AT&T/Time Warner Decision: The Triumph of Economic Analysis
|Topics:||Corporations, Securities & Antitrust • Law & Economics|
|Sponsors:||Corporations, Securities & Antitrust Practice Group|
On June 12, Judge Richard Leon of the District Court for the District of Columbia roundly rejected arguments by the Antitrust Division of the Department of Justice urging the court to block AT&T’s acquisition of Time Warner. AT&T announced in October 2016 that it had agreed to pay approximately $85 billion for Time Warner. The transaction would combine AT&T’s extensive pay TV subscriber base and mobile and broadband distribution with Time Warner’s vast library of content. Following a prolonged investigation, and to the surprise of many antitrust observers, the DOJ in November 2017 filed a complaint in federal district court seeking to block the transaction from closing. The DOJ alleged that the combined AT&T/Time Warner likely would substantially lessen competition in the sale of video programming and distribution by enabling AT&T to use Time Warner’s television content either to raise its competitors’ video programing costs or, by withholding “must have” Time Warner content, to drive those same competitors’ customers to AT&T’s subsidiary, DirecTV.
The case marks the first time in 40 years that a court has heard a fully-litigated challenge to a vertical merger – that is, an acquisition that combines companies in different levels of the same supply chain. Due to the absence of any competitor consolidation and the significant efficiencies that often result from vertical integration, vertical mergers rarely raise competitive issues and thus typically either have not been challenged by the antitrust agencies or have been resolved with behavioral remedies tailored to address narrow competitive concerns. Following a six-week trial, Judge Leon issued a detailed 172-page opinion that completely repudiates the sufficiency of the DOJ’s evidence against AT&T/Time Warner. The Antitrust Division is currently considering appeal.
The decision does not break new legal ground. The significance of Judge Leon’s opinion – as is so often the case in antitrust – is in the details and, in particular, its analysis of the economic evidence presented to the court. The decision invariably will have significant ramifications at the margin on whether firms pursue vertical transactions in the future, and offers a reminder to the antitrust authorities about the difficulties of prosecuting vertical mergers. As populist cries calling for increased government intervention to combat perceived widespread industry consolidation continue to grow, Judge Leon’s decision is a welcome reminder of the importance of evidence-based antitrust and a triumph of the role of economic analysis in antitrust law.
Judge Leon’s decision offers several important takeaways for merger law and policy.
Litigating in the Absence of the Structural Presumption Proved Difficult
Since the Supreme Court’s decision in US v. Philadelphia National Bank in 1963, the government has benefited from a presumption of illegality against any merger that threatens to create undue concentration in the market. Although the Court has not explained precisely what constitutes “undue concentration,” it has stated that the creation of a firm with a mere 30 percent share is sufficient to trigger the structural presumption. The structural presumption gives the antitrust agencies a considerable advantage in merger litigation by placing a thumb on the scale against the merging firms even before the government has made any actual showing of likely anticompetitive effects. That might be fine if the presumption found support in modern economics. Rather, despite the fact the structural presumption remains law, the economics that supported its adoption in 1963 has widely been debunked. Today it is well understood that there is no systematic relationship between market concentration and competitive effects.
In AT&T/Time Warner we witnessed the DOJ litigating without the benefit of the structural presumption. Because the transaction involved the combination of firms with a vertical relationship – rather than horizontal competitors – the transaction did not increase market concentration and thus could not trigger the structural presumption. As a result, the DOJ was required to present evidence beyond mere market shares in order to make its case that the transaction likely would result in anticompetitive effects. It did not carry that burden. Had the presumption applied, and the thumb been placed on the scale in favor of the DOJ, Judge Leon may have reached a different result. It is worth noting that the Federal Trade Commission’s last merger loss also came in a case that did not depend on the structural presumption (Steris/Synergy). The DOJ’s loss in AT&T/Time Warner is a reminder that the structural presumption is a powerful tool for the government and one that may be doing real harm if it allows the antitrust agencies to win merger challenges even when they cannot produce evidence sufficient to carry their burden of showing that the transaction is likely to harm consumers.
