The Justice Department’s Fanciful Case Against AT&T-Time Warner

There is rarely anything to celebrate when two companies in the same industry decide to merge. Mergers–whether horizontal or vertical–tend to entrench incumbents and raise barriers to entry for disruptive newcomers, which robs consumers of choices.

Within the industry itself, mergers channel capital toward scale, at the expense of innovation, which can lead to stagnation and ennui.

And, while the shareholders of the companies involved may see a short-term windfall, in the long run the buyer generally just ends up inheriting whatever problems drove the seller to sell in the first place, without actually solving them.

So, there is more than ample cause to be skeptical of AT&T’s proposed $109 billion acquisition of Time Warner.

That said, however, the theory of the government’s case for blocking the merger, which went to trial this week, seems cockeyed.

In its complaint and opening statement, the Justice Department argued that by acquiring Time Warner’s valuable programming assets, including HBO, CNN, and the Turner networks, AT&T would have both motive and means to extort higher prices from competing pay-TV distributors by threatening to withhold “must have” programming, thereby ultimately driving up prices for consumers.

The government cites a model developed by University of California economist Carl Shapiro to estimate consumers in aggregate will pay $400 million more per year, or $6.00 per subscriber per year, as a result of the merger.

“The merger will take a tool needed to compete and turn it into a weapon,” attorney for the Justice Department Craig Conrath told the court.

But surely, AT&T’s ultimately goal is to drive the cost of programming down, not up. Even after the acquisition, should it go through, AT&T’s primary business will still be connectivity and delivery, not programming. And as with all TV distributors, the biggest challenge to its margins will still be the ever-rising cost of content. By bringing HBO and the rest of Time Warner’s TV content in house, AT&T would be able to keep a lid on at least a portion of its content budget.

That wouldn’t necessarily preclude it from trying to charge higher prices to other distributor. But incentive to do so would be tempered by a countervailing incentive to restrain the overall rise in content costs. A higher price in the marketplace for HBO is likely to be mirrored by higher prices for other programming which AT&T would still need to license.

So far, AT&T hasn’t really raised that argument, which is surprising since it was central to its case for acquiring DirecTV in 2015. AT&T needed a larger base of subscribers, the company argued at the time, to gain sufficient leverage with media companies to drive down programming costs so it could create skinny bundles and build the wireless video delivery business it envisions.

Bringing Time Warner’s content under its own roof could easily be portrayed as part of AT&T’s overall, long-term strategy to constrain programming costs.

There is even a real-world analog it could point to, in Comcast’s acquisition of NBCUniversal, which the government approved.

“Our math suggests that NBCU’s affiliate fees (the best example of content/distribution leverage) have grown at a slower rate than the cable net universe since its deal with Comcast,” UBS analyst John Hodulik wrote in a recent report. “Claims in the DoJ brief that AT&T could work with Comcast to keep content off of [over-the-top services] and use HBO against competitors do not reflect the realities of the OTT world, in our view.”

Instead, lawyers for AT&T have chosen to challenge the government’s case on its own terms, disputing the government’s economic theories and pointing to the flourishing of competition Time Warner faces from the likes of Amazon, Google, and Facebook.

That may make sense from a tactical legal point of view (IANAL). But it makes it more likely that the case will ultimately be decided or settled on grounds that are largely at odds with what’s actually happening in the marketplace.

Nothing Neutral About Disney’s Bid For Fox

It was fitting, albeit likely coincidental, that the Walt Disney Co. announced its $52 billion acquisition of most of the movie and TV assets of 21st Century Fox on the day the Federal Communications Commission voted to repeal its own net neutrality rules, because the deal is very much about the future of content delivery over the internet.

Disney CEO Robert Iger

Under the deal, Disney would absorb the 20th Century-Fox film and TV studio and its library, including the first three “Star Wars” films; most of Fox’s cable networks group, including National Geographic, FX, and 300-plus international channels but excluding Fox News or Fox Sports; and 22 regional sports networks (RSNs). The deal also includes Fox’s one-third interest in Hulu, giving Disney majority control over the streaming service.

