JD SPORTS APPEALS CMA PROHIBITION DECISION CITING IMPACT OF COVID-19 AS A KEY CONSIDERATION

JD SPORTS APPEALS CMA
PROHIBITION DECISION CITING
IMPACT OF COVID-19 AS A KEY
CONSIDERATION
26 June 2020 | London
Legal Briefings – By Daniel Vowden

JD Sports has filed an appeal with the Competition Appeal Tribunal
(CAT) against the decision by the CMA to prohibit its acquisition of
rival retailer Footasylum, with the appropriate treatment of Covid-19 a
key area of dispute between the parties and the CMA.

Among the grounds of appeal published on 23 June 2020, JD Sports alleges that the CMA
erred in law and / or acted irrationally by excluding the effect of Covid-19 on Footasylum
when considering the relevant counterfactual (i.e., the competitive situation that would have
prevailed absent the merger). JD Sports further alleges that the CMA was also mistaken in
finding that Covid-19 would not materially affect the competitive constraint exercised by
Footasylum.

In prior public statements JD Sports claimed that the CMA had failed to take proper account
of the “seismic impact” of Covid-19 on the UK retail sector.

To date consideration of the impact of Covid-19 by the CMA, and other merger authorities,
has focused primarily on the risk that a financially failing firm could exit the market if a
relevant merger had not occurred. In April 2020 the CMA published guidance on the “failing
firm defence” in response to Covid-19 (see our blog post here). This re-stated the CMA’s
existing, pre-Covid-19 position, with no relaxation provided in relation to the stringent tests
to be met to qualify as a failing firm.

The guidance was issued following the provisional clearance by the CMA of the acquisition by
Amazon of a stake in Deliveroo, applying the failing firm defence in the context of the
Covid-19 outbreak (see our e-bulletin post here). The provisional findings in Amazon /
Deliveroo were reversed on 24 June 2020 insofar as they related to the application of the
failing firm defence. This followed evaluation of new evidence by the CMA on the impact of
Covid-19 on Deliveroo’s performance and finances.

While Footasylum had experienced trading difficulties prior to its acquisition by JD Sport,
issuing three profit warnings in 2018/19, it was not characterised by the merging parties as a
“failing firm” during the CMA’s investigation. The grounds of appeal, as set out in the
summary application, indicate that JD Sports instead submits that the impact of Covid-19
should have been considered by the CMA more broadly, including in relation to disrupted
patterns of consumer behaviour and related changes to the structure of competition, and not
solely through the lens of the failing firm defence.

Many parts of the UK economy have been severely affected by Covid-19. This appeal may
provide much-needed guidance as to the appropriate treatment of Covid-19 as a
consideration in the assessment of mergers. The outcome will be keenly followed by parties
contemplating M&A activity in sectors as varied as retail, leisure, construction and civil
aviation, all hard-hit by Covid-19

Other important aspects of the CMA’s decision in JD Sports/Footasylum have not been
appealed. In particular, at Phase 2 the CMA concluded that footwear and sportswear apparel
sales made in-store and online comprised part of the same relevant market. This conclusion
still stands. It is an important departure from the CMA’s general approach when examining
retail mergers, with the CMA typically identifying separate markets for sales made via bricks-
and-mortar store networks and online channels.

It is notable that this is the latest in a series of recent appeals made against CMA merger
decisions. Appeals have also been brought in in Tobii / Smartbox, Ecolab / Holchem and Sabre
/ Farelogix.

These appeals arise against a backdrop of increasingly robust intervention by the CMA. Four
mergers have been abandoned so far in 2020 following significant CMA criticism (Illumina /
Pacific Biosciences, McGraw-Hill Education / Cengage Learning, Kingspan / Building Solutions
and Prosafe SE / Floatel International). Including JD Sports / Footasylum, the CMA has to date
effectively prohibited five mergers since April 2019 (J Sainsbury / Asda, Tobii / Smartbox,
Ecolab / Holchem, Sabre / Farelogix).

We have separately discussed the CMA’s current approach to mergers in a recent webinar
series.

BACKGROUND
JD Sports is an international retailer of sports, fashion and outdoor products. In the UK it
operates a network of more than 350 stores under varied brands and also makes significant
sales via online channels.

In March 2019 JD Sports made a public bid for Footasylum, a retailer of fashionwear and
sports casualwear. The bid was successful and JD Sports acquired Footasylum in June 2019.
The CMA commenced its investigation into the completed acquisition in July 2019, launching
an in-depth Phase 2 inquiry on 1 October 2019.

