VIVENDI/FIRST AQUA MERGER - PART 1 OF 2 PARTS

8 Nov 2002 12:15 PM

Competition Minister Melanie Johnson has asked the Director General of Fair Trading and the Director General of Water Services to advise further on remedies in relation to Vivendi Water PLC's proposed merger with First Aqua (JV Co) Ltd, owners of Southern Water Services Ltd, to ensure consumers have a fair deal.

Miss Johnson has accepted the Competition Commission's view that the merger may be expected to operate against the public interest by prejudicing the Director General of Water Services' ability to make comparisons between different water enterprises, a practice which is important to ensure consumer interests can be properly considered.

Under the Fair Trading Act, the Secretary of State has a duty to make the final decision on what action to take in response to an adverse report.

Miss Johnson said:

"This is a very complex case, but I want to be absolutely sure that the consumer gets a good deal now and in the future. In the great majority of adverse reports the CC is able to reach a unanimous view, and the Director General of Fair Trading agrees with them. In such cases Ministers nearly always find themselves in agreement with the CC's recommendations on remedies. In this case we find ourselves in the unusual situation where the Competition Commission has not reached a unanimous decision on remedies, and the Director General of Water Services considered a third and different remedy was worth further exploration"

"I have taken into account all their views. I have decided that the CC majority remedy is not an appropriate remedy, and decided to ask the Director General of Water Services to discuss with Vivendi the terms of two other possible remedies. I have asked him to provide his views to the DGFT, who will then recommend to me which of these remedies, or another, such as the divestment of Three Valleys, should be required."

The Director General of Water Services will discuss the following possible remedies with Vivendi:

- The creation from Southern Water's assets, and subsequent selling-off, of a new water company covering Hampshire and the Isle of Wight (Hampshire Water). This would enable Vivendi to retain Southern Water's sewerage operation and some of its water operations.

- The expansion of the current Folkestone and Dover water services (which, after the merger, would be 100% owned by Vivendi) to encompass part of Southern Water's existing region, namely Thanet and Hastings. Again, this newly formed company would then be sold off.

The DGWS will consider, amongst other things, the following concerns:

- Set up and transitional costs should be borne by the Vivendi shareholders, not by customers.

- Changes to any tariffs should be handled in a sensitive manner.

- Proposals should include a clear timetable for achieving the separation and disposal of the newly created comparator within an appropriate timeframe.

Miss Johnson said:

"In a market where water companies operate as regional monopolies, the regulator needs a strong and effective regulatory regime. The use of comparisons between water companies is therefore essential. This further consideration will ensure the best interests of consumers are served, so that the regulatory regime continues to encourage the development of best practice. This is beneficial to all water customers."

The Minister noted concerns raised in the Competition Commission report about the proposed financing structure for the transaction, and has encouraged Vivendi to share details of its plans with the Director General of Water Services, so he can consider fully the possible operational effects.

Referring to the Enterprise Bill, which has received Royal Assent, Miss Johnson said:

"The Enterprise Bill will see the introduction of a number of completely new procedures and more resources to deal with complex cases of this nature. The CC will publish provisional findings part way through an inquiry to allow for an earlier, more transparent and more extensive consideration of remedies. It will also establish a new specialist remedies unit to advise on complex cases such as these in the future."

Notes for Editors

1. The Competition Commission's full report on the merger(Cm 5681) is available from the Stationery Office, price £25.75.

2. The reference was made to the Competition Commission under the Water Industry Act 1991 on 23 May 2002 (see DTI News Release P/2002/322). The CC reported on 23 September.

3. Under the Water Industry Act 1991, the Secretary of State is obliged to refer to the CC proposed mergers of regulated water companies whose assets exceed £30 million.

4. The proposed merger comes within the scope of the EC Merger Regulation. The European Commission, which cleared the case under the ECMR on 23 August 2002, recognised the legitimate interest of the UK in examining the merger's implications for the regulatory regime under the Water Industry Act. Section 34(3)(a) of the Act provides that the CC, in considering whether a water merger may be expected to operate against the public interest, 'shall have regard to the desirability of giving effect to the principle that the [regulator's] ability, in carrying out his functions .., to make comparisons between different water enterprises should not be prejudiced'. This ability underpins the regime of comparative competition in the water industry, in which the level of product market competition is very low.

