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WASHINGTON (Reuters) - The antitrust battle over whether food giant Sysco Corp (SYY.N) will be allowed to buy rival US Foods Inc USFOO.UL will likely focus on whether the merger will drive up costs for thousands of restaurants, hospitals and hotels that they supply on nationwide contracts.
The Federal Trade Commission will examine Sysco's $3.5 billion deal to buy debt-ridden US Foods from private equity, which was announced in December and would combine the only two food suppliers with a nationwide reach.
While the review is in early stages, the mega-merger has already rattled customers who rely on the companies for everything from pre-scrambled eggs for school meals to truffle mousse desserts for high-end restaurants.
One source said some restaurants and school districts have begun to discuss how to oppose it, and hospital food providers are "buzzing" about the proposed transaction, according to a second source.
The main concern is that national buying groups that negotiate for perhaps hundreds of hospitals or hotels will no longer be able to play Sysco and US Foods off against each other to get the best contracts for their members.
"If there's a problem here, it's in the national market place," said Seth Bloom, a former general counsel of the U.S. Senate Antitrust Subcommittee. "There is a potential for a problem even if the (overall) market share isn't that large."
Bloom also said a national-level problem could be fixed if the companies agreed to sell off enough warehouses, food distribution centers or other assets to build a regional competitor up into a national competitor.
Restaurants, schools, hospitals and hotels spend $223 billion annually buying food and other products to serve meals for their customers, according to industry data experts Technomic.
Sysco is by far the biggest food distributor, with revenues of $39 billion in 2012. US Foods, the only other company with nationwide reach, is No. 2, with $21 billion in revenue. Following the giants are Performance Food Group ($12 billion in revenues); Reinhart Foodservice ($6 billion) and Gordon Food Service Inc at $5 billion, according to consulting firm Technomic.
The FTC will approve the merger if it complies with antitrust law, but can try to stop it or require asset sales if it would severely damage competition or drive up costs.
The agency held meetings with regional competitors, including Performance Food Group, on Thursday and Friday of this week, according to a source, who was not authorized to speak on the record.
In addition, the Florida and Indiana attorneys general have acknowledged that they are part of a "multi-state group" reviewing the deal. There are 11 attorneys general in the group, the source said.
John Briggs, an antitrust expert with Axinn, Veltrop and Harkrider, said the deal could live or die depending on what national customers tell officials about the likely price effect on them. "I think there's a chance that the deal won't happen," Briggs said.
Sysco defends the merger as efficient and good for customers. "Sysco operates in a highly competitive and fragmented space," the company said in a statement this week. "This proposed merger will allow us to take meaningful cost out of the system and thereby make Sysco more competitive."
Sysco, whose shares jumped when the deal was announced in December, has said that it would be able to save money with fewer warehouses and fuller trucks and thus drive out costs.
Profit margins in the industry are tight, and have been getting tighter in recent years, but this deal would allow Sysco to make them larger, according to an industry expert who was not authorized to speak on the record.
"US (Foods) is known for being extremely price competitive in their efforts to secure new business, and this has had a direct impact on the falloff in Sysco's margin on their street customers," said the expert, referring to individual customers or small chains.
"Taking US (Foods) out of the equation will help Sysco increase their margins. And everybody else," the expert said.
David Balto, a veteran of the FTC who has clients concerned about the deal, said the market power of the two companies could prove problematic for the prospects of approval.
"If you look at the crucial competition in the market, it's between US Foods and Sysco," Balto.
Sysco, which will assume US Foods' debt of $4.7 billion, said it expected about $600 million in annual cost savings within three to four years.
Sysco has said that it would limit any divestitures in the deal to $2 billion in revenues. US Foods would receive $300 million in a termination fee if the deal is scrapped.
Diana Moss, an antitrust expert who teaches economics at the University of Colorado, said it's hard to see how divestitures would resolve this deal's problems.
"I'd be skeptical that the way the market is structured, that they could easily pull that off," said Moss, who believes that the deal should be stopped.
Reporting by Diane Bartz; Editing by Karey Van Hall and Tom Brown