaction

10.

On September 20, 2000 Distillers and SFW entered into an agreement in terms of which Distillers would acquire, subject to the approval of the shareholders, the assets and liabilities of SFW, including the shares held by SFW in the issued share capital of Western Province Cellars Limited, SFW Holdings Limited, Bofor Properties (Pty) Ltd, and Devon Road Property (Pty) Ltd, and all the trade names and trademarks of SFW. The assets sold by SFW to Distillers included SFW’s shares in its operating companies and all its trademarks, but excluded certain specified assets. An addendum to the sale agreement was executed on 9 October 2000 (A171). Pursuant to the transactions, the merged entity was renamed Distell Group Limited (“Distell”).

11.

Two common shareholders, Rembrandt-KWV Investments (currently known as Remgro-KWV Investments Limited) and South African Breweries, held 90% of the voting equity in both acquiring and target firm. The remaining 10% of each firm was held by the general public.

12.

Post-merger the (simplified) share holding structure is as follows:

Remgro KWV Investments   South African Breweries          Public shareholders
                  60%                                 30%     10%

Distell Group Limited

South African Distillers and Wines

SFW Holdings Limited     Others

History of the transaction

13.

On 8 June 2000, the legal representatives of the merging parties approached the Commission and asked it to clarify whether the proposed transaction to merge the businesses of SFW and Distillers constituted a notifiable transaction. The parties’ essentially held that because of the common identity of the parties’ shareholders the transaction constituted an internal restructuring and not a merger as defined in the Act. On 7 August 2000, the Commission concluded in a letter addressed to the parties’ legal representatives, that the proposed transaction would not constitute a merger as defined in section 12 of the Act and accordingly was not notifiable in terms of section 13. Based upon this opinion, the parties proceeded to issue cautionary announcements advising of the proposed merger.

14.

In terms of an agreement dated 20 September 2000 (amended on 9 October 2000) the merging parties effected a transaction whereby Distillers acquired all the principal assets and liabilities of SFW. The purchase consideration in respect of the SFW assets, in the amount of R515 157 950,31, was settled through the issue by Distillers to SFW of 55 580 000 Distillers ordinary shares in the share capital of Distillers. These Consideration Shares were distributed by way of a dividend in specie and reduction in share capital to the SFW shareholders.

15.

Seagrams, a large multinational producer of various alcoholic beverages, subsequently launched an application in the Cape High Court on 10 November 2000 in which it asked the court to find that the transaction between SFW and Distillers constituted a merger in terms of the Act. The applicant sought an interdict restraining the respondents from implementing the merger, alternatively an order referring the matter to the Competition Tribunal. In his judgment, Jali J ruled that section 65(3) made it clear that the High Court did not have jurisdiction to hear the matter, insofar as it related to competition matters within the exclusive jurisdiction of the competition authorities.

16.

Bulmer SA (Proprietary) Limited (“Bulmers”) (the local subsidiary of another large multinational producer and distributor of alcoholic beverages) and Seagram Africa (Proprietary) Limited (“Seagrams”), both competitors of Distell, subsequently brought an application to the Competition Tribunal in terms of section 62(1) of the Competition Act 89 of 1998. The basis of the application was that the respondents failed to notify a transaction that the applicants contended was a merger as defined in terms of section 12(1) of the Act.

17.

The Tribunal found that the transaction constituted a merger as defined in terms of section 12 of the Competition Act and ordered the parties to notify the merger to the Competition Commission. This judgement was upheld by the Competition Appeal Court on 27 November 2001.

18.

The merger was subsequently notified on 12 December 2001. The Competition Commission recommended in June 2002 that the merger be approved subject to certain conditions. Essentially, the conditions recommended by the Commission relate to the sale of a number of brandy and sparkling wine brands.

Rationale for the transaction

19.

The parties claim that the merger will generate increased efficiencies that will enhance international competitiveness and shareholder value. In particular, they argue that, absent the merger, neither company could afford the intensive marketing strategies nor effectively manage the supply and distribution of alcoholic products overseas. The merged entity, on the other hand, would, through combining marketing budgets and by cost savings, achieved through economies of scale and reduced duplication, have a significantly greater chance of penetrating international markets. The cost savings would be realized by a rationalization of support services, manufacturing and distribution facilities and by reductions in working capital and fixed assets.

The Hearing

20.