Ordinary Course Documents Were Unpersuasive
The antitrust agencies customarily have viewed business documents as an important element of merger investigations. “Bad” documents uncovered during an investigation may very well increase the likelihood that the transaction will be challenged and almost certainly will be put forth as part of the government’s prima facie case in court if the agency ultimately seeks to block the deal. Such materials are enticing, as they frequently are laced with boastful rhetoric from authors who never imagined the documents would be scrutinized so closely. AT&T/Time Warner was no different. In order to substantiate its increased-leverage theory of harm, the DOJ relied extensively upon numerous ordinary course documents as evidence of the parties’ anticompetitive intent. The DOJ asserted that evidence of anticompetitive intent “can also form the basis of a court’s prediction of harm,” and that it had carried its burden to support its increased-leverage theory of harm by presenting what it described as “real-world objective evidence,” comprised of statements from the parties’ prior regulatory filings and ordinary course documents, as well as testimony from third-party competitor witnesses.
The court found that neither the statements from prior regulatory filings nor statements in the parties’ internal documents were of any particular probative value when considered in context. Indeed, Judge Leon refused to admit into evidence or to allow the DOJ to cite in post-trial briefing internal documents lacking foundation or accompanying background. Judge Leon was equally as critical of DOJ’s reliance on statements in the parties’ ordinary course documents. He dismissed as irrelevant many proffered excerpts contained in preliminary drafts of documents authored by lower-level employees not involved in strategic decision-making relating to the merger that subsequently had been removed or changed such that upper-level executives did not see or rely on them; their importance and relevance was often overemphasized by the DOJ.
The DOJ also presented statements made by AT&T and DirecTV in prior regulatory filings, acknowledging the possibility that vertical integration allows the integrated entity to gain an unfair advantage over its rivals, as evidence that the parties have previously recognized the validity of applying DOJ’s increased-leverage theory in the context of affiliate fee negotiations. Of course, mere “possibility” was not in dispute. The relevant question was whether the tie-up between AT&T and Time Warner specifically would result in probable harm to consumers. Judge Leon remained focused on that question, and avoided being drawn into a debate over the general costs and benefits of vertical integration. In rebuking the DOJ’s reliance on those filings and other documents to support this theory of harm, Judge Leon noted that the limited value from those statements “cannot, and does not, overcome the numerous insufficiencies with the Government’s case,” particularly when the documents could not be squared with the economic evidence. Additionally, the court concluded that the parties’ prior predictions regarding the combined Comcast/NBCU’s ability to increase prices by threatening to withhold particular programming were not useful in determining whether the combined AT&T/Time Warner could raise prices, given the more competitive marketplace that exists today. Importantly, Judge Leon prioritized economic analysis over “hot” documents – and in particular, econometric analysis by Professor Dennis Carlton, the parties’ expert, concluding that the Comcast/NBCU merger did not cause content prices to increase – in reaching this conclusion.
Judge Leon emphasized that the documentary evidence put forth by the DOJ, when weighed against the considerable contrary evidence presented during trial, provided little support for the contention that the combined AT&T/Time Warner will gain increased leverage from the merger. Though ordinary course documents will no doubt continue to play a role in merger investigations, this case is a cautionary tale for relying on “hot” documents that conflict with testimonial evidence and economic analysis.
Court Relied Heavily Upon Economic Evidence and Analysis
A central theme of Judge Leon’s opinion is the importance of sound economic analysis to his conclusion that the transaction is unlikely to harm competition. Judge Leon discusses at great length the economic analyses offered by both parties, spelling out precisely the shortcomings and strengths of the economic experts’ models and testimony, the quality of inputs into those models, and their conclusions. At the end of the day, the analysis offered by Professor Carl Shapiro, the DOJ’s expert economist, could not withstand such scrutiny, particularly in light of his concession that the transaction will result in $352 million in annual savings for DirecTV customers.
At the heart of Dr. Shapiro’s analysis was the claim that the acquisition of Time Warner would give AT&T more bargaining leverage when negotiating carriage licenses with pay-TV providers. The court’s opinion takes on Dr. Shapiro’s bargaining model in detail. Judge Leon carefully analyzes and critiques the model’s inputs and assumptions one by one, pointing out inconsistencies with testimony and other economic evidence – as well as limitations resulting from Dr. Shapiro’s “significantly flawed” sources and methodology – along the way. Judge Leon discredited all three inputs Dr. Shapiro used as part of his bargaining model, finding:
- the long-term subscriber loss rate (i.e., the number of subscribers that would leave their current TV distributor if Time Warner content was withheld) he calculated was unreliable because he depended upon flawed data sources;
- the diversion rate (i.e., the number of subscribers who, after they left their current TV distributor, actually would switch to DirectTV) he used minimized the rate of cord-cutting and was thus understated; and
- the lifetime values used to calculate monthly profit margins for AT&T’s video customers were outdated and too high, and therefore overstated any potential harm.
