Proposed Settlement Does Not Solve U.S. Antitrust & Governance Concerns in $4.1B Lithium Saga
A few months ago I wrote an article about a proposed $4.1 billion transaction whereby Tianqi Lithium (“Tianqi”), a Chinese chemical company and one of the world’s biggest lithium producers, agreed to purchase 62,556,568 “Series A shares” of Sociedad Química y Minera de Chile S.A. (“SQM”), a U.S.-listed Chilean chemical company and another of the world’s leading lithium producers, from Nutrien, a U.S.-listed Canadian company and the world’s largest provider of crop inputs and services (the “Nutrien-Tianqi Transaction”).
What is at stake in this case is the availability and pricing of lithium chemical products, which has a direct impact in, and is particularly critical for, the U.S. technology industry and the U.S. electric vehicle market.
Lithium carbonate and lithium hydroxide are principally used to produce the cathodes for rechargeable batteries, taking advantage of lithium’s extreme electrochemical potential and low density. According to SQM’s filings, “batteries are the leading application for lithium, accounting for approximately 59% of total lithium demand, including batteries for electric vehicles, which accounted for approximately 27% of total lithium demand.”
Some background on the Nutrien-Tianqi Transaction
The consideration of the Nutrien-Tianqi Transaction was $65 per share in cash, a roughly 15% premium over market share price at the time of the transaction. The transaction represented the entirety of Nutrien’s “Series A shares” in SQM at a gross valuation of approximately $4.07 billion. This stake represents 44.84% of SQM’s “Series A shares” and 23.77% of SQM’s total equity.
The following related transactions should also be noted:
- First Public Auction of Nutrien’s “Series A shares”: On April 20, 2018 Nutrien sold via a public auction 1,500,000 “Series A shares” of SQM on the Santiago Stock Exchange, a stake that represented approximately 1% of SQM’s “Series A shares”, and 0.57% of SQM’s total equity. Each share sold at a price of $50.46, for gross proceeds of $75.7 million.
- Second Public Auction of Nutrien’s “Series B shares”: On June 6, 2018, Nutrien sold via a public auction 20,166,319 “Series B shares” of SQM on the Santiago Stock Exchange, a stake that represented approximately 16.74% of SQM’s “Series B shares” and about 7% of SQM’s total equity. Each share sold at a price of $49.34, for gross proceeds of $1 billion.
- First Acquisition by Tianqi of SQM “Series B Shares”: In 2016, Tianqi tried to buy a controlling stake of SQM from Grupo Pampas but it was unsuccessful in such efforts. However, in November of 2016 Tianqi acquired 5,516,772 “Series B shares” of SQM, accounting for about 2.1% of SQM’s total equity, from San Francisco-based private equity firm SailingStone Capital Partners for $209.6 million (at a price of $38 per share, at a time when SailingStone held about 20% of the New York-listed shares of the company).
Considering these transactions, Nutrien has already sold ~8% of its total equity stake in SQM, and is seeking to sell its remaining 23.77% equity stake in SQM to Tianqi, who will end up owning about 25.86% of SQM’s total equity.
Why is Nutrien selling its SQM stake if prospects for lithium are so hot?
The official answer is because regulators from China and India ordered Nutrien to divest its equity interests in SQM as a condition to approve the merger between Potash Corporation of Saskatchewan Inc. (“PCS”) and Agrium Inc., which led to the creation of Nutrien.
Interestingly, the Nutrien merger was approved by the U.S. Federal Trade Commission (FTC), so we know that the FTC has jurisdiction to rule over this matter. However, to date the FTC has not issued any opinion over the Nutrien-Tianqi Transaction.
The Chilean National Economic Prosecutor (“FNE”) Report and the Proposed Settlement between FNE and Tianqi.
On September 7th, 2018, the FNE published a thorough 79-page report (although unfortunately it extracted much of the relevant market data, only available in a “confidential annex”) laying out the scope of its investigation, analyzing the terms of the Nutrien-Tianqi Transaction, the lithium market and the antitrust effects of the transaction in Chile, concluding that Tianqi’s partial acquisition of SQM could generate anti-competitive effects in the Chilean lithium market.
In order to mitigate some of the anti-competitive effects of the transaction, the FNE proposed a settlement agreement with Tianqi to “effectively protect competition in the lithium industry in the post-Acquisition scenario.” The FNE noted that “this extrajudicial agreement, whose content we are submitting for the approval of the TDLC, marks a milestone, because for the first time measures are imposed in connection to the acquisition of minority interests by a competitor.”