After the merger was referred to the Competition Tribunal in June 2002 a prehearing conference was held July 7^th 2002, and a hearing was duly convened, spanning five days in total:

15 August 2002

16 August 2002

22 August 2002

9 October 2002

15 November 2002

21.

A total of nine witnesses were heard. These were called by the Competition Commission, the merging parties and the Competition Tribunal.

22.

The following witnesses were called by the Competition Commission:

- Mr. Alistair Norman Lewis, AC Nielsen South Africa

23.

The following witnesses were called by the merging parties

Mr. John Forsyth, partner McKinsey and Company

Mr. Johannes Jacobus Scannel, MD of Distell

Mr. Valerio Doriano Toros, Distell

Mr. Jacobus Hendrik Visser, Distell

24.

By the Competition Tribunal:

Mr. Michael Clifford Veysie, MD Bulmers

Mr. Tim Hutchinson, CE Douglas Green Bellingham

Mr. David Hooper, MD E. Snell & Co

Mr. Colin Robinson, MD Robinson Liquors

Competition Evaluation

Background

25.

The alcoholic beverages sector represents to competition folklore in South Africa, what, we imagine, the oil industry represented to those concerned with competitive markets in the USA at the turn of the last century. Not only do we have what is, to all intents and purposes, a single domestic beer producer, but we have a longstanding history of state intervention in the production of wine and spirits, intervention manifestly designed to support narrow private interests rather than the public interest, that is possibly unparalleled in its breadth and intensity. The 1982 Competition Board Report on the liquor industry notes:

“As early as 1918 a written agreement, a so-called ‘gentlemen’s agreement’ was entered into by the KWV and the wine merchants under which the KWV would refrain from competing with the merchants it supplied. Specifically, the KWV, as a quid pro quo for the co-operation of private entrepreneurs, undertook not to compete with the existing interested parties in the trade in or distillation or manufacture of wines and spirits in Africa south of the equator.”

26.

And, further: “In 1924 Parliament incorporated this principle in Act 5 of 1924, so that the KWV is not allowed to sell any wine or spirits to any person not being a bona fide distiller, wholesaler, association of distillers or wholesaler or co-operative society”.

27.

However, the apotheosis of anti-competitive conduct in this sector is surely the agreement which secured South African Breweries’ beer monopoly and the Rembrandt Group’s pre-eminent position in the spirits, particularly the brandy, market. We refer, of course, to the notorious market sharing arrangement between the beer producer and its counterpart in the wine and spirits sectors that saw the former agreeing to limit its involvement in wine and spirits in exchange for an undertaking from the Rembrandt group to stay out of the beer market. To add insult to injury, KWV was allowed to take up a significant share of the new spirits and wine company.

28.

The market sharing arrangement was effected by the restructuring in 1979 of the South African liquor industry. This involved an arrangement between SAB, SFW, OMG (effectively Distillers’ predecessor) and KWV, culminating in the formation of a new entity, Cape Wine and Distillers Limited (“CWD”).

29.

CWD was listed on the Johannesburg Stock Exchange, its shares being allocated (and held) in the following manner:

- The Rembrandt group: 30%

- SAB:                                       30%
- KWV:                              30%
- General public:                          10%

30.

This restructuring was designed to facilitate a split in the liquor industry in terms of which:

SAB purchased the Rembrandt Group’s beer interests (Intercontinental Breweries, or ICB, the large brewery with which SAB had been in a price war that year);

SAB agreed to pool its wine and spirits interests (including SFW and Henry Tayler & Ries) via the CWD and to limit its involvement in wine and spirits to its 30% investment holding in CWD;

The Rembrandt Group sold its wine and spirits operations (the Distillers Corporation Ltd and the Oude Meester Group and thereby the retailers Western Province Cellars and Liquortown);

The Rembrandt Group undertook to have no interests in the beer market;

Rembrandt and SAB undertook to divest their retail liquor interests; and

SFW, Distillers and OMG become wholly-owned subsidiaries of CWD.

31.

This restructuring effectively meant that SAB sacrificed its wine and spirits interest to CWD in return for a beer monopoly and a stake in CWD, whilst spirit and wine production was concentrated in the CWD, which acquired the two largest producer-wholesaler bodies, namely SFW and Oude Meester Group (OMG).

32.

Shortly thereafter, the Rembrandt Group and KWV pooled their shares in CWD (60%) in a jointly owned holding company, Rembrandt-KWV Investments Limited.

