ANALYSIS: How will regulators view Australian consolidation moves?

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Anti-trust officials are voicing concerns about Virgin Australia's recently announced plan to match the Qantas portfolio of domestic carriers by buying 60% of Tiger Australia and all of Skywest Airlines.

Low-cost carrier Tiger would compete on Virgin's behalf with Jetstar, while Skywest would do the same with QantasLink on regional and mining routes. Virgin will fund the acquisition of these carriers, and the cost of beefing them up, partly by selling a 10% stake in itself to Singapore Airlines.

This ambitious initiative is part of Virgin Australia's rebranding strategy, designed to distance itself from the low-cost sector and compete more with mainline Qantas in the business market.

The Tiger and Skywest acquisitions require governmental approvals, including that of the Australian Competition and Consumer Commission (ACCC). Commission chairman Rod Sims warns that Virgin's takeover of Tiger faces close scrutiny because of its possible anti-competitive effects.

Sims denies any "instinctive view" about how the commission should rule, but he notes that Australia now has three airlines - Qantas (via Jetstar), Virgin Australia and Tiger - in the low-cost sector. If Virgin buys Tiger, Australia will end up with "two well-established players, rather than a third player nipping at their heels, and this merger would make it harder for another third player to come along".

Sims concedes that these deals will make Virgin Australia a stronger competitor to Qantas. "That's the plus," he says, "but they will take out the remaining competitor to do it - that's the negative."

Australia uses a will it "substantially lessen competition" test to judge acquisitions and mergers - the same test used in the UK, the USA and several other nations. Competition agencies generally focus on two issues: how concentrated the industry is and what market share the merged firm would control after a takeover.

Australia's skies are fairly concentrated, but there are also questions about how to measure the market. For example, are premium airlines in the same market as low-cost carriers? Sims thinks so. "You can't segment it to say there is an absolutely separate premium and low-cost carrier market," he told local reporters. "They do cross over."

The European Commission makes a distinction between "time-sensitive" and "non-time-sensitive" passengers in its airline merger analysis, but European practitioners such as Sven Volcker write that "drawing a clear line for market definition purposes is very difficult".

If all scheduled air travel in Australia is counted as one market, the Qantas family controls 65%, Virgin Australia 30%, Tiger 4% and Skywest less than 1%. The country's only other players are small. Virgin's proposed acquisitions would yield a Qantas-Virgin split of 65-35.

No magic numbers dictate when competition officials will approve or reject a takeover. In one case, the US Supreme Court rejected a merger of two banks because the move increased concentration in commercial banking by one-third, even though the merged bank would still control only 30% of that market.

Conversely, Brazil's competition agency, CADE, recently approved GOL's takeover of WebJet, lifting GOL's market share to almost 40%. But Brazil's skies are less concentrated because of other airlines, such as Azul. Concentration and control seem to be the key factors.

Part of the US court's reason for rejecting the bank merger was that the bank failed to show how its proposed merger would avoid or minimise anti-competitive effects. As this suggests, enforcement agencies are willing to consider factors other than the numbers. The American Bar Association's anti-trust section says these include how likely rivals are to compete vigorously after the merger, barriers facing a potential start-up and the prospect that one of the merger parties might fail without the merger.

In European acquisitions and mergers, the EC is also willing to consider likely efficiencies that could bring consumer benefits. How much officials elsewhere will do this is unclear. As anti-trust professors Gellhorn, Kovacic and Calkins write: "The issue of efficiencies in merger review has stimulated grand debates and disagreements."

If the ACCC is willing to consider such evidence, Virgin Australia will surely claim that its potential portfolio of business, leisure and regional airlines will compete more effectively against a dominant Qantas that already has all three in one group.

But the ACCC could counter that Virgin Australia has already built a regional network with its existing Skywest joint venture. Why could it not do the same with Tiger to create a low-cost network without the anti-competitive baggage that comes with a takeover? This enters the realm of what anti-trust academics call "merger-specific economies" - those that cannot be achieved without the merger. The ACCC's Sims says: "It will come down to what we think the alternative world will look like."

Rod Eddington, former Ansett chairman and British Airways chief executive, says: "History in Australia suggests that domestic aviation is ultimately a two-horse race. But the horses are more multi-faceted than they were before."

Whether it is All Nippon Airways with Peach or WestJet with Encore, airlines around the world are adopting a portfolio strategy with separate brands for different segments of their markets. Virgin Australia's plan to fast-track this by acquiring existing airlines instead of forming its own will be a test case for this new approach.