The court also criticized Dr. Shapiro’s model for failing to account for the long-term affiliate agreements Time Warner’s Turner networks currently have with all of their distributors and the fact that there has never been – and is likely never going to be – a long-term blackout of the Turner networks. The forty pages of the opinion dedicated solely to a discussion of the weaknesses in Dr. Shapiro’s bargaining model concluded with Judge Leon describing the model as a “Rube Goldberg contraption” lacking in both reliability and factual credibility.
Judge Leon also engaged closely with Dr. Carlton’s economic analysis. The court examined Dr. Carlton’s econometric analyses of the effect of prior vertical transactions in the video programming and distribution industry on content prices, considering critiques by Dr. Shapiro and the DOJ in turn. The government, however, was not able to provide a sufficient basis to discredit this analysis, which was consistent with testimony from Comcast-NBCU and Time Warner executives. Judge Leon concluded that Dr. Carlton’s analysis, which definitively showed that prior instances of vertical integration in this industry have had no statistically significant effect on content prices, could be afforded probative weight in predicting the potential pricing effects of the AT&T/Time Warner transaction.
Proponents of economics-based antitrust can count this opinion as a win, regardless of differing views on the ultimate outcome. Judge Leon’s willingness to engage carefully with the evidence presented by both the parties and the DOJ, and the lengthy analysis that resulted from that exercise, surely will inform how merging parties present their cases going forward. The court’s opinion serves as a long overdue and useful model for vertical merger analysis from which courts, practitioners, and antitrust agencies seeking to apply an evidence- and economics-based approach to antitrust can and should learn.
Implications for Vertical Merger Review and Enforcement
Like most district court opinions, in AT&T/Time Warner = Judge Leon did not make sweeping conclusions about the law. Nor did he decide broad questions of economic theory. In fact, Judge Leon acknowledged the possibility that a vertical merger might harm competition under certain conditions. Judge Leon instead presented a detailed and fact-specific analysis of the case and concluded that the government had failed to present evidence sufficient to demonstrate that this transaction likely would substantially lessen competition. But it would be a mistake to dismiss Judge Leon’s decision as one with no implications for merger policy moving forward. It certainly is destined for the casebooks. Moreover, it provides the first guidance from an Article III judge on a vertical merger decision in decades.
Indeed, for the past year, many businesses have sat on the sidelines waiting to see whether the DOJ’s challenge of the AT&T/Time Warner transaction was a sign of things to come from the agency. Those businesses viewed the DOJ’s announcement that it would no longer accept behavioral remedies – that is, commitments limiting the parties’ commercial practices rather than requiring the divestiture of assets – coupled with the AT&T/Time Warner challenge as signaling a new vertical merger enforcement agenda. Judge Leon’s opinion alleviates those fears, at least for now. While Assistant Attorney General Makan Delrahim has made clear the DOJ will bring tough cases it believes in – an admirable and desirable stance for any law enforcement agency – the question about the AT&T/Time Warner challenge never has been about the willingness to make tough decisions, courage, or the integrity of the Antitrust Division. They score high marks in all three categories, as does Assistant Attorney General Delrahim. We also believe the DOJ’s preference for structural remedies should be commended. It is sound policy born out of recognition that markets are complicated and skepticism of government intervention.
The resounding defeat in federal court offers many lessons for agencies, practitioners, and academics. But the loss should come as no surprise to observers when the DOJ concedes on the record that the transaction is expected to generate at least $350 million in efficiencies annually while its own economic expert presents an estimated net harm that, as Judge Leon keenly observed, is statistically indistinguishable from zero.
* * *
Joshua D. Wright is University Professor and Executive Director of the Global Antitrust Institute, Scalia Law School at George Mason University, and former Commissioner of the Federal Trade Commission.
Jan M. Rybnicek is Senior Associate, Freshfields Bruckhaus Deringer, and Adjunct Professor, Scalia Law School at George Mason University.