Assuming the deal passes antitrust muster — highly likely given Rupert Murdoch’s closeness to Donald Trump — it will give Disney control over vast new libraries of content as it prepares to significantly expand its direct-to-consumer streaming business. Strategic control over Hulu will also give Disney a solid foundation from which to challenge Netflix and Amazon directly as an over-the-top content aggregator.

Yet, while the coming showdown with Netflix has grabbed most of the headlines about the deal, there is another important streaming dynamic likely to play out that has gotten less attention but which could be directly impacted by the repeal of the net neutrality rules.

Whether, or not, the bulked up Disney succeeds in challenging Netflix and Amazon, its growing direct-to-consumer ambitions give the Mouse a major stake in the coming contest between programming services and broadband providers over the terms and conditions of engagement on last-mile networks.

The over-the-top streaming business has so far developed very differently from traditional movie and television delivery businesses. In the traditional TV business, the owners of the last-mile pipes — cable and satellite operators, local broadcast affiliates — pay program providers for access to their content.

Disney, in particular, has been successful in leveraging that dynamic, earning ESPN the highest per-subscriber carriage fees of any cable network.

Unlike a cable TV system, however, internet access networks have utility and value independent of any particular content, allowing access service providers to build their networks — and subscriber bases — without having to pay for the content moving across those networks.

If anything, the monopoly or duopoly status most internet access providers enjoy within their footprints has raised concerns that ISPs could use the leverage of their control over their networks to compel content providers to pay for access to their subscribers.

The FCC’s original Open Internet Order was designed in part specifically to deny ISPs that leverage, by prohibiting the blocking or throttling of data based on its source, or accepting compensation for favorable treatment of data from a particular source. Those rules left the status quo in place, at least for the time being. But they left open the possibility that the streaming business could eventually develop more like the traditional TV business, in which access providers are compelled to

The FCC has now voted to lift those rules — their ultimate fate awaits the outcome of inevitable litigation — potentially upsetting the current balance of power.

Determining who will ultimately holds the leverage in that balance remains a work in progress, however. One way to read Disney’s bid for Fox is as an attempt to position itself not only against Netflix but against last-mile network operators for the inevitable battles ahead.

From that perspective, the real trigger event for Disney was AT&T’s (still pending) acquisition of Time Warner. Assuming that deal goes through, it will mean that two of Disney’s (and Fox’s) major competitors — NBCUniversal, now owned by Comcast, and Time Warner — will be owned by major broadband providers. That could leave Disney at a disadvantage in the struggle for leverage over the terms of OTT distribution.

One option would have been for Disney to sell itself to a network operator. But the only one out there with the scale to do it and not already betrothed is Verizon, and Verizon execs have made it clear they’re not in the market for a major studio.

By buying Fox, Disney is hoping to gain enough scale as a content provider to treat with network operators on equal or better terms.

 

America Exits The World

For all intents and purposes, Donald J. Trump will assume the presidency in January with no discernable policy agenda. Apart from a few signature flights of fancy, such as building a wall along 1,500 miles of southern border and rounding up 11 million immigrants for summary deportation, his policy pronouncements consisted largely of an ever-shifting farrago of ignorance, indifference, truculence, and personal animus boiled down into 140-character outbursts. As a general matter, we simply do not know what the Trump administration might do.

trumpGiven the enormity his election represents, speculating on the fallout for any particular industry could seem petty, if not beside the point entirely. But for what it’s worth, the media and technology industries may be among the first to feel the impact.

As a near-term matter, Trump said on the campaign trail that he would block AT&T’s pending merger with Time Warner and would look to undo already done media mergers, including Comcast’s acquisition of NBCUniversal. Setting aside the question of whether the Justice Department would have legal grounds to do either (and the perhaps more interesting question of whether a Trump Justice Department would feel constrained by established law and precedent), Trump’s rhetoric could cast a pall over M&A activity, just as the media industry seems poised for another round of it in the wake of AT&T-Time Warner. Read More »