Affected market: Tobacco processing equipment
The OFT’s Decision on reference under section 33(1) of the Enterprise Act 2002 given on 18 May 2006. Full text of decision published 31 May 2006.
Please note that square brackets indicate figures or text which have been omitted or replaced with a range for reasons of commercial confidentiality.
European Tobacco Development (ETD) is a subsidiary of Garbuio SpA (Garbuio), a privately owned Italian company involved in the manufacture and installation of primary tobacco processing equipment and the provision of associated spare parts.
Dickinson Legg Group plc (Dickinson Legg) is an AIM listed company involved in the manufacture and installation of primary tobacco processing equipment and the provision of associated spare parts. Its worldwide turnover for the financial year ended 30 June 2005 was £33.5 million.
Garbuio proposes to, via ETD, acquire Dickinson Legg by way of a cash offer pursuant to Rule 9 of the City Code on Takeovers and Mergers. As a result of the transaction, Dickinson Legg will become 100 per cent controlled by ETD.
The OFT’s administrative deadline for deciding whether to refer the merger to the Competition Commission is 18 May 2006.
As a result of this transaction Garbuio and Dickinson Legg will cease to be distinct.
The parties overlap in the supply of primary tobacco processing equipment and spare parts. While shares of supply fluctuate significantly from year to year, the merging parties’ combined share of supply in the UK in 2004/5 by value was [greater than 25 per cent] and consequently the share of supply test in section 23 of the Enterprise Act 2002 (the Act) is met. The OFT therefore believes that it is or may be the case that arrangements are in progress or in contemplation which, if carried into effect, will result in the creation of a relevant merger situation.
FRAME OF REFERENCE
Garbuio and Dickinson Legg overlap in the provision of primary tobacco processing equipment. Primary tobacco processing involves conditioning, cutting, expansion, drying and flavouring of tobacco lamina and stem. Primary processed tobacco is subsequently used to manufacture cigarettes, hand rolling tobacco or pipe tobacco in the secondary production process.
As well as providing processing equipment, both Garbuio and Dickinson Legg supply spare parts for their own machinery. For some products, spare parts are only supplied by the original equipment manufacturers, whereas for other products third parties may supply spare parts as well. However, neither parties’ spare parts are interchangeable, and therefore there are no overlaps between them. This is supported by comments from customers, who have not pointed to any particular spare parts where problematic overlap emerged between the parties. In view of this, the OFT has not considered the supply of spare parts separately from the manufacture of primary tobacco processing equipment.
Garbuio considers that the product scope is, at its narrowest, the production and supply of primary processing equipment. It suggests that the product scope might be extended further, on the basis of supply side substitutability, to include the manufacturers of secondary processing equipment. However, historically switching between the manufacture of primary and secondary tobacco processing equipment by suppliers has been very limited.
Third party responses indicate that some customers see different producers as having individual strengths in particular items of processing equipment (i.e., cutting, conditioning and drying and expansion equipment), and are prepared to divide up tenders to take account of such factors. Moreover, particular items of equipment are subject to more frequent upgrade and replacement than is required for the complete processing line and therefore the patterns of procurement differ amongst various equipment parts. However, on the supply side, most manufacturers produce the full range of primary processing equipment and are capable of bidding for turnkey projects in plants. Furthermore, third party comments suggest that customers are receptive to innovation, and therefore different manufacturers’ strengths in a particular processing area can be subject to change over time. Lack of industry data by individual equipment type also indicates that a narrow product scope is not appropriate, but it was not necessary to reach a conclusion on product scope as the merger does not raise competition concerns. The OFT has looked at both the manufacture and supply of primary processing equipment as a whole and at individual items of primary processing equipment (albeit on limited information).
Garbuio considers the relevant geographic scope to be global. Both parties to the merger commercialise their products on a worldwide basis and supply most of the major global tobacco companies. This view is supported by third parties. Customers have told us that location of manufacturing facilities is not a key consideration when procuring a product, and competitors have said that they frequently ship their products around the world. The OFT therefore considers that competition takes place on a global basis.
Contracts and therefore revenues in this industry are lumpy, shares of supply vary considerably from year to year, and over a short timeframe they may not be a useful indicator of market power. The merging parties' estimates of their global shares of supply for the past three years range from about 30 to 45 per cent (increment about 10 to 15 per cent). Their main competitors (Hauni and Comas) range from 20 to 45 per cent. Information on shares of supply of individual primary processing equipment was not available.
The details of bids supplied by the parties suggest that they are close competitors. However, most customers did not seem to consider the merging parties to be particularly close competitors. Neither the parties nor their competitors could give an estimate of shares of supply by particular equipment parts, and all considered that all competitors could provide a full range of equipment.
The industry is characterised by excess capacity, which makes it less likely that the merger would give rise to a substantial lessening of competition. Dickinson Legg's 2005 Annual Report states that ‘[c]ompetition for available business is fierce and margins will remain under pressure, whilst there is an excess of capacity.’ The merging parties and the competitors that we spoke to all indicated that they are running on a capacity utilisation of 60-70 per cent.
There is evidence that tobacco manufacturers are able to exercise buyer power. Most contracts are put out to competitive tender and customers have told us that they are able to negotiate the prices paid. Garbuio has also provided a number of examples of customers using their buyer power by, for instance, demanding that potential suppliers [redacted].
It appears to be relatively easy for smaller players to expand their share of the sector, particularly by producing good quality, innovative products. SUR, a Brazilian manufacturer, told us that it took them no more than three years to reach a global share of supply of around 5 per cent.
Third parties suggested that all out entry may be more difficult due to the need for technological know-how. However this may be easier for companies that are already active in related fields; for instance, one competitor moved into the manufacturing of primary processing equipment having been active in equipment refurbishment.
This merger does not raise any vertical competition issues.
THIRD PARTY VIEWS
Apart from one customer who submitted that the merger may limit its choice of suppliers in the longer term, no other third parties raised concerns. The customers that we spoke to accounted for over 98 per cent of Dickinson Legg’s sales in the UK, and all of Garbuio’s third party sales in the UK.
While this is a merger of two large primary processing equipment manufacturers, there will continue to be strong competition, particularly from Hauni and Comas, in an environment of excess capacity. Most customers do not appear to consider the parties to be particularly close competitors on a global basis. Barriers to expansion appear to be low, and customers appear to have significant countervailing buyer power. Finally, the vast majority of third parties raised no concern.
Consequently, the OFT does not believe that it is or may be the case that the merger may be expected to result in a substantial lessening of competition within a market or markets in the United Kingdom.
This merger will therefore not be referred to the Competition Commission under section 33(1) of the Act.