During its Phase 2 inquiry the CMA undertook a widespread review of 2,500 internal
documents obtained from the merging parties. To assess the degree of competition between
the merging parties the CMA conducted surveys with over 10,000 of the parties’ customers in
October 2019. Other evidence considered by the CMA included an analysis of store openings
and closure and the resulting diversion of customers between JD Sports, Footasylum and
other competitors. The CMA also consulted extensively with third parties, seeking the views
of other retailers such as Sports Direct and important suppliers, notably Nike and adidas who
also make direct-to-customer (DTC) sales of sportswear products.

The merging parties made extensive submissions, with the onset of Covid-19 occurring at the
final stages of the CMA’s Phase 2 inquiry. Prior to the Covid-19 outbreak Footasylum had
been characterised by the parties as “a significantly weakened and less effective
competitor”. It was not suggested that Footasylum would exit the market imminently absent
the merger, rather it was submitted that Footasylum suffered from serious and durable
financial difficulties, diminishing its competitiveness absent the merger. Further analysis on
the potential impact of Covid-19 on Footasylum’s finances and its continuing ability to
compete effectively was provided shortly before the publication of the CMA’s Final Report.

It was also argued by the parties that Covid-19 and social distancing measures would cause
long-term structural changes to the market. For instance, it was submitted that substantially
reduced footfall at stores would further accelerate the growth of online sales and increase the
competitive significance of online only retailers such as ASOS and Amazon. Potential supply
chain issues arising due to increased competition between retailers and certain suppliers
were also identified, with Nike and adidas viewed as likely to favour their own DTC sales
ahead of making supplies to retailers.

PROHIBITION DECISION AND CONSIDERATION OF
COVID-19
In its Final Report the CMA concluded that the merger of JD Sports and Footasylum had given
rise to a substantial lessening of competition (SLC) in the supply of sports-inspired casual
footwear and apparel sold both in store and online in the UK, leaving shoppers worse off.

While the merging parties had a reasonably modest share of the overall market, and the
share increment resulting from the merger was small, the CMA concluded that JD Sport and
Footasylum were close rivals and their merger had therefore eliminated an important source
of competition.

The CMA concluded that the sale of Footasylum in its entirety comprised an effective and
proportionate remedy to the concerns it had identified.

In the Final Report, issued on 6 May 2020, the CMA acknowledged that its Phase 2 inquiry
was largely completed before the onset of Covid-19. The first confirmed cases of Covid-19
were reported in the UK on 31 January 2020.

The CMA considered the impact of Covid-19, as far as possible, to see if it changed its
findings. It noted, however, that there was considerable uncertainty about the extent and
duration of the impact of Covid-19. While it may take account of changes to market
conditions in the foreseeable future, in this case the CMA noted that it could not determine
with sufficient certainty whether the effects of Covid-19 were likely to have an enduring
impact on the market structure, relevant to its substantive assessment.

The CMA also observed that all retailers were subject to the same change in market
conditions. It was difficult to predict with sufficient certainty the effect of Covid-19 on
different retailers and how each might respond. For example, in relation to the supply of
footwear the CMA noted that it had not seen evidence suggesting that either of the merging
parties was worse affected by Covid-19 than the other or relative to other retailers.

Overall, the CMA did not envisage that the impact of Covid-19 was likely to reduce materially
the extent to which JD Sport and Footasylum were close competitors, or else increase
materially the competitive constraints exercised on the merging parties by their rivals, such
as to reduce the likelihood of a SLC.

The CMA’s approach appears broadly consistent with statements contained in its guidance on
merger assessments during the Covid-19 pandemic (available here). In that guidance the
CMA observes that its decisions must be based on “evidence and not speculation”, and that
there “remains considerable uncertainty about the extent and duration” of the impact of
Covid-19 (paragraph 22). The CMA sounds a further note of caution, observing that “[e]ven
significant short-term industry-wide economic shocks may not be sufficient, in themselves, to
override competition concerns that a permanent structural change in the market brought
about by a merger could raise” (ibid).

REACTION TO FINAL DECISION AND APPEAL

Responding to the Final Report in a press release on 6 May 2020, JD Sports claimed that the
CMA had failed “to take proper account of the dynamic and rapidly evolving competitive
landscape in which we operate, as well as the long lasting - and likely permanent - impact
that Covid-19 has had on our industry, which may never return to its pre-merger state, to the
particular detriment of smaller retailers like Footasylum”.

