The competition watchdog has flagged "serious" concerns with Woolworths Group Ltd (ASX: WOW)'s buyout of PFD Food Services.
In August, the supermarket giant announced its intention to acquire 65% of PFD, which provides food services to clients like pubs, restaurants, cafes and convenience stores.
The Australian Competition and Consumer Commission (ACCC) on Tuesday revealed in its preliminary findings that the buyout is "likely to increase Woolworths' already substantial bargaining power" with suppliers.
Woolworths needs ACCC approval for the deal to complete.
"The ACCC is concerned that the proposed acquisition would remove PFD as an important alternative customer in the food sector, reducing the number of buyers and increasing Woolworths' relative size as a customer of food manufacturers and suppliers," said ACCC chair Rod Sims.
"The dominance of Coles Group Ltd (ASX: COL) and Woolworths in food retail means that wholesale food distribution is an important alternative customer channel for manufacturers."
Woolworths shares were up 0.42% to $39.34 at the time of writing.
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Woolies CEO reckons he can talk ACCC around
The supermarket acknowledged ACCC's announcement to the ASX but denied the acquisition would reduce competition.
"We have been working closely and constructively with the ACCC on these issues," said Woolworths chief executive Brad Banducci.
"We will see no reduction in competition, in any relevant markets, from our proposed partnership with PFD."
The ACCC will hand down its final decision in April, with Banducci saying he was "confident" he could address the preliminary worries.
The supermarket in September quietly launched its Woolworths at Work arm, which serves non-hospitality commercial clients such as childcare centres and white-collar corporates. PFD was set to complement that operation by servicing the hospitality sector.
Woolworths also has an operation called Woolworths AGW, which supplies petrol and convenience stores, that overlaps with PFD.
PFD deal could harm 'downstream' competition
The competition authority also flagged that the Woolworths-PFD acquisition could also structurally deteriorate the food supply sector.
For example, PFD potentially supplies some of Woolworths' competitors.
"If Woolworths was able to use its existing bargaining power as a retail buyer to gain better supply prices for PFD than PFD could obtain on its own, in the medium term this could have serious consequences for the structure of the wholesale food distribution sector, such as reduced range, choice, and service levels," said Sims.
The ACCC will take feedback on these preliminary issues until 1 February.
