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From Antitrust Law Daily, March 13, 2018

Justice Department, AT&T lay out arguments on TWI merger

By Lynn Stanton, TR Daily

AT&T, Inc.’s proposed acquisition of Time Warner, Inc., would lead to American consumers "paying hundreds of millions of dollars more than they do now to watch their favorite programs on TV" and the "development of emerging competition will slow down," according to the Department of Justice.

In its brief filed on March 9 with the U.S. District Court for the District of Columbia ahead of a trial set to begin later this month in the Justice Department’s attempt to block the AT&T-TWI merger on antitrust grounds, the Justice Department cited statements by AT&T prior to its agreement with TWI that vertical integration of programming distributors and content producers create the incentive and ability for the integrated company to use its "control as a weapon to hinder competition." Directv, before its acquisition by AT&T, made similar arguments, the Justice Department said.

The Justice Department said that these previous concessions by AT&T and Directv regarding the potential for vertical integration of programming and distribution to harm consumers and competition "will be backed up and reinforced at trial by confirming evidence — internal documents from the files of defendants and others, informed opinions from expert witnesses who have carefully studied the industry generally and this transaction in particular, and, most importantly, multiple knowledgeable industry participants who work in the marketplace day in and day out. Thus, expertise and real-world experience alike will demonstrate that this proposed transaction poses an unacceptable threat to competition and consumers.

"What is the defendants’ response to all this? It is fourfold. First, there is the Star Wars defense: 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. Not so. To the contrary, as will be shown at trial, the government is challenging this merger to address the real concerns of real people who populate the real marketplace today. And tomorrow as well, since the acquisition would give AT&T a new tool to slow down the development and growth of disruptive online competitors in the future. The fact that this is an evolving industry does not provide a reason to let the challenged acquisition proceed. Just the opposite: It provides a compelling additional reason why it should be blocked. AT&T can profess it wants to lead the charge to the future, but its internal documents reveal a less attractive reality," the department continued. Additional detail on what those documents show is redacted in the publicly available brief.

"Second, defendants argue that this is a vertical merger and therefore undeserving of scrutiny. But the Clayton Act is directed at all acquisitions, and tests them all by the same standard—whether they will likely lead to a substantial lessening of competition. The fact that most vertical mergers (like most horizontal mergers) are procompetitive or competitively neutral is immaterial to that inquiry," the department said.

"Third, defendants claim that, with the merger, they will achieve efficiencies they could not achieve otherwise. But defendants’ efficiency claims are a mile wide and an inch deep," and lack "the solid documentation and verification that the law demands," the Justice Department said, redacting details on AT&T’s claims.

"Fourth, defendants filed a self-contradictory answer that is 29 pages long but boils down to this: our merger poses no competitive problem … and, besides, we have a cure for it! Reality, however, is that the proposed merger would be decidedly anticompetitive. And defendants’ proposed ‘cure’ — an offer made to competitors post-Complaint promising to engage in ‘baseball-style’ arbitration to license Time Warner content for the next seven years — is no cure at all. It is a fundamentally flawed effort to undermine the free market solution by merely offering to behave in a way that is contrary to the merged company’s natural business incentives and interests. With no oversight. And, if this sort of do-it-yourself price regulation is sufficient to cure structural harm to the market in this merger, why wouldn’t it be appropriate in every merger?" the department said.

Specifically, the Justice Department said that the merger would harm competition in the multichannel video distribution product market, and that the relevant geographical markets are local footprint overlap zones "where consumers have the same choice of distributors." TWI content is a key input for multichannel video programming distributors (MVPDs) and virtual MVPDs, it said in a heavily redacted section apparently laying out market share and pricing information for various TWI channels.

"The merger would harm competition by empowering AT&T to raise the programming costs of its rivals" and by "constraining AT&T’s rival distributors from effectively using HBO as a competitive tool," the Justice Department said. The merger would also "facilitate coordination between AT&T and Comcast/NBCU to disadvantage emerging virtual MVPD rivals," it added. "Coordination would reduce competition from virtual MVPDs and mean higher prices, fewer options, and less innovation for consumers," it said.

"Defendants apparently maintain that this merger cannot violate Section 7 unless the merging entities have market power in an upstream market and that Turner and HBO lack that power. They are wrong on both counts," the Justice Department said. "Under the plain language of the statute, a plaintiff need only show competitive harm in one relevant market."

As for the companies’ claims the merger should be allowed because it would generate significant efficiencies, the department said that the Supreme Court has never expressly approved an efficiencies defense and lower courts have rarely, if ever, held that efficiencies successfully rebutted the government’s prima facie case.

"Defendants will fall short of showing that their asserted ‘synergies’ (a term they use to encompass both cost reductions, a type of efficiency regularly claimed in mergers, and the less familiar category of ‘revenue synergies’) satisfy any of these elements," the department said, redacting further details of its argument on this point.

Nor does a vertical merger make new entry more likely, the Justice Department said, contrasting the vertical merger’s potential for increased cost to competitors with the horizontal merger’s potential for price increases to consumers, which can make market entry more attractive.

As for the companies’ proposed cure, the Justice Department said, "With a self-created arbitration proposal they claim to have modeled on provisions in the FCC’s order and the Department of Justice’s consent decree regarding Comcast’s acquisition of NBC Universal. Specifically, Turner has offered to distributors licensing terms that, for seven years after the closing of the merger, allow the distributor to invoke ‘baseball-style’ arbitration if the parties fail to reach an agreement on mutually acceptable terms for certain Turner content. Each party submits a final offer of a complete carriage agreement to the arbitrator, the parties conduct discovery, and the arbitrator picks the offer best representing ‘fair market value,’ a term undefined in the offer and not used in the ordinary course of Turner’s business. Turner would be prohibited from withholding the content once the distributor has noticed its intent to arbitrate and so long as the distributor continues the arbitration proceeding."