The press release also added that “behind this agreement there is a thorough investigation, which allowed us to detect possible competitive risks that this operation may generate for the country and establish measures that will take care of such risks in an effective and proportional way, preventing the flow of information between Tianqi and SQM.”
SQM argued against the proposed settlement because it considered that the terms of the settlement did not provide sufficient safeguards to mitigate the anti-competition risks.
Mitigation Measures Targeted to the Governance Structure of SQM.
As stated by the FNE, “the main risks identified by the FNE are related to possible coordination effects associated with the flow of information between competitors (…) To maintain competitive market conditions and mitigate any risks identified in the transaction, the fundamental principle of the settlement is to limit access to commercially sensitive information of SQM by Tianqi, via SQM’s Board of Directors”.
The settlement agreement stipulates a list of commitments by Tianqi including not to nominate directors, executives or employees of Tianqi to SQM’s Board, and restricting its access to commercially sensitive information from SQM’s lithium business for a period of four years, with a two year extension.
Tianqi also came up with a “Directorship Agreement” to be entered between Tianqi and the three directors that it would nominate to SQM’s board, and a “Compliance Program” to make sure that Tianqi and its SQM directors comply with their commitments.
Next, I will explain why this settlement would be insufficient under a U.S. antitrust and governance perspective.
Concerns based on U.S. Antitrust Laws and Governance Practices
The Nutrien-Tianqi Transaction will not give Tianqi outright control over SQM, but it will give it a tremendous amount of influence, with the right to select three out of SQM’s eight directors. Partial acquisitions that do not result in effective control may nevertheless present significant competitive concerns and in this case, it raises all the concerns outlined in Section 13 of the Horizontal Merger Guidelines.
Partial Acquisitions Concerns per Section 13 of the Horizontal Merger Guidelines.
There are at least three questions to consider with this settlement:
a) Voting and Governance Rights: The Tianqi-Nutrien transaction will grant Tianqi three board seats in SQM (out of a total of eight board seats). These voting and governance rights can lessen competition in the lithium market by giving Tianqi the ability to influence the competitive conduct of SQM. Tianqi may use this influence to induce SQM to compete less aggressively and/or to coordinate its conduct with Tianqi.
- How does the settlement attempt to mitigate this risk? The settlement still allows Tianqui to appoint board members, but it limits whom the company can appoint. Under Section 8 of the Clayton Act, a “person” is prohibited from simultaneous service for two competing companies, and US courts and antitrust authorities have interpreted “person” to also prohibit corporations from holding the right to nominate shareholders or directors at competing corporations.
b) Acquisition of a Minority Position in a Direct Competitor: The Nutrien-Tianqi Transaction can lessen competition by reducing the incentive of Tianqi to compete with SQM (a direct competitor). Tianqi will own 25.86% of SQM’s total equity, which might significantly blunt the incentive of Tianqi to compete aggressively because it shares in the losses thereby inflicted on SQM. This reduction in the incentive of Tianqi to compete arises even if it cannot influence the conduct of SQM.
- How does the settlement attempt to mitigate this risk? It does not. This risk has not been mitigated since the settlement allows Tianqi to purchase the full 62,556,568 “Series A shares” of SQM. This is where the settlement fails to address the biggest concern of this transaction.
c) Tianqi Will Access Non-Public, Competitively Sensitive Information from SQM: Even absent any ability to influence the conduct of SQM, access to competitively sensitive information can lead to adverse unilateral or coordinated effects. This information may refer to production plans, inventory, investments, technology, know-how, sales agreements, pricing strategy, patents, new mining, refining or expansion plans, new business plans, operating costs and other strategic competitive variables. For example, joint technical development programs by SQM with key customers may be exposed to Tianqi. This may enhance the ability of Tianqi to coordinate its behavior, and make other accommodating responses faster and more targeted.
- How does the settlement attempt to mitigate this risk? The proposed settlement attempts to limit access to competitively sensitive information by excluding Tianqi-nominated directors and Tianqi from getting access to SQM’s competitively sensitive lithium business information. The restriction is for a term of four years, with a two-year extension. As stated by the FNE, this is the main concern addressed by the settlement agreement.
Other U.S. Federal Antitrust Concerns
1. Hart Scott Rodino Act Antitrust Improvements Act (“HSR”)
For a deal of the size and scope of the Nutrien-Tianqi Transaction, it should be expected that at least one of the U.S. Agencies would review and approve the transaction. However, there is no public evidence that the transaction has been reviewed and/or approved by any of the U.S. Agencies. This is a surprising fact, considering that the FTC has jurisdiction over the matter since it approved the Nutrien merger and this transaction could impact significantly the U.S. lithium market.