33.

In 1982 the Competition Board (Competition Board Report no.10) recommended that the vertical integration in the liquor industry be prohibited and that the merger which had taken place in 1979, giving rise to the formation of CWD, be reversed:

”The competition that previously existed between SAB and ICB and between the two largest producer-wholesalers of wine and spirits SFW and Oude Meester, has inevitably been either terminated or restricted by the restructuring”

And further: ”The Board is convinced that the circumstances described … do not justify in the public interest the KWV’s acquisition of an interest in CWD”.

34.

This recommendation was rejected by the government of the day.

35.

However, in 1988, the then Minister of Economic Affairs supported a separation of the two main components of the CWD, namely SFW and OMG, reportedly motivated by a desire to enhance competition. The separation was effected by a separate listing on the Johannesburg Stock Exchange of SFW and a new entity, named the Distillers Corporation SA Limited, comprising the interests of OMG. This event constituted a partial reversal of the 1979 restructuring that had created a concentration of wine and spirit interests within a single corporate structure.

36.

It is undoubtedly the breathtaking audacity of these manifestly anti-competitive agreements and their endorsement by the political powers of the time, that accounts for the persistence of anti-competitive structures in the alcoholic beverages sector and for the intensity of the disquiet articulated by consumers, distributors, the current government and, in particular, other, inevitably smaller, producers at the state of affairs in this industry. However, while the structure of the industry that has emerged as a result of these agreements undoubtedly demands an unusual degree of vigilance from the competition authorities, we cannot use the provisions of the Competition Act to turn the clock back, to redeem, ex post facto, the sins of the past. We are, regrettably, obliged to take the structure of the industry as we find it and, in merger proceedings at least, to limit our interventions to those transactions that result in a substantial lessening of competition.

The Relevant Markets

The Geographic Market

37.

It is common cause between Distell and the Competition Commission that the relevant geographic market is national. The Tribunal agrees that the relevant geographic market is indeed the South African market and this issue will not be considered further.

The Product Market

38.

In common with other contested merger proceedings, the main area of contention between the parties and the Competition Commission centres on the identification of the relevant product market. In short, whereas the merging parties contend for a broad product market that encapsulates all alcoholic beverages, the Commission prefers a narrower definition that places each traditional category of alcoholic beverage – brandy, whisky, wine, etc – in separate relevant markets.

39.

The Commission defines a variety of relevant product markets based on traditional liquor categories, including spirit type, different types of wine (table wine, sparkling wine and fortified wine) and a market for flavoured alcoholic beverages or FABs. The Commission finds product overlaps in the following markets:

Table 1: Market shares and HHI changes per liquor category

Liquor category	Post-merger Market share (% sales value)	Post-merger HHI	HHI increase due to merger
Whisky	11.8	2487	65.6
Brandy	71.7	5366	1941.1
Vodka	16.6	4565	130.3
Cane	39.4	4309	424.7
Gin	73.2	5147	1542.9
Table wine	59.5	N/a	N/a
Sparkling wine	74.4	Approx 5580	Approx 2710
Fortified wine	80.8	N/a	N/a
FABs	61.8	4793	861.4

Source: AC Nielsen data and Competition Commission recommendations

40.

While, as will be elaborated below, the Commission found that the impact on competition of the horizontal overlap in most of these markets is ameliorated by other factors – for example the unusual dynamism of the FABs market or the merged entity’s relatively small market share in whisky – the Commission’s narrow, category-based market definition was the basis for its finding of a substantial lessening of competition in the brandy, sparkling wine and gin markets and, accordingly, for its recommendation that the merged entity be compelled to divest itself of a number of brands in these markets.

41.

In the brandy market the Commission recommended that Distell be compelled to dispose of 16% of its market share whilst terminating the manufacture and distribution of all KWV brands. In the sparkling wine market the Commission recommended that Distell dispose of brands with a cumulative market share of between 20-30% in volume.

42.

The merging parties on the other hand define the relevant market to include all alcoholic beverages, ranging from beer to spirits, including wine and FABs. The parties find that Distell’s post-merger market share in the national alcoholic beverage market, based on litres absolute alcohol, is 19.7%.

43.

Accordingly, the parties have argued that there is no substantial lessening of competition in the relevant market and suggest that, even if there was, the efficiencies generated by the merger would offset any detrimental effects of the merger.

44. &