Monopolies and the Law

As simple as they may appear, mergers can often be long and complicated. For instance, the proposed merger of Sirius (Nasdaq: SIRI  ) and XM (Nasdaq: XMSR  ) has raised concerns that various regulators may block any deal between the two satellite radio providers. Many believe that between antitrust laws and FCC guidelines, it'll be difficult for Sirius and XM to get the necessary approval to go forward.

Though they play an important role in nearly every merger, antitrust laws are sometimes difficult to understand. As with most legal language, antitrust laws give regulators the flexibility they need to evaluate each situation independently and act in what they believe is consumers' best interest. Bearing in mind the consequences of past monopolies, regulators use antitrust laws to prevent them from occurring again.

The origins of antitrust
Antitrust laws have existed for more than a century. During the late nineteenth century, the Industrial Revolution led to rapid expansion in business activity in the United States. Businesses in many industries -- including railroads, oil drilling, and tobacco production -- were originally small and geographically dispersed around the nation. As these small businesses consolidated in large national enterprises, however, they threatened to dominate entire industries across the country. This not only contradicted the need for diverse competition, but also made it difficult for small businesses to stay afloat, as the business environment encouraged practices that would be frowned upon today.

Popular opinion ran against the large enterprises, which became known as business trusts. Laws designed to combat them were therefore dubbed antitrust legislation. The Sherman Act, passed in 1890, prohibited monopolies and restraints of trade. Later laws defined more specific types of prohibited behavior. For instance, charging different prices to different customers could be illegal under certain circumstances, as was the practice of forcing consumers to buy multiple products in order to obtain the one they really wanted.

Full of gray areas
Nevertheless, antitrust remains a particularly murky area of corporate law. The main problem with antitrust laws is that they depend almost entirely on how one chooses to define a market. The prospective Sirius-XM deal provides a good example. If you define the market you're trying to protect as the business of providing radio broadcasts via satellite, then it's obvious that a combination of the two major companies in that market would lead to a virtual monopoly in satellite radio. However, if you look at these two companies in the broader context of radio broadcasters generally, satellite radio commands just a tiny fraction of the overall market, and Sirius and XM are both extremely small in comparison to traditional radio broadcasters like Clear Channel (NYSE: CCU  ) .

The interpretation the government takes for a given merger rests largely on the Federal Trade Commission, which seeks to protect consumers and prevent anti-competitive business practices. In cases where there are legal violations, the Justice Department has the power to stop companies from using prohibited business practices. Without approval from these government bodies, proposed mergers can sometimes fail entirely.

Adjusting to antitrust
As a practical matter, however, antitrust laws usually result in modifications to merger terms rather than killing deals outright. In many cases, merging companies will divest themselves of a certain portion of their joint businesses in order to ease antitrust concerns. For instance, when Exxon and Mobil combined to form ExxonMobil (NYSE: XOM  ) , there were some areas of the country -- especially the Northeast, California, and Texas -- in which the combined entity would have had an overwhelming percentage of gas station market share. In response, the FTC conditioned its approval of the merger on ExxonMobil's agreement to sell more than 2,400 gas stations to other oil companies in order to foster competition in those areas.

Some argue that antitrust laws have outlasted their usefulness. With the economy becoming increasingly global, applying antitrust laws to relatively small geographical areas may appear to be unnecessarily provincial and irrelevant to broader competition around the world. Some also point to recent antitrust actions, such as the suit against Microsoft (Nasdaq: MSFT  ) in the late 1990s, as unfairly penalizing companies simply because they happen to be the largest players in their particular industry.

However, given that many states have their own antitrust legislation in place, it's unlikely that the focus of antitrust law will expand along with the scope of the global economy. While national and international agencies like the World Trade Organization have looked at the broader consequences of multinational corporations on the world economy, states are likely to continue to stress consumer protection in their enforcement of antitrust laws, even when the population affected by a particular transaction or business practice is extremely small.

Investor caution
For investors, antitrust laws represent a barrier to what may otherwise be a lucrative merger or acquisition. The possibility of antitrust problems is part of the reason why shares tend to trade below the price offered by a potential acquirer. In evaluating a proposed merger, investors should look closely at whether antitrust concerns may pose problems or require significant adjustments to the terms of a deal.

For the most part, however, antitrust laws have become part of the general business environment. While they may prevent certain actions that would be beneficial to a particular company, they also provide a safeguard against corporate behavior that often proves harmful both to consumers and small businesses.

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With all the mergers and acquisitions going on in the markets today, it's important to understand and anticipate how M&A activity works. The Motley Fool's investing newsletters take a close look at possible takeover activity and its impact on your investments as one of many parts of its overall analysis of stocks. You can take a trial run with any of our newsletters free for 30 days.

Microsoft is an Inside Value selection and XM is a former Rule Breakers pick.

Fool contributor Dan Caplinger is both pro-trust and pro-antitrust. He doesn't own shares of any of the companies mentioned in this article. The Fool's disclosure policy is anything but anti-competitive.


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