2. Section 7 of Clayton Act.
Per the proposed terms, the Nutrien-Tianqi Transaction could violate Section 7 of the Clayton Act, which prohibits acquisitions of stock where “the effect of such acquisition may be substantially to lessen competition.”
The courts have held that Section 7 violations generally involved acquisitions of at least 15%. That cross-ownership has the potential to change firms’ unilateral pricing incentives and/or to encourage collusive behavior has been well known in the industrial organization/antitrust literature for some time. The competitive effects of partial ownership depend critically on two separate and distinct elements: financial interest and corporate control.
In applying Clayton Act Section 7 to partial acquisitions, the case law focuses on two elements of control in cross ownership cases:
- In each case, there is clear, uncontroversial control over “Firm A”, with the key question being whether the acquisition of stock provides sufficient control or influence over “Firm B.”
- In considering whether the challenged stock acquisition will threaten anti-competitive harm, the focus has been on very substantial stock acquisitions (>20%) and the extent to which the stock held or being acquired allowed the acquirer to control the target. The courts have found that “influence” was sufficient as long as there was proof of anti-competitive effect.
3. Section 8 of the Clayton Act “Interlocking Directorates.”
Section 8 of the Clayton Act was enacted to provide a bright line rule prohibiting interlocking directorates which could otherwise facilitate coordination among competitors. Like other portions of the forward looking Clayton Act, Section 8 was designed to “nip in the bud incipient violations of the antitrust laws by removing the opportunity or temptation to such violations through interlocking directorates.”
The statute provides in the relevant part: “No person shall, at the same time, serve as a director or officer in any two corporations (other than banks, banking associations, and trust companies) that are . . . by virtue of their business and location of operation, competitors, so that the elimination of competition by agreement between them would constitute a violation of any of the antitrust laws… if each of the corporations has capital, surplus, and undivided profits aggregating more than $10,000,000 as adjusted pursuant to paragraph (5) of this subsection [currently US$34,395,000].”
As part of the Nutrien-Tianqi Transaction, Tianqi will have the right to nominate three directors out of SQM’s eight directors. Both companies are competitors in the lithium business, and qualify within the category of companies subject to Section 8 of the Clayton Act. Both companies have capital, surplus and undivided profits in excess of $34,395,000. Both companies had sales in their last fiscal years of products in competition with products of the other in excess of $3,439,500. Each firm’s annual competitive sales of these products exceeded 2% of its annual sales. The annual competitive sales of these products by each firm also exceeded 4% of its total sales.
Because Tianqi will remain a competitor of SQM in the lithium business, Tianqi’s right to nominate three members of SQM’s board of directors violates Section 8. Although the text of Section 8 prohibits a “person” from simultaneous service for two competing companies, courts and the antitrust authorities have interpreted this to also prohibit corporations from holding the right to nominate shareholders or directors at competing corporations.
Precedent from the DOJ’s Tullett Prebon and ICAP Transaction.
On July 16, 2016 the Department of Justice announced the restructuring of a $1.5 billion transaction between Tullett Prebon Group Ltd. (Tullett Prebon) and ICAP plc (both British foreign issuers) to address the Department’s concerns that the transaction would violate Section 8 of the Clayton Act by creating an interlocking directorate.
As originally structured, the transaction would have resulted in ICAP owning 19.9% of Tullett Prebon and having the right to nominate one member of Tullett Prebon’s board of directors. Given that ICAP and Tullett Prebon would continue to compete after the transaction, the department had serious concerns that ICAP’s ability to nominate a Tullett Prebon board member would create an interlocking directorate in violation of Section 8 of the Clayton Act. The revised agreement provided that ICAP should not own any part of Tullett Prebon after the transaction and should have no right to nominate a member of Tullett Prebon’s board of directors.
“Robust competition depends on competitors being actually independent of each other — that’s what Section 8 requires,” said Principal Deputy Assistant Attorney General Renata Hesse of the department’s Antitrust Division. “As originally proposed, this deal would have violated that core principle — creating a cozy relationship among competitors.”
