The antitrust world is abuzz with the surprising decision of the Department of Justice to file a complaint in federal District Court to block the proposed $85 billion deal in which AT&T would acquire Time Warner. The deal is a vertical merger because the two companies work in different parts of the media cycle. AT&T is a transmission company that does not create its own content. Time Warner is primarily a content company that does not engage in actions of transmission. The DOJ position appears to be that it will allow the merger to go through uncontested only if AT&T agrees to sell off either its own DirecTV satellite unit or Time Warner’s Turner Broadcasting division that counts among its property CNN, TBS, and TNT. The DOJ denies that the President has intervened, and it is best to deal with this proposed acquisition on its merits, whatever the views of the President.
It did not take long for AT&T to give its stern response to DOJ’s action. AT&T General Counsel David R. McAtee II made it clear that AT&T had no intention of getting rid of the CNN division as part of any overall deal, and noted that AT&T is prepared to fight DOJ if it wishes to dismember either company in the process of approving the acquisition. This position tracks the conventional antitrust wisdom that vertical mergers are generally not troublesome because by definition they do not increase concentration in either the upstream or downstream components of the transaction. In AT&T’s view, this transaction allows for the greater efficiencies of a uniform distribution platform that “will help make television more affordable, innovative, interactive and mobile.” In contrast, mergers between two or more direct competitors raise potential antitrust issues if they allow these competitors to raise prices, reduce output, or both.
As an outsider, I have no idea whether this merger would deliver the promised efficiencies. Indeed, vertical mergers of this sort have often foundered because of the business difficulties involved in integrating two companies that might have been better off using long-term contracts to govern their relationship, given that these do not require a single governance umbrella. Exhibit A is, of course, the disastrous 2000 merger between AOL and Time Warner. At the time, various consumer groups protested that the new colossus wrought by Time Warner’s acquisition of AOL would transform the industry for the worse by linking the strongest content producer with the leading distributor. In fact, the entire deal fell apart in 2009 when Time Warner spun off its failing AOL unit because it could not find any synergies that justified keeping the two companies together. AOL seriously misplayed its own position and lost out to other companies that proved themselves to be faster and nimbler. In so doing, it exposed one of the weaknesses of an aggressive vertical integration strategy. A strong linkage that seems to be an asset turns out to be a real disadvantage if and when incompatibilities emerge during day-to-day operations. It is a lot harder to break off a bad merger than it is to modify an unworkable contract or to form a new contract with a better content provider or distributor. The merger strategy should never be regarded as risk-free from a business point of view, and the proposed AT&T-Time Warner merger is no exception to the general rule. But these business risks are not antitrust problems; if the merger fails, the transaction will be undone or modified, and if it succeeds, it will produce enduring social advantages. My guess is that AT&T and Time Warner know what they are doing. They have surely looked at past mergers to see what they could learn from them, and there have been a welter of technological and market fixes since the AOL debacle that could well justify their conclusion that this merger is a good idea.
So the ultimate question in this particular case is whether there is some antitrust risk that the DOJ is in a position to see. The telltale sign that something is seriously amiss in this case derives from the two alternatives it proposed in negotiation, neither of which is mentioned in the government’s complaint. The first DOJ proposal is that AT&T spin off its DirecTV division—but why? The integrated nature of AT&T and DirecTV suggests there are strong efficiencies that come from this particular union. At least the government has not done anything to deny that this is the case, or to explain what the antitrust objections are to merging the companies while allowing AT&T to keep DirecTV. Why, in negotiations, did DOJ seek to condition the approval of a merger on weakening one of the two parties to the transaction, when efficiency losses are the last thing anyone wants out of any merger? DOJ’s other proposal is that Time Warner drop one of its key portfolio companies, CNN. Again, there seem to be obvious synergies between companies that provide complementary content services. Or at least there is no particular antitrust difficulty with the constellation of Time Warner companies that would justify any DOJ action to prevent the merger with AT&T. So why demand that at least one party to the transaction go through an uncertain transformation when there is no independent evidence that the merger itself will have any anticompetitive effects in any market on either side of the transaction?
The mystery only deepens when considering that the new antitrust chief, Makan Delrahim, is a self-described conservative who once toed the traditional (and correct) line that a vertical merger between two companies does not pose any threat to competition that justifies DOJ intervention. What changed his mind in this case? One explanation, drawn from his Keynote Address at the American Bar Association’s Antitrust Fall Forum, is that Delrahim generally prefers “structural” merger remedies, as opposed to allowing mergers to go through subject to various limitations—on practices such as pricing, tie-in, and nondiscrimination—which he calls “certain behavioral commitments.” In his view, the behavioral commitments are “fundamentally regulatory, imposing ongoing government oversight on what should preferably be a free market.” To avoid that difficulty he prefers structural restraints because they are one-and-done controls.
Nonetheless, the case is not that one-sided. As Randolph May and Theodore Bolema of the Free State Foundation point out, the 2011 acquisition of NBCUniversal by Comcast included a number of restrictions of company practices that have generated no litigation of note in the six years since. There is, in a word, no categorical set of reasons that make structural restraints universally preferable to practice decisions. We know that these structural constraints often impose major restrictions on mergers, and they are impossible to reverse if they turn out to be erroneous. Practice restrictions are easier for the parties and government to modify if circumstances change in ways that make them obsolete. So there is a difficult trade-off between the relative simplicity of structural reforms and the greater flexibility of practice reforms. In this case, moreover, it is hard to see, as noted above, why the spin-off of either DirecTV or CNN advances any sensible goal.
It is, for that matter, also difficult to see what particular practice restrictions would make sense in connection with this vertical merger. In dealing with this issue, the government complaint argues that the proposed merger is a violation of Section 7 of the Clayton Act on the grounds that it would substantially weaken competition “in both the All Video Distribution product market and the Multichannel Video Distribution product market in numerous relevant local geographic markets throughout the country.” The fear is that AT&T would raise the prices that it charges to other content companies to carry their material on its network. But that is playing with fire if those companies decide go elsewhere to distribute their goods, leaving AT&T with a smaller content base on which to support its transmission grid. Alternatively, the government suggests that Time Warner only transmit its content over the AT&T network, which again has the unfortunate effect of cutting down on the exposure of its content.
In doing so, the government complaint reveals this weakness about the structure of the market. It acts as if the market is hidebound. Its opening salvo insists that “American consumers have few options for traditional subscription television.” In the next paragraph, it notes that “disruptive entry is now challenging that traditional model.” But it never puts the two points together to conclude that the dynamic changes that take place make antitrust intervention peculiarly ineffective to deal with this market. The weakness of its complaint is further evidenced by its bland declaration that “the proposed merger would be unlikely to generate verifiable, merger-specific efficiencies in the relevant markets sufficient to reverse or outweigh the anticompetitive effects that are likely to occur.” The argument appears wrong on both dimensions. The conclusory denial of any efficiencies from the merger has to stand up to the willingness of AT&T to give chapter and verse on this matter in discovery and through trial. And its insistence that the two companies when vertically integrated could generate huge price increases that they could not do separately is utterly inconsistent with the downward pressure that technological improvements and new entry have on prices.
In sum, a far better way to think about this issue is to ask whether the combination of the two networks will make AT&T a more desirable place for other content carriers to come by offering them superior services. The DOJ could come up with some novel, but sound, theory that shows the competitive harms that could come from this merger for which some modest practice restriction will not work. But for the moment at least, the government’s complaint is at best a threadbare effort that forms a wholly insufficient ground for blocking this proposed merger.