By Annie Gasparro And Brent Kendall
To save their planned merger, food-distribution rivals Sysco
Corp. and US Foods Inc. need to convince a federal judge over the
next two weeks that their industry is a lot more diverse than
antitrust enforcers claim.
The nation's two largest food distributors and the Federal Trade
Commission will square off in a federal court in Washington,
beginning Tuesday, in a seven-day hearing that carries high stakes
for the restaurants, hotels and schools that rely on the companies
for food ingredients and other supplies.
The FTC filed suit in February to block the merger after
investigating it for more than a year, arguing that the deal would
eliminate direct, vigorous competition between the two companies
that other distributors couldn't replace.
The commission alleges that Sysco and US Foods, with roughly $65
billion in combined annual revenue and hundreds of thousands of
customers, would account for 75% of sales to big chain restaurants
and other national customers and have more than a 50% market share
in 32 cities, including 80% in the Washington area.
"These customers face a substantial risk of higher prices and
diminished service compared to what they would receive without the
merger," the FTC said in court papers.
The companies call the FTC's math "pure fiction" because it
doesn't include a wide range of competing suppliers: wholesale
stores like Restaurant Depot, small specialty purveyors of items
such as meat and produce, and regional full-service distributors
that don't have warehouses within a certain radius of some markets
but which do deliver there. Sysco and US Foods say that focusing on
national customers is misleading, and that they have a combined
market share of just 25% when all customers are taken into
account.
"There is no one-size-fits all distribution model in the food
service distribution industry," the companies say in a court
filing. "Customers create their own distribution mix using multiple
providers."
Customer experiences in San Diego, where the FTC says Sysco and
US Foods have a 100% market share, show the critical role the big
distributors play, while also suggesting there is sometimes more
competition than the government acknowledges.
Jim Phillips, general manager of Studio Diner in San Diego, says
he uses specialty suppliers for meat, produce, and bread, but gets
the vast majority of his supplies from Sysco.
"I need one guy who can handle at least 80% of my stuff and get
me the best deal over the long term," he said. "I can't have my
kitchen manager talking to a dozen salespeople all day long."
Mr. Phillips says he supports the merger because he thinks the
combined company will be able to offer him better deals. He says
there are other competitors locally, including Shamrock Foods Co.,
a full-service distributor that delivers to San Diego from a
warehouse about 100 miles north and is eager for his business.
"Sometimes the Shamrock salespeople are here twice a day," Mr.
Phillips said.
Sysco, which has 73 full-service distribution centers, and US
Foods, which has about 60, are the only food distributors with
nationwide networks. But Sysco says some 16,000 regional
distributors, boutique shops and wholesale stores have been
poaching its customers for years and forcing it to lower
prices.
The FTC doesn't count Shamrock as a competitor in San Diego
because of its distance from the market. The Phoenix-based company
opened a Southern California warehouse four years ago, one of four
it operates, all in the western U.S.
Distance does have drawbacks, restaurants say. It can be harder
for them to arrange rush deliveries from more-distant suppliers
when items run out unexpectedly.
"Shamrock is more than willing to make the trip," said Mike
Morton Jr., CEO of Brigantine Family of Restaurants, a 13-unit San
Diego-area chain. "But it does make us stress with our guys that
they need to be accurate in their orders."
Brigantine switched to US Foods after disagreements with its
former supplier, Sysco. Mr. Morton switched again to Shamrock once
he heard about the pending merger. He says he is happy with
Shamrock's service and prices, which he says he couldn't get from a
patchwork of small suppliers. But, he said, "Certain markets like
San Diego don't have many players, so I totally understand why the
FTC is looking at it."
The FTC, seeking to rebut the merging companies' arguments, says
that specialty distributors and wholesalers can't replace one-stop
shops like Sysco and US Foods that have a full suite of products,
frequent deliveries and services such as menu planning. National
chains and institutions also need the consistency and breadth of a
distributor with nationwide reach, it says.
Hoping to poke holes in the FTC's analysis, Sysco sent employees
to find other distributors making deliveries in San Diego and
Washington. In San Diego, Sysco employees parked on a
restaurant-filled street in the popular Gaslamp district filming
rivals' trucks pulling up. The company said it found at least two
dozen competitors within a 200-mile radius.
The commission is asking U.S. District Judge Amit Mehta to
preliminarily block the merger so it can hold a full trial on the
deal in its own in-house administrative court in July.
In reality, Judge Mehta's ruling will likely determine whether
the merger goes through.
If the FTC can't win a preliminary injunction from the judge, it
will face pressure to abandon its case. And if the companies lose
in this initial round of litigation, they would face a long, uphill
battle. "This merger will not survive a lengthy administrative
trial. This court will decide the merger's fate," Sysco and US
Foods told Judge Mehta in court papers.
The companies and the FTC ended up in court after settlement
discussions failed. Sysco and US Foods offered to sell 11
distribution centers that generate a combined $4.6 billion in
revenue to their next-largest competitor, Performance Food Group
Inc. Eight of them are in markets the FTC called problematic,
including San Diego, but the agency said it wasn't enough.
Sysco's shares--which gained about 16% in the 14 months after
the company announced its plan to acquire US Foods in December
2013--have fallen nearly 7% since the FTC announced its suit, to
$37.16 on Friday. US Foods is owned by private-equity firms
including KKR & Co.
The merger challenge marks an important moment for the FTC,
which hasn't litigated a high-profile deal since 2007, when it
sought to block Whole Foods Market Inc. from acquiring a
competitor. The FTC lost that case in the trial court but won an
appeal, and the two sides eventually settled.
The FTC has a reputation for bipartisanship, but it split 3-2
along party lines in deciding to sue to block the Sysco-US Foods
merger, with Democrats in the majority. The companies have
emphasized the FTC split in court papers.
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