Last week, a federal court released a public version of its 93-page opinion providing its reasons for denying the Federal Trade Commission's challenge to Whole Foods Markets' acquisition of organic grocer Wild Oats. Given the publicity surrounding Whole Foods' "bad documents" that surfaced during the FTC's investigation of the transaction, including e-mails authored by Whole Foods' CEO, the court's opinion is noteworthy for its reliance on "market facts" and other economic evidence instead of the tantalizing and colorful comments found in Whole Foods' documents. While the court's analytical approach should be reassuring to practitioners and clients alike, it would be a mistake to conclude that "all's well that ends well."

FTC's Challenge to the Whole Foods/Wild Oats Merger

Four months after Whole Foods and Wild Oats filed their merger notification with the FTC the FTC voted to challenge the merger by seeking a preliminary injunction from the U.S. District Court in D.C., pending the outcome of an administrative proceeding in the FTC. The FTC claimed that Whole Foods and Wild Oats were the two dominant players in the relevant market—a market that the FTC defined as "premium and natural organic supermarkets"—in 17 metropolitan areas where both companies already operated stores and in seven metropolitan areas where Wild Oats already had a store and Whole Foods had planned to open a store. Contending that the two supermarket chains were their own closest competitors, the FTC argued that allowing the transaction to close would result in higher prices for those consumers patronizing "premium and natural organic supermarkets."

In its submissions to the court, the FTC relied heavily on Whole Foods' own documents to prove that Whole Foods viewed Wild Oats as its main competition and the retail distribution of "premium and natural organic foods" is a specialty area dominated by the two organic supermarket chains. For example, Whole Foods CEO John Mackey's statement that "Safeway and other conventional retailers will keep doing their thing—trying to be all things to all people. They can't really effectively focus on Whole Foods Core Customers without abandoning 90% of their own customers." The FTC also relied on presentations to the Whole Foods Board of Directors, suggesting that the merger would give Whole Foods some power over the prices to consumers. For example, John Mackey explained to the board that "[b]y buying [Wild Oats] we will…avoid nasty price wars in Portland (both Oregon and Maine), Boulder, Nashville and several other cities which will harm our gross margins and profitability."

As their defense, the merging parties demonstrated that Whole Foods would suffer a "critical loss" and find it unprofitable to raise prices after the merger because enough consumers would switch to other conventional supermarket chains for their grocery needs in response to a significant price increase. Their economist pointed to the market-switching behavior of "premium and natural organic foods" consumers who shifted their purchases from other conventional supermarket chains when a Whole Foods store opened in two metropolitan areas (one area where a Wild Oats store operated and one where it did not). The merging parties also focused on how other supermarket chains had already repositioned themselves to compete with organic supermarkets like Whole Foods and Wild Oats by reconfiguring their stores and enhancing their offerings of organic and natural foods.

After a two-day evidentiary hearing and the review of a voluminous record of FTC investigative hearing and deposition transcripts, witness declarations, expert reports, witness declarations and extensive briefing from the parties (and amicus curiae), the court agreed with Whole Foods and Wild Oats that the relevant market was much broader than "premium and natural organic supplements" and should include the larger supermarket chains such as Safeway, Wegmans and Delhaize. The court seemed to be especially persuaded by the defendants' expert economist and his empirical evidence that Whole Foods and Wild Oats competed in a broader market than the narrow market that the FTC delineated.

Criticizing the FTC's argument that the organic supermarkets' efforts to differentiate themselves from the larger, more-established supermarket chains was strong evidence that the "premium and natural organic supermarket chains" constituted a separate product market, the court observed that, to the contrary, differentiation is often the very essence of competition and reminded the FTC that the key issue in defining a market is whether customers could switch to a reasonable substitute if prices were to rise after the merger. The court stated that the FTC's focus on the "core customers" of the organic supermarkets completely missed a fundamental principle of the FTC's Horizontal Merger Guidelines, namely that market definition should focus on the conduct of the marginal customer (e.g., price shopper) who would switch to other suppliers to defeat a price increase and not the behavior of the "core" or infra-marginal customer who would not switch.

