Saturday, March 10, 2018

Department of Justice Pre-Trial Brief Describes A Case Against AT&T/Time Warner Merger That Will Be Difficult to Win

The Department of Justice and AT&T-Time Warner have released their pre-trial briefs regarding the DOJ’s antitrust challenge to the AT&T/Time Warner merger. The trial briefs lay out the cases each side expects to present at the upcoming trial, which is set to begin Monday, March 19, 2018. Put simply, for a vertical merger, the Department of Justice is seeking unprecedented relief in the modern antitrust era, and proving its case is likely to be very difficult.
The proposed merger is a vertical merger of Time Warner, a programming content provider that sold off its cable systems years ago, and AT&T, a programming distributor through its DirecTV, U-Verse, and Internet-based services. The last time the U.S. government went to court seeking structural changes to a vertical merger was in 1979, when the Federal Trade Commission lost its challenge to truck trailer manufacturer Fruehauf’s acquisition of a brake component supplier.
The DOJ is insisting that behavioral remedies would not be effective and structural relief is needed, which might mean blocking the merger entirely or requiring the parties to sell off DirecTV or the Time Warner channels that are central to the merger transaction. Since 1972, every vertical merger challenge by the federal government was either unsuccessful or was settled out of court, usually with behavioral restrictions rather than structural changes. Thus, the DOJ is facing the additional burden of not only having to prove that the proposed merger will lead to anticompetitive harm, but also that these anticompetitive concerns are sufficient to justify the first court-ordered structural relief in a vertical merger case since 1972.
I previously pointed out how the Complaint filed by the DOJ in November 2017 was light on details about how the DOJ planned to litigate the case, and heavy on conclusory claims about anticompetitive outcomes and quotes from mostly unidentified documents from the merging parties suggesting motive. I noted that the DOJ will have to provide actual market evidence of how the anticompetitive harm would occur.
In its pre-trial brief, the DOJ provides much more information about how it plans to litigate the case. The brief indicates that DOJ will rely on case studies to show the economic impact of programming that is removed from cable systems when programming providers and distributors fail to reach agreements on prices. DOJ intends to argue that AT&T’s power to withhold Time Warner programming will give it market power over competing programming distributors who know they will lose customers if they cannot deliver Time Warner programming.
DOJ’s basic theory is that AT&T will use its new leverage from the Time Warner programming to harm content providers who compete with AT&T’s programming distribution services. In short, DOJ alleges that AT&T after the merger will have an incentive to raise prices for Time Warner programming, knowing that some or most of the competing content providers will pay the higher prices. And if content providers don’t pay the higher prices for Time Warner programming, DOJ claims that AT&T will recapture some of its lost revenues when a portion of the customers from those non-paying content providers subscribe instead to DirecTV or U-Verse because they want the Time Warner programming badly enough to switch.
DOJ’s characterization of the possible anticompetitive harms may be plausible in theory, but it suffers from many shortcomings. First, it is possible to describe equally plausible theoretical ways in which the anticompetitive strategy described by the DOJ would harm the merged parties more than it would help them, which DOJ will have to disprove in order to make its case before the court. It seems unlikely that AT&T would spend over $100 billion (including assumed debt) for the Time Warner channels only to damage their value by limiting access to these channels in order to increase the market share of DirecTV and U-Verse.
Second, there are good reasons to believe that changes in the market, many of which have occurred since some of the case studies cited in the DOJ brief, make it much less likely that anticompetitive strategies that may have worked in the past would work today. The DOJ brief mocks these arguments as the “Star Wars’ defense” because the merging parties claim, “everything the government is telling the Court is stale and out of context–it is from a long time ago in a galaxy far, far away.” Nonetheless, consumers are becoming far more willing to cut the cord and look to Internet platforms for information and entertainment. By early 2017, Amazon Prime subscriptions climbed to 80 million and Netflix surpassed 50 million, and 64% of TV households subscribed to Amazon Prime, Hulu, or Netflix. And the 2014 dispute over DirecTV’s carriage of The Weather Channel (TWC), which ended after three months when DirecTV refused to pay TWC’s higher rate and TWC folded, illustrates how owners of content providers have less leverage than in the past.
Third, the DOJ brief specifically identifies the HBO channels as valuable Time Warner content that the combined company could use to place competing distribution services at a disadvantage. But those channels are already available in many different ways, including through the online SlingTV and Hulu services. The HBO Now app is currently pre-loaded on all Apple TV for users of iPhones and iPads, and similar apps can be uploaded to Android, Amazon Fire, and Kindle devices. If a competing cable service were to lose access to HBO, its customers likely could find it elsewhere, and at a similar price to what their cable service charged. Eliminating access to HBO through all of these distribution services after the merger would hardly go unnoticed by consumers.
Finally, the AT&T and Time Warner brief asserts certain economic efficiency benefits that will allow them to better compete in the broader content deliver market with the much larger Google and Facebook. The merging parties claim: “In total, AT&T projects merger synergies of more than $2.5 billion in annual synergies by 2020 and more than $25 billion in total synergies on a net present value basis.” DOJ will have the burden of showing that these efficiency benefits are less than the cost of any anticompetitive effect DOJ can demonstrate.
For a substantive analysis of the merger and the context in which it should be reviewed, see my February 8, 2018 Perspectives from FSF Scholars entitled “The Proper Context for Assessing the AT&T/Time Warner Merger.” Free State Foundation President Randy May and I also discussed the challenges faced by the DOJ in bringing this case shortly before the DOJ filed its challenge here.