It’s been almost eighteen months since the boards of AT&T and Time Warner unanimously voted to sign an agreement to merge their two companies together and create a content and distribution powerhouse. That deal, pegged at $108 billion including debt from Time Warner, would be among the largest corporate mergers in American history. The U.S. Department of Justice sued to block the deal this past November, and now after long last, the antitrust trial that will determine the deal’s fate is about to start tomorrow with opening statements, following a snow delay today in Washington DC.

This case is sprawling — the Justice Department intends to present 519 exhibits already — and much of the case will hinge on technical legal minutia. However, at its heart is a critical question on whether a combination of AT&T and Time Warner would help or hurt competition and thus ultimately consumer welfare.

This is a very important case to understand, because the court will have to reach a nuanced understanding of antitrust law in the complex and deeply interconnected world of video services. The decision rendered here could drastically affect consumer choice as well as the business practices of companies across the tech industry.

A framework to understand antitrust

Before getting into the specifics of AT&T-Time Warner though, we need to understand how antitrust works — which is quite a bit more nuanced than the media generally describes.

The essential goal of antitrust regulations is to protect consumers from predatory business practices driven by companies who hold outsized market power. While companies can grow market power over time (think a fast-growing startup eating more and more marketshare), the reality is that the U.S. government by and large avoids using antitrust to target a company in the normal operation of its business (Microsoft back in the 1990s being a notable exception).

Instead, the Federal Trade Commission and the Department of Justice directs its attention to mergers and acquisitions as key decision points where it can review a transaction and determine whether the combined company helps or hurts competition. Companies conducting transactions must submit documentation to antitrust bodies as part of what is known as the HSR process.

Mergers are generally divided into two categories. The first is a horizontal merger, which is when two direct competitors join forces and merge — think Uber and Lyft hypothetically. The other form is a vertical merger, which is when two companies with related businesses come together in order to offer a more comprehensive and synergistic set of services in their product market.

In reviewing these transactions, the FTC’s goal is to increase competition and improve consumer welfare in all industries. Horizontal mergers are generally placed under strong scrutiny, since by definition, removing a competitor from a marketplace reduces competition (although there are exceptions).

Here is where the nuance starts to become more pronounced. The FTC generally views vertical mergers more positively, since combining related companies can reduce costs, which ultimately improves consumer welfare.

Bruce Hoffman, the acting director of the Bureau of Competition at the FTC, explained vertical merger theory and why the FTC generally looks more favorably on the practice in a speech earlier this year:

As compared to arms-length contracting, a vertically integrated firm can more readily realize efficiencies in the form of lower costs or improved quality, conditions that greatly benefit customers of the firm. In addition, vertical mergers can eliminate the problem of “double markup,” which occurs when two firms, each with market power over a complementary product, set prices independently. Due to the problem of double markup, separate price setting leads to a higher prices and lower levels of output. A vertical merger of these two firms allows for joint price setting over the two products, which leads to higher profits but also increased output. These built-in effects, while not necessarily large or dispositive in all cases, render the starting point for our analysis of vertical mergers more challenging than horizontal mergers.

The FTC may look more favorably upon vertical mergers, but that doesn’t mean it always supports them. Hoffman noted in his speech that the FTC has fought 22 vertical mergers since 2000. He indicates three typical concerns: that the merged companies can block new competitors, that they can foreclose competitors from customers or key inputs, and that they may have confidential information that allows them to compete with competitors unfairly. Each of these may be a reason to either block a transaction, or to demand changes or on-going monitoring of a merger.

So to review, the FTC doesn’t care about size per se — it isn’t against consolidation, and in fact, may favor consolidation in cases where the newly merged company can be a more effective competitor in the marketplace and therefore increase consumer welfare.

Antitrust and AT&T-Time Warner

With that framework in mind, AT&T-Time Warner becomes much more complicated. The video production and distribution industry is oligopolistic — there are a handful of major studios, channels, distributors, and platforms in the industry that drive most of the value here. Balancing those competing interests against each other is the best route toward maximizing competition and therefore consumer welfare.

The players in this space are some of the largest companies in the world. Through DirecTV, AT&T is the largest multichannel video programming distributor (MVPD) in the U.S. with 25 million subscribers, and of course, it is the largest telecom company in the world. Time Warner is one of the most powerful content producers in the U.S., owning channels like TBS and TNT, premium subscription services like HBO, as well as Warner Bros, which is one of the largest and most profitable movie studios.