In addition, the DOJ required the parties to restructure the transaction such that ICAP shareholders would receive 56% stake in Tullett Prebon (as opposed to ICAP receiving 19.9% and ICAP shareholders receiving 36.1%, as originally agreed). Partial acquisitions such as this one raised antitrust concerns, and in this transaction the DOJ believed that following the acquisition: (1) ICAP would be able to influence Tullett Prebon’s competitive conduct, (2) ICAP’s incentives to compete with Tullett Prebon might be reduced, and (3) ICAP might gain access to Tullett Prebon’s competitively sensitive, non-public information.
Thus, restructuring the transaction to allow ICAP shareholders, but not ICAP itself, to hold the additional 36.1% stake helped to resolve DOJ concerns regarding the potentially “cozy relationship among competitors.”
Precedent from the DOJ’s CommScope Inc. and Andrew Corp case
In United States v. CommScope Inc., the DOJ alleged violations of both Section 7 and 8 of the Clayton Act in a proposed merger between CommScope and Andrew Corporation, a transaction that included Andrew’s interests and management rights in another company, Andes Industries, Inc. CommScope competed with Andes in the U.S. market for drop cable used by cable television companies. Andrew’s interest in Andes included a 30% equity position, plus warrants to acquire additional stock, as well as several governance rights, such as the ability to designate members of Andes’ board.
According to the DOJ, CommScope’s acquisition of Andrew’s holdings in Andes would violate Section 7 by giving CommScope both the ability and incentive to coordinate with Andes or undermine its competitive decision making. The proposed purchase agreement with Andrew also violated Section 8 by giving CommScope the ability to appoint Andes board members, a firm with sufficient competitive sales to trigger Section 8. To settle charges related to both sections, CommScope agreed to divest Andrew’s entire ownership interest in Andes, and forfeit any rights to appoint members of Andes’ board.
How could the Nutrien-Tianqi Transaction be resolved under U.S. law?
Similar to the Tullett Prebon and CommScope cases detailed above, Tianqi may have to forfeit any rights to appoint members of SQM’ board of directors and at least one of the U.S. Agencies could order Nutrien to divest its 23.77% stake in SQM via a public auction (similar to how Nutrien divested its other equity stakes in SQM) or have Nutrien shareholders receive via dividend the 23.77% total equity stake in SQM (as opposed to Tianqi acquiring this stake).
Thus, restructuring the Nutrien-Tianqi Transaction to allow new non-competitive shareholders, or Nutrien shareholders (but not a direct competitor such as Tianqi), to own the remaining 23.77% stake in SQM would help resolve concerns regarding this “cozy relationship among competitors.”
Why are U.S. regulators silent over this matter?
It’s unclear if any of the U.S. agencies is currently conducting an investigation over this transaction, due to the confidential nature of their investigations.
But without the purview of U.S. regulators, both Tianqi and Nutrien are trying to close the transaction by the end of this year.
Tianqi is seeking to gain market share in the lithium market by having access to two of the most productive lithium mining operations in the world:
- In Australia: Tianqi and Albermarle already have a joint venture called Talison Lithium (“Talison”), which owns and operates a lithium mine in Greenbushes, Western Australia, that supplies at least a third of the global total lithium supply. Talison is controlled by Tianqi (51%), with the remaining stake held by Albermarle (49%). Talison has recently announced plans to significantly expand their lithium production.
- In Chile: Tianqi is seeking to gain access to the Salar de Atacama, where only SQM and Albermarle currently operate, having both recently renewed their lease and operating agreements with the Chilean Economic Development Agency (“CORFO”), which included significant expansions of their lithium production quotas.
Nutrien is selling its remaining 23.77% equity stake in SQM to the highest bidder. Tianqi is willing to pay the biggest premium (15%). You can’t fault the CEO of Nutrien for trying to maximize the return for the sale of this stake. Better to sell for $65 per share instead of ~$50 per share.
But it should be noted that if Tianqi is successful in acquiring 44.84% of SQM’s “Series A shares” from Nutrien, three interlocking entities — Tianqi, SQM and Albermarle — who now control over 70% of the lithium market, will have significant horizontal shareholdings and will increase their market concentration in the lithium market.
The Nutrien-Tianqi Transaction has critical implications for the global lithium market. It is time for the United States to take a closer look at this transaction to review its impact for U.S. consumers and the U.S. technology industry.
Author: Evan M. Epstein
Founder & Managing Partner
Pacifica Global Corporate Governance
Pacifica Global was founded in San Francisco to serve as the leading international advisory firm focused on corporate governance, anti-corruption, and shareholder rights issues. The mission of Pacifica Global is to help multinational public and private companies solve some of their most complex governance problems including cross-border regulatory and compliance challenges.