5. The DGFT has been asked to report back to the Secretary of State by 21 February 2003.

6. A copy of the advice received from the Director General of Fair Trading and the Office of Water Services is attached.

7. This is the seventh case since May 1997 that the Secretary of State has not accepted Competition Commission recommendations on remedies. Sixty references have been made to the CC in this time.

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THE DIRECTOR GENERAL OF FAIR TRADING'S SUBMISSION FOLLOWING THE REPORT BY THE COMPETITION COMMISSION ON THE PROPOSED ACQUISITION BY VIVENDI WATER UK PLC OF AN INTEREST IN FIRST AQUA (JVCo) LIMITED

BACKGROUND

1. Vivendi Water UK PLC (Vivendi Water) is a wholly-owned subsidiary of Vivendi Water S.A., a leading water and waste operator. Vivendi Water, via Vivendi Water Capital Funds, has a controlling interest in three water enterprises in Great Britain: Three Valleys Water plc (Three Valleys), Tendring Hundred Water Services Limited (Tendring Hundred), and Folkestone and Dover Water Services Limited (Folkestone & Dover). It has a 31.4 per cent holding in a fourth regulated water company, South Staffordshire Group PLC (South Staffs Group). As at 31 March 2001, the net book value of the gross assets of Three Valleys was £430 million, that of Tendring Hundred was £35 million, and that of Folkestone and Dover was £30 million and that of South Staffs Group for the year 2002 was £177 million.

2. First Aqua Holdings Limited (First Aqua) is the parent company of First Aqua (JVCo) Limited (JVCo) which, through an intermediary - First Aqua Limited - owns Southern Water plc (Southern).

3. Southern is the holding company for Southern Water Services Limited (Southern Water Services), a firm holding an Instrument of Appointment under the WIA as a water and sewerage undertaker. The net book value of the gross assets of Southern's water business as at 31 March 2001 was £2,437 million.

JURISDICTION

4. The proposed merger falls within the ambit of Council Regulation (EEC) No 4064/89 of 21 December 1989 on the control of concentrations between undertakings (the ECMR), because of the parties' combined world and EC turnover. The proposed transaction also amounts to a merger of water enterprises for the purposes of the WIA and triggered a mandatory reference to the CC, under section 32(1) of the WIA. The legitimate interest of the UK in examining the merger's implications for the regulatory regime under sections 32 to 34 of the WIA has been recognised by the European Commission in a Decision. The European Commission cleared the merger under the ECMR on 23 August 2002.

ADVERSE FINDINGS

10. The CC has concluded that the proposed merger may be expected to operate against the public interest because it would prejudice the DGWS's ability to make comparisons between different water enterprises pursuant to section 34(3)(a) of the WIA. The CC also concluded, in accordance with section 34(3)(b), that the benefits created by the transaction would not be of "substantially greater significance" for the public interest than the detriment which the merger would cause to the DGWS's ability to make comparisons between different water enterprises pursuant to section 34(3)(a).

11. A dissenting fifth member of the CC group took the view that the detriment arising from the loss of Southern's independence is greater than the majority believes it to be. He also considered that Folkestone & Dover would "disappear" as a consequence of the merger, creating further prejudice to the DGWS's ability to make comparisons. Furthermore, he took the view that the complex and [?] financial structure envisaged by Vivendi Water is liable to prejudice the DGWS's ability to promote improved efficiency and quality of service.

REMEDIES

12. The CC considered prohibition of the merger to be
disproportionate to the detriment identified. It considered a variety of possible types of remedy and concentrated on the following three:

(a) to require Vivendi Water to divest Three Valleys, the largest of its three water- only companies;

(b) to create a new comparator from within Southern by the establishment and sale of a new water company covering Hampshire and the Isle of Wight; or

(c) to require the divestment of Vivendi's 31.4 per cent stake in South Staffs Group, which owns South Staffordshire Water Limited, thereby securing the independence of that company as a comparator.