The two companies may be powerful, and combining them will only heighten those powers. However, they are facing incredible headwinds from the technology industry, namely the so-called FAANG group of internet giants: Facebook, Apple, Amazon, Netflix, and Google (and by extension, YouTube). Every single one of these companies has made video a top priority, and their war chests and valuations are similarly powerful.

As the counsel for AT&T-Time Warner pointed out in trial according to CNNMoney, “Petrocelli told Judge Leon that their estimates show FAANG is worth $3 trillion collectively, while an AT&T-Time Warner entity post-merger would be worth $300 billion. ‘We’re chasing their tail lights,’ Petrocelli said.”

Given that industry context, the critical question then is whether combining AT&T and Time Warner would help consumer choice in the video industry by allowing the two companies to more effectively compete as equals with the internet giants, or whether it would use its assets to leverage additional fees from competitors, and ultimately suck its competitors dry by forcing more customers on to its platforms, thereby limiting consumer choice.

The Department of Justice is clearly arguing the latter. There are a couple of considerations. In the government’s favor, Time Warner owns the assets to several critical live sports and news organizations including the NBA, MLB, NCAA men’s basketball tournament (i.e. March Madness), and the PGA, along with CNN and associated networks. This live programming is increasingly valuable for distirbutors, because viewers watch ads and also perceive the content to have scarcity.

Therefore, such programming is considered “must have” for distributors, so Time Warner is able to charge a premium for access. If AT&T and Time Warner merged, the fear is that they would raise prices on this sort of critical content, forcing its competitors to increase prices to retain carriage rights. AT&T could keep the prices of its own distribution level (they own the content after all), which would make its services more attractive to consumers. Ultimately, that limits consumer choice.

Another factor in favor of the government, particularly since December when the FCC repealed net neutrality, is that AT&T, as a major mobile telecom provider, will have significant power to control the quality of service that customers of the internet giants will experience. AT&T could throttle Netflix, for instance, unless Netflix buys Turner-produced content. A merger gives the company more market power, and that would likely cause price increases in the industry.

The government doesn’t have a simple case to make though. A factor in favor of AT&T-Time Warner is that its content costs are increasingly being dwarfed by the internet giants. Time Warner’s HBO segment spent $2.2 billion in 2017 according to the company’s 10-K form, compared to more than $6 billion dollars by Netflix in the same time period. Turner, the segment that includes TBS and TNT, spent $4.46 billion.

In other words, Netflix is spending almost as much money as Time Warner as a whole does, and also owns its customers through its streaming subscription model. Add in large original content budgets from Google, Apple, and Amazon, and suddenly Time Warner looks like a (relatively) small fish in a very large pond.

Another point in favor of the merger is that the government allowed Comcast’s acquisition of NBC to go through, albeit with restrictions on the deal and active monitoring. As Hoffman of the FTC said in January though, “…we prefer structural remedies—they eliminate both the incentive and the ability to engage in harmful conduct, which eliminates the need for ongoing intervention.” Structural remedies here means divestitures or an outright block, as opposed to active monitoring requiring the DoJ to continually work with a company to ensure compliance.

These are just some of the points that both sides are going to argue over the next six to eight weeks in district court. The court will have to decide how consumers are going to fare in a merger scenario and whether they are better off with or without it.

In my view, the merger is unlikely to be favorable to consumers, given the history of similar mergers in the past, AT&T’s business actions in recent years, and the generally positive business models of Netflix and other online streaming services with their convenience and efficiency for consumers.

The caveat is that the internet giants are just that — giants, and their continued growth means that fewer and fewer companies can compete with them in these markets. Allowing AT&T-Time Warner to go through may limit competition today, but that may already happen in the future if Time Warner falls behind its content competitors.

Unfortunately, markets are dynamic, while the conclusion of tomorrow’s case is a static decision in a point of time. While the future may be hard to predict, it seems unlikely that FAANG’s aspirations are going to diminish, and their consolidation may limit what little competition exists in this space. On balance, the court should probably say no, but that decision may well have been different a year or two from now.

As Judge Leon, who is overseeing the case, said this week quoted by CNNMoney, ”I always tell people at parties, I don’t have a crystal ball. In this case I have to get a crystal ball! Maybe at one of those second-hand stores somewhere!” Let’s hope that crystal ball is very good indeed.

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