In the same press release JD Sport suggested that Covid-19 had produced “a long-term
societal and behavioural change in how consumers shop … it is virtually certain that footfall
levels will not return to pre-crisis levels. This outcome would disproportionately impact
smaller retailers like Footasylum, whose stores and shopping centre outlets rely so heavily on
concentrated footfall and high trading densities.”

In line with these statements, in its appeal JD Sports alleges that the CMA erred in law by
failing to sufficiently consider the impact of Covid-19.

In addition, JD Sports has alleged that the CMA failed to determine whether the lessening of
competition caused by the merger was “substantial” in nature. JD Sports is also critical of the
CMA’s evaluation of the competitive constraints exercised by suppliers, in particular Nike and
adidas, as well as Sports Direct, alleging that the CMAs’ findings in these respects are
irrational and/or inadequately reasoned.

JD Sports has applied to the CAT for an order quashing the CMA’s prohibition decision and
remitting the matter for reconsideration by the CMA.

COMMENT
The severe impact of Covid-19 on the UK economy is beyond dispute. Analysis by the UK
Office of National Statistics (ONS) starkly illustrates the impact on the retail sector. ONS data
shows that retail sale volumes in April 2020 fell by a 18.1%, the biggest monthly fall on
record.

The CAT must now determine, among other matters, whether or not the CMA acted
reasonably when evaluating what the potentially foreseeable impact of Covid-19 might be,
including on likely conditions of competition absent the merger.

The reversal by the CMA of its provisional findings in Amazon / Deliveroo provides a salutary
reminder of the difficulty of making such predictions. As recently as April 2020 the CMA
provisionally cleared the transaction, having regard to the deterioration in Deliveroo’s
financial position caused by Covid-19. New evidence considered by the CMA indicates a
considerable improvement in Deliveroo’s financial position reflecting, in part, changes which
the CMA maintains were not foreseeable during the early stages of the pandemic.

Other notable aspects of JD Sports / Footasylum have not been subject to appeal. In
particular, at Phase 2 the CMA departed from its conventional approach to market definition
in retail mergers. While it has generally treated in-store and online sales as comprising
separate product markets, in JD Sports / Footasylum the CMA ultimately concluded that these
sale channels formed part of a single product market.

The CMA changed its position on this key issue during the course of its investigation. At
Phase 1 the CMA concluded that in-store and online supplies of sports-inspired casual
footwear and apparel comprised distinct markets. In light of mixed evidence on this point, at
Phase 1 the CMA found that online sales exercised an indirect, “out-of-market” competitive
constraint on in-store activities, and vice versa.

Following more extensive investigations, the CMA reached a different view at Phase 2.

In determining that in-store and online sales channels were substitutable and formed part of
the same market the CMA attached significance to the fact that the merging parties both
targeted younger consumers, aged 16-24.

The CMA observed that this demographic group was most likely to make purchases online.
Demand among younger consumers was found to centre on “multi-channel retail
experiences”. The CMA found that in-store and online sales channel could be used
interchangeably for different aspects of a consumer’s journey – including search, comparison
and purchase. Demand for products was often achieved through marketing online - using
social media influencers or sports personalities - as well as through in-store promotion.
Survey evidence clearly showed that a sizeable proportion of consumers searched for
products via one sales channel (e.g., online) and then made purchases via the other sales
channel (e.g., in-store).

The CMA further noted that all national in-store retailers of sports-inspired casual footwear
and apparel also had an online offering. Retailers increasingly facilitate consumer switching
between sales channels, for example through in-store click-and-collect amenities that mean a
retailer’s entire online range can be accessed in-store. Consistent with this, the merging
parties did not discriminate in their internal documents between competitors’ in-store and
online offerings.

KEY CONTACTS
If you have any questions, or would like to know how this might affect your business, phone,
or email these key contacts.

SUSAN BLACK              DANIEL VOWDEN           MARK JEPHCOTT
PARTNER, LONDON          PARTNER, BRUSSELS       PARTNER, LONDON

+44 20 7466 2055         +32 251 81851           +44 20 7466 2323
Susan.Black@hsf.com      Daniel.Vowden@hsf.com   Mark.Jephcott@hsf.com

LEGAL NOTICE
The contents of this publication are for reference purposes only and may not be current as at
the date of accessing this publication. They do not constitute legal advice and should not be
relied upon as such. Specific legal advice about your specific circumstances should always be
sought separately before taking any action based on this publication.

© Herbert Smith Freehills 2020

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