The FTC has appealed the court's ruling to the D.C. Court of Appeals and, after the district court denied a stay of its ruling, sought a stay of the ruling from the court of appeals which was denied. In its brief, the FTC protested that the district court had erred by ignoring the "contemporaneous, high-level statements and strategic documents authored by senior executives, describing their view of the market realities and of the effect of the merger." Nonetheless, the court of appeals held that "[a]lthough the FTC has raised some questions about the district court's decision, it has failed to make a 'strong showing that it is likely to prevail on the merits of its appeal.'" Within days after the court of appeals' denial of a stay, Whole Foods purchased Wild Oats' shares.

Lessons Learned

While Whole Foods and Wild Oats have reason to celebrate the outcome once the federal court proceeding, it may be useful, after the party is over, to examine the import of Whole Foods' generation of numerous "inartfully" drafted documents. Loose and ill-chosen words in documents, especially those authored by top executives, provided the ammunition for FTC staff to undertake an investigation and discovery that reportedly resulted in the production of more than 20 million documents, the taking of 40 investigative hearings and depositions, the drafting of extensive briefs and an ongoing SEC investigation of Whole Foods for its CEO's alleged surreptitious participation in an investors' "chat room." While only the parties know the actual costs of the FTC investigation and court proceeding, some antitrust practitioners have estimated the costs to be in the range of $15 million - $20 million, almost 5% of the value of the deal.

Moreover, Whole Foods' ordeal does not end with the court of appeal's denial of a stay and the closing of the agreement with Wild Oats. Because the investigation of the merger was assigned, at the time of the filing to the FTC instead of the U.S. Department of Justice (which has concurrent jurisdiction with the FTC in merger review), Whole Foods faces the prospect of undergoing an administrative proceeding under the rules of the FTC where the ultimate outcome could be an FTC ruling ordering Whole Foods to divest itself of the Wild Oats assets that it had acquired years earlier. An FTC administrative proceeding (which the FTC already initiated on June 28, 2007, but stayed on August 7, 2007) typically involves additional extensive document discovery, numerous depositions, expert preparation, a trial before an administrative law judge assigned to the FTC (without the benefit of the Federal Rules of Evidence) and an appeal to the commission itself of the judge's order. If the commission agrees with its staff that a divestiture should be ordered, Whole Foods would then have the option of appealing the FTC's ruling to a U.S. court of appeals. In reviewing the record of the administrative proceeding, the Court of Appeals, however, typically gives "substantial deference" to the finding of the commission.

If the FTC chooses to continue to pursue its administrative proceeding (as its rules enable it to do), the final outcome of the Whole Foods/Wild Oats merger is far from certain and, in any event, several years away. While this power of the FTC to pursue an administrative divestiture proceeding even after a federal court has found that the FTC has failed to demonstrate that the effect of the merger "may be substantially to lessen competition or tend to create a monopoly" has been questioned by the Antitrust Modernization Commission and others, that power is still intact and is currently being exercised by the FTC in a petroleum refinery merger where the FTC is deciding whether to pursue an administrative divestiture proceeding after losing a merger challenge in federal court more than two months ago.

This uncertainty over the ultimate fate of the Wild Oats assets is likely to affect Whole Foods' stock price adversely and inhibit its ability to manage (and dispose of) Wild Oats' assets in the most efficient manner. And, if the FTC decides to pursue its administrative proceeding, the uncertainty will likely hover over Whole Foods for the next three to five years.

Additional Information

You can find the full text of the FTC's opinion at http://www.perkinscoie.com/files/upload/LIT_07-08_OPINION_FTCvWholeFoods.pdf. You can find discussions of other recent cases, laws, regulations and rule proposals of interest to public companies on our website.