13. Option (c) is the preferred remedy of the majority of the CC on the grounds that it would be the most appropriate and proportionate remedy for the adverse effect identified.

14. The dissenting fifth member of the CC, however, believes that, since South Staffs Group already behaves as an independent comparator, and since it is regarded by the DGWS and by the company itself as such, the value of the remedy recommended by the majority is "small and hypothetical". He therefore believes that the sale of Three Valleys, in addition to the divestment of the stake in South Staffs Group, is the remedy that most closely matches the detriment to the public interest.

15. On 15 October 2002 Vivendi Water announced that it had sold its 31.4 per cent stake in the South Staffs Group.

VIEWS OF DGWS

16. In his advice, the DGWS agrees with the CC that the detriment is material. However, he is of the view that the CC majority has not fully appreciated its extent and has thus underestimated the remedy required. Furthermore, the DGWS is of the view that the CC has not quantified the material prejudice (to the regulator's ability to compare water enterprises) in such a way that the proportionality of each of the options available as a remedy can be measured with any great precision. He believes that the CC majority's recommendation, the disposal of Vivendi Water's minority stake in the South Staffs Group, even in conjunction with the earlier disposal of a minority stake in Bristol Water , is an inadequate remedy for the harm to the regulatory regime arising from the merger. However, he believes that it would be disproportionate to the detriment arising to block the merger in the face of the CC's conclusions.

17. The DGWS considers that the creation of a new comparator in Hampshire (one of two undeveloped alternative remedies) potentially offers a proportionate remedy but that it would require substantial work to determine whether a viable and acceptable option could be established. He nevertheless offers you the option of asking him to explore this as a potential remedy.

18. With regard to the disposal of Three Valleys (in addition to the disposal of the minority South Staffs Group stake) the DGWS states that it is the only clear-cut practicable remedy available immediately. He believes it would fully address the detriment arising from the loss of an independent Southern. It would not be a disproportionate remedy, but he regards it as being towards the "high end" of the scale of remedies.

RECOMMENDATION

19. The CC majority's recommended remedy is the divestment by Vivendi Water of the 31.4 per cent stake in the South Staffs Group, thereby securing the independence of that company as a comparator. Vivendi Water has already announced this disposal. A stronger remedy is preferred by the CC dissenting minority - that of the disposal of Three Valleys (in addition to the disposal of the minority stake in South Staffs Group). The DGWS also believes this to be the only clear cut practicable remedy available immediately, but has also offered the further option of exploring the potential for creating a new comparator in Hampshire.

20. The OFT has no sectoral regulatory expertise in assessing the public interest test of section 34(3) of the WIA. We are therefore not best placed to make a recommendation on either the extent of the detriment arising from the merger or on the most appropriate remedy to that detriment. I am therefore exercising my discretion under section 86(1) of the FTA and not recommending which, if any, of these views might represent the most appropriate remedy.

21. You might, however, consider the following points. On the one hand, the views of the DGWS reported above at paragraphs 16 to 18 were put to and considered by the CC. By a majority, the CC nevertheless recommended only the remedy in relation to Vivendi Water's holding in the South Staffs Group. As you know, under the Enterprise Bill, it is proposed that it will be for the CC to decide whether a merger of water enterprises has or may be expected to prejudice the DGWS's ability to make comparisons between different water enterprises. In addition, it is proposed that it will be for the CC to decide whether to take action for the purpose of remedying, mitigating or preventing the prejudice to the DGWS or any adverse effect which may be expected to result from the prejudice to the DGWS, and, if so what action should be taken. These considerations might point to acceptance of the CC majority's recommended remedy. On the other hand, the DGWS is particularly well placed to advise on the sectoral regulatory issues.

22. This proposed merger has a Community dimension and the European Commission will want to verify that any action taken is appropriate, proportionate and non-discriminatory.

23. I recommend that, having regard to the CC Report and the points above, you decide between

- accepting the remedy recommended by the CC majority (the disposal of the holding in the South Staffs Group, which has already occurred)

- securing additionally a further disposal, for example that of Three Valleys,

and that you then invite me, under section 88 of the FTA, to obtain suitable undertakings from Vivendi Water.

ENDS PART 1 OF 2 PARTS