26 March 2019

Competition Regulator OK With QANTM/Xenith Merger, But Notes That Group Firms ‘Lack Incentive to Compete’

Tick of ApprovalLast Thursday, 21 March 2019, the Australian Competition and Consumer Commission (ACCC) completed its public review of the proposed merger of QANTM IP Limited (ASX:QIP) and Xenith IP Group Limited (ASX:XIP), which commenced back in January.  The outcome of the review was ‘not opposed’, i.e. the competition regulator found no basis to object to the proposed merger under the ‘substantial lessening of competition’ test established by section 50 of the Australian Competition and Consumer Act 2010 (‘CCA’).  Focussing primarily on patent services (for reasons that I will explain further below), the ACCC concluded that ‘a merged QANTM and Xenith is likely to continue to face competition from a number of alternative large and medium suppliers’.

Notably, however, the ACCC distinguished between the independence of firms providing attorney professional services within the QANTM and Xenith groups, for avoidance of conflicts as required under the Code of Conduct for Trans-Tasman Patent and Trade Marks Attorneys 2018, and the presence of actual competition between such firms.  In particular, the ACCC stated that:

While firms within the same ownership group have regulatory obligations to maintain independence for the purposes of managing conflicts of interests, the ACCC considered that firms within a merged QANTM and Xenith do not have the incentive to compete with each other.  (Emphasis added.)

This is, I think, a subtle but important distinction, which indicates that the ACCC has developed a fairly good understanding of the dynamics within the market for IP services in Australia.  This will carry over into its ongoing review of the prospective hostile takeover of Xenith by IPH Limited (ASX:IPH), with the consequence that the absence of any objection to a QANTM/Xenith merger does not necessarily imply a similarly smooth passage for an IPH acquisition of Xenith (although, personally, I rate the likelihood of the ACCC actually blocking such an acquisition at virtually nil).

While this regulatory hurdle has now been overcome, it remains uncertain whether the QANTM/Xenith merger will proceed, in light of IPH’s opposition as owner of nearly 20% of Xenith shares.  On the one hand, Xenith now requires nearly 94% of the remaining votes (i.e. 75% of the total) to be in favour for the merger with QANTM to go ahead.  On the other hand, IPH still requires a green light from the ACCC, and would then need to secure 75% of the votes it does not control in order to succeed in its takeover bid for Xenith.  So even if IPH is successful in blocking the QANTM/Xenith merger, this is no guarantee that it will get its own way in the end.

For my further thoughts on these most recent events, and where they may lead, please read on.

Patents Dominate the Market Considered by the ACCC

The ACCC considered the effect of the proposed merger on competition for the supply of IP services in Australia for all four types of registered rights, i.e. patents, trade marks, designs, and plant breeder’s rights.  However, its conclusion is based primarily on an its analysis of competition in relation to patent services.  There are a couple of reasons for this.

Firstly, uniquely among all the registered rights, patent attorneys are granted exclusivity in the provision of services relating to drafting, amendment, and procurement of patents under sections 201 and 201A of the Patents Act 1990.  Legal practitioners have some rights to practice in relation to patent matters, subject to their own regulatory obligations, but these are limited by section 202 of the Patents Act.  No such exclusivity exists in relation to the other registered rights, and anybody may provide services in relation to application for, and acquisition of, trade mark, design, or plant breeder’s rights registration (albeit that nobody may call themselves a ‘trade marks attorney’ unless actually registered as such, and only a registered patent or trade marks attorney may call themselves a ‘trade marks agent’).

There is, as a result, more reason to look closely at the level of competition within the already substantially closed market for the supply of patent services.  As stated in its analysis:

The ACCC noted that the proposed merger would combine the second and third largest providers of IP services in Australia, and that the merger parties have about 30 per cent of total patent filings in Australia.

The ACCC found that corporate customers rely on the expertise and infrastructure of large IP firms, such as those within QANTM and Xenith, to handle their work in complex technology areas and to manage their volume of patent filings.

Secondly, the ACCC noted that not only is there a greater range of suppliers for services in relation to the other registered rights, including commercial law firms, but that, as a practical matter, lesser degrees of technical expertise are involved and that, in the case of plant breeder’s rights in particular, ‘the combined market share of QANTM and Xenith is low’ and ‘the majority of filings are made by applicants directly’.

