Illumina-Grail lawsuit casts shadow over prospects for Lockheed, Aerojet Rocketdyne

The US Federal Trade Commission’s lawsuit to block Illumina’s acquisition of Grail contains some ominous portents for Lockheed’s proposed combination with Aerojet Rocketdyne.

The deals, which are in significantly different industries, nonetheless share important structural similarities. One of the parties in each deal holds a monopoly in a product market, both deals pose a variety of foreclosure threats to competitors, and technological advances have created high barriers to entry in both situations.

But perhaps most telling, the FTC in the Illumina lawsuit declined to consider behavioral remedies and swatted down the common defense that the elimination of double marginalization can offset the potential harm to competition in vertical deals.

These are key issues for the defense merger, too. Unless the Department of Defense pushes the FTC to overlook the harm to competition for national security reasons, it’s difficult to see Lockheed and Aerojet Rocketdyne getting a more sympathetic hearing from the FTC than Illumina and Grail.

The FTC announced last week that it had filed an administrative complaint to block the Illumina-Grail deal. The agency argued that Illumina is "the only provider of DNA sequencing that is a viable option" for Grail and its competitors, and would therefore be able to discriminate against Grail's competitors if the deal is completed.

— Supply agreements, EDM —

The FTC said that “existing or potential supply agreements between Illumina and [customers that also make early detection cancer tests] cannot offset the likely anticompetitive effects of this Acquisition because these agreements cannot account for each and every current and future method by which Illumina may foreclose, raise the costs of, or otherwise disadvantage Grail’s rivals.”

The companies are fighting back by offering exactly such a contract to Grail’s competitors.

In the defense deal, Lockheed hopes to negotiate a behavioral agreement to play fair post-merger and offer Aerojet’s products and services to its competitors, too. But the Illumina complaint essentially takes the position that there isn’t a way for the government to account for all possible future harms, and therefore no contract can be designed to account for those potential harms.

Possibly more significant is the FTC's rejection of the double-marginalization argument, which the agency dispensed with in a single paragraph in its 28-page complaint against Illumina and Grail.

The FTC said that the “respondents fail to demonstrate that the Acquisition would likely generate verifiable, cognizable, merger-specific efficiencies that would offset the likely and substantial competitive harm from the Acquisition.

“To the extent that Acquisition results in any elimination of double-marginalization, Respondents cannot demonstrate that such a reduction in margin would offset the likely harm of the Acquisition,” the complaint said.

Double marginalization is where two companies in a supply chain set their prices to ensure a profit margin for each. In theory, a merger between those companies will allow for the elimination of double marginalization, or EDM, when the combined entity collects a single margin — presumably a lower one than the two margins combined.

The commission, but importantly the Republican commissioners, have long held that EDM often offsets the harms found in vertical mergers — that is, mergers between a supplier and a customer. Rebecca Slaughter, a Democrat who is now acting FTC chair, disputed the benefits of EDM when she was in the minority.

The decision to block the Illumina deal was approved 4-0, including votes from the commission’s two stalwart Republicans, Noah Phillips and Christine Wilson.

Though federal antitrust enforcers tend to say that every case brings its own unique set of facts, these two mergers share significant similarities.

Illumina is a gene sequencing company proposing to buy Grail, a company about to go to market with a blood test to identify 50 early-stage cancers. The FTC sued to block the deal March 30.

Lockheed Martin is one of the US’s biggest defense contractors and has proposed buying Aerojet Rocketdyne, the last independent maker of solid rocket motors and the only maker of Divert and Attitude Control Systems (DACS), which help guide missiles to their targets.

— Foreclosure, domestic competitors —

The FTC asserts that Illumina’s gene sequencers are an innovative, critical technology that Grail and its competitors rely on to build their blood testing products. The commission says that Illumina can already foreclose Grail’s competitors but lacks the economic incentive to do so — and that will change if the companies merge.

Lockheed and other major defense contractors rely on Aerojet for DACS and solid rocket motors, so while Aerojet has the theoretical ability to cut off Lockheed's competitors, it lacks the economic incentive to do so. That could change after the Lockheed merger.

Foreclosure isn’t just about increasing prices or refusing to sell a product or service to a competitor. Those tactics are relatively easy to identify and litigate. It is more difficult to demonstrate that a company has, for example, slowed a competitor by taking time to establish a firewall to protect its sensitive information; assigned a B-team of engineers or scientists to a competitor’s project; or denied or delayed important technical assistance.

The commission said Illumina is such a dominant player in the gene sequencing business that it produces 90 percent of the world’s sequencing data with few, if any, adequate substitutes.

Aerojet is the sole maker of DACS. There are no substitutes. And the product is so sophisticated and custom-built for each client’s missile that it can’t be easily replicated. What’s more, the military is unlikely to take a chance on a new entrant with no experience directing a missile to its target.

The FTC’s suit against the Illumina deal says Grail’s early-stage cancer blood tests will require FDA approval to receive reimbursement from healthcare payers. Products made outside the US without FDA approval won’t provide competition.

In Lockheed’s acquisition of Aerojet, there is a similar issue. The DOD and Congress take a dim view of foreign suppliers of defense products for national security reasons, including concerns about the potential impact on supply during a time of conflict.

It is unclear whether the agency’s analysis of the Illumina-Grail merger is a harbinger of a new approach or a response to a unique set of circumstances. But the similarities between Illumina-Grail and Lockheed-Aerojet are so striking that it would be difficult to understand how the agency could sue to block the healthcare deal while waving through — or attempting to fix — a defense merger that presents nearly identical concerns.