Justice Department Requires Divestiture of Morpho’s ETD Business to Bless Smiths Acquisition

Coming as no surprise, the U.S. Justice Department in late March said it will require Britain’s Smiths Group to divest the explosives trace detection (ETD) of Morpho Detection as a condition for approval of Smiths pending $710 million acquisition of Morpho from France’s Safran Group.

The Justice Department’s condition for the deal follows one earlier this year by European regulators, who also are requiring Smiths to divest Morpho’s trace business to allow the acquisition to proceed.

In response to European authorities’ concerns about allowing Smiths to consolidate its existing trace business with Morpho’s, Smiths Group said in January that it would divest Morpho’s explosive trace detection business. Smiths and Safran announced the deal last April.

Regulators want to ensure robust competition in the U.S. and in Europe for the ETDs, which are used to help in the screening of airline passengers and their baggage, aviation cargo, and to protect other critical infrastructures worldwide.

“In particular, Morpho has a history of bidding aggressively for contracts to supply and service desktop ETD devices in this market,” the Justice Department complaint says, referring to bids for airport checkpoint applications. “By underbidding its rivals, Morpho delivered to the TSA a lower-priced option while also incentivizing competitors to respond with more competitive prices and terms of sale. Absent the merger, Morpho was expected to continue to be an aggressive competitor. As a result, the proposed acquisition would give Smiths the ability and the incentive to raise prices and decrease the quality of its service.”

The complaint also says that Morpho has a track record of bidding aggressively for contracts to supply ETD systems for the air cargo screening market.

In the second half of 2017, TSA is expected to issue a new solicitation to supply desktop ETD systems, the complaint says. Without the divestiture, there would only be two suppliers of the systems, “likely leading to higher prices and less advantageous terms for that agency,” it says.

The Justice Department’s announcement notes that Morpho Detection had about $325 million in sales in 2015, about $65 million through ETD product sales. Morpho Detection’s U.S. revenue in 2015 was about $262 million, the Justice Department says.

Smiths Detection, a business unit of Smiths Group that will integrate Morpho Detection, had about $730 million in sales in 2015, the Justice Department says in its complaint. Once the transaction closes, Smiths Detection will have about $1 billion in annual sales. Smiths Detection had $225.7 million in U.S. revenue in 2015.

OSI Systems’ [OSIS] Rapiscan Systems division is considered a potential buyer for Morpho’s trace business although the company previously passed on acquiring Implant Sciences, which supplies handheld and desktop ETDs worldwide.

Once the acquisition is finalized, Morpho Detection will still provide Smiths Detection business with a well-established product line for computed tomography-based explosive detection systems used at airports worldwide to automatically screen checked baggage for explosives.

Smiths, Morpho and Massachusetts-based L3 Technologies [LLL] are the only suppliers in the U.S. of desktop ETD systems. Currently the Transportation Security Administration operates desktop ETDs from Smiths and L3 although in the past it has acquired the systems from Morpho.

L3 acquired Implant Sciences last year to enter into the trace business.

China’s NucTech also sells ETDs.

The Justice Department’s complaint requiring the divestiture of Morpho Detection says that annual sales of desktop ETD systems in the U.S. for passenger air travel averaged about $13 million a year for the past six years. It says that annual sales of the desktop systems for screening air cargo averaged about $5.5 million during that same period.

Once the acquisition closes, Smiths will have a comprehensive suite of imaging and detection systems for transportation and critical infrastructure protection. The company has 90 days from the filing of the March 30 Justice Department complaint to divest Morpho Detection, which includes its global ETD business of desktop, handheld and portal ETD products.

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