No ‘Incentive to Compete’

Some in the profession will, perhaps, have been surprised by the ACCC’s statement that ‘firms within a merged QANTM and Xenith do not have the incentive to compete with each other’.  In practice, the firms within each of the three listed groups do, currently, compete with one another just as they have always done.

This is, however, essentially by default.  By and large, new business development activity by patent attorneys is fairly unfocussed, and consists largely of maintaining a presence (online, and in-person at industry events, conferences, and the like) in the hope of being ‘top of mind’ when a prospective new client is looking for an IP service provider.  Substantial clients tend to be ‘sticky’, and most attorneys and firms therefore consider that attempting to ‘win’ a client away from a competitor is rarely worth the effort in view of the low prospects of success.  Where a client does transfer work to a new firm, this tends either to be opportunistic, and/or initiated by the client as a result of dissatisfaction with an existing service provider.

In this context, a ‘business-as-usual’ approach means that firms within listed groups are effectively continuing to compete with one another to the same extent they always have – and to the same extent that they compete with firms outside the group.

However, it is not difficult to imagine circumstances in which a lack of competition between firms within an ownership group could manifest itself.  The most obvious, and likely to arise in the shorter term, is where a significant prospect puts work out for tender.  Responding to a substantial request for tender (RFT) is often a relatively onerous project, that may involve considerable time and effort on the part of senior attorneys, as well as business development and marketing staff.  Replicating such efforts across multiple firms in a group, placing them in competition against each other in circumstances where some may have better prospects of success than others, might not be regarded as an effective use of resources.  A better approach could be to direct efforts into a single response, either on behalf of one member of the ownership group, or to offer the services of attorneys across two or more firms under a single proposal.

Clearly, in such a scenario, there is less competition for the tender than there would be if all firms in the group were vying for the work.  On the other hand, the tendering party might be perfectly happy with the situation.  There are benefits in receiving a smaller number of higher-quality responses, and they might also obtain better pricing and service offerings from firms with the support of a listed parent behind them.  All of which only goes to demonstrate just how difficult it is to assess the impact of the listed group model on competition in the market for IP services.

Assessment of the IPH Takeover Proposal

In reviewing the proposed QANTM/Xenith merger, the ACCC noted that ‘the merger parties have about 30 per cent of total patent filings in Australia’.  On my data, it was actually 34% in calendar year 2018.  By comparison, IPH and Xenith collectively filed 44% of all patent applications in 2018.

If this is the primary measure of ‘market power’, 44% is a very substantial share, that would be likely to cause concern to any competition regulator.  As another measure, a combined IPH/Xenith would employ over 25% of all patent attorneys working in the ‘service provider’ sector, while QANTM and Xenith collectively employ around 23% of these attorneys.  Crossing the ‘magic’ 25% threshold on any measure of size or power could be a trigger for closer scrutiny.

It is therefore certainly not a given that the ACCC will reach the same conclusion of ‘not opposed’ to an acquisition of Xenith by IPH.  It was originally due to report on 2 May 2019, however this has been brought forward to 28 March 2019.  The announcement may be a final decision (i.e. ‘not opposed’) or the release of a Statement of Issues, setting out any concerns that the ACCC may have.  I will not be surprised either way, however ultimately I expect that the ACCC will be unable to block an acquisition of either Xenith or QANTM by IPH.  Any effort to do so is likely to involve Federal Court action, which IPH would surely defend vigorously.

Conclusion – Continuing Uncertainty for IP Attorneys

I am pleased to see that the ACCC has brought forward the reporting date for its review of IPH’s proposed acquisition of Xenith.  One of my major issues with the current drama is that it leaves many employees of IP firms, particularly within the Xenith group, in limbo with regard to the future ownership of their employers, which is a distraction that has obvious impacts on morale and confidence in the future of their own careers.  The sooner Xenith shareholders have certainty with regard to the position of the competition regulator with respect to both of the deals currently on the table, the sooner they will be in a position to decide how they might vote in each case.

Xenith shareholders had been scheduled to vote on the QANTM merger on 3 April 2019.  With the ACCC’s review of the IPH proposal pending, I understand that Xenith has been considering postponing this vote.  It now seems likely that it will await the ACCC’s announcement on 28 March 2019 before deciding on its next steps.

My hope is that the situation will be resolved as quickly as possible, for the sake of all the affected employees who are living with the current uncertainty.  However, in a worst-case scenario – where QANTM and Xenith are blocked from proceeding with their proposed merger, and IPH continues to pursue its own acquisitive interests – the saga could drag on for many months.


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