It added, "The response of MVPDs and Virtual MVPDs has been underwhelming. … [which] is not surprising as the offer fails in many ways to address the threatened harm to competition. To the extent defendants’ arbitration proposal should even be considered a ‘remedy’ (since it does not restore competition that will be lost through the merger), defendants will fall short of carrying their burden of showing it would ‘redress the violations.’"

In their own pretrial brief, AT&T, Directv, and TWI said, "Modern antitrust law recognizes that mergers between suppliers, such as Time Warner, and distributors, such as AT&T, almost always create efficiencies and synergies that lead to lower consumer prices and greater innovation. For these reasons, as the government itself has explained, such vertical mergers ‘should be allowed to proceed except in those few cases where convincing, fact-based evidence relating to the specific circumstances of the vertical merger indicates likely competitive harm,’" citing a note submitted by the U.S. delegation to the Organisation for Economic Co-operation and Development Competition Committee in 2007. "There is no fact-based evidence that this merger will harm competition. Nothing will be withheld from competitors; consumer prices will not go up. To the contrary, the government now concedes it would not be profitable for the new company to withhold its television networks from pay-TV distributors and that the new company’s prices to its own television customers will go down. As a result, the government’s suit to block this merger is not only baseless in fact, but it is affirmatively contrary to consumer welfare, making it difficult for the government even to allege a viable antitrust claim, much less prove one," the companies said.

"When it filed its Complaint, the government’s principal theory of harm was that, after the merger, the combined firm could ‘more credibly threaten to withhold’ Time Warner’s Turner television networks s (e.g., TNT, TBS, and CNN) from pay-TV distributors like Comcast and DISH, forcing them to pay more for Turner programming and raise their consumer prices, in turn enabling AT&T’s traditional pay-TV business, DIRECTV, ‘to raise its own [consumer] prices relative to what it could have’ charged," the companies said.

"Since then, the government’s lead economic expert has conclusively refuted that theory. Among other things, he has opined that the merged entity will not withhold the Turner networks because the licensing and advertising revenues it would lose would vastly exceed any gains it might theoretically receive from denying rivals access to that programming. He also has opined that, because the merger will achieve otherwise unattainable efficiencies, the combined firm will reduce its own consumer prices for DIRECTV compared to what it would have charged," they continued.

"Today, the government claims that the merger will enable Turner to charge its pay-TV providers higher prices for Turner programming than it otherwise could have and that the providers will pass on some portion of that price increase to their customers. The essential premise of the theory is that the post-merger Turner — now backed by AT&T — will be more likely to drive harder bargains with AT&T’s distribution rivals, forcing them to pay higher prices to avoid losing access to Turner programming," they said.

They pointed out that the government has recognized that Turner cannot "tolerate" the loss of revenue it would incur by withholding content. They also said that the merger "has never been about making Time Warner programs less accessible or more expensive. Just the opposite: it is about making Time Warner and AT&T more competitive during a revolutionary transformation that is occurring in the video programming marketplace" with the rise of vertically integrated over-the-top video programming creators and distributors such as Netflix, Inc., Amazon, Inc., and Google LLC.

"Contrary to the government’s superficial theories of harm, the evidence will show that this combination will make both Time Warner and AT&T stronger competitors and promote consumer welfare. For its entire history, Time Warner has been effectively trapped as a wholesaler of video content — it produces and aggregates valuable programming, but it traditionally has had to rely on other companies to distribute its programming to consumers. With that wholesaler position comes two competitive challenges that Time Warner must overcome to continue to compete effectively," that is, lack of information about viewers and their preferences, and the ability to sell directly to consumers, the companies said. The merger will address those challenges, they added.

For AT&T, the merger will address its past difficulties in "obtain[ing] sufficient distribution rights from unaffiliated programmers to achieve its vision for the next wave of products and packages, including lower-cost, ad-supported services," the companies said.

"And for the combined company, the merger will also create the combined scale necessary to develop the first industry-wide platform for bringing targeted advertising to premium video, offering advertisers a viable alternative to the digital advertising duopoly of Google and Facebook," they said.

The companies’ brief makes no mention of concerns about whether the Justice Department’s decision to oppose the merger was unduly influenced by the White House and President Trump, who has made no secret of his dislike for TWI news channel CNN.

In a policy note for New Street Research LLC, NSR adviser Blair Levin wrote that "the difference in the perception of the market" by the Justice Department and AT&T was striking, with the company viewing the market as having undergone significant changes in the past decade, while the government "sees no such revolution in the current market. It mentions cord cutting (and entities like Netflix and Amazon) once," while emphasizing that "‘the overriding reality [is] that the vast majority of American households still subscribe to traditional MVPD service and they will continue to do so well into the future.’"

"If the Judge appears to buy the government’s worldview that internet video does not affect the pricing power of MVPD content and internet delivered video is still in danger of foreclosure, then the odds of the Government prevailing rise," Mr. Levin wrote.

He also said, "As a result of the heavy redaction [in the government’s brief], it is difficult to assess whether the government will convince the Judge that Turner programming has the market power that the government asserts."

Regarding the cure offered by the companies, Mr. Levin said, "The Government, in our view, did a good job of listing a number of reasons why AT&T’s offer of baseball style arbitration might not be sufficient to address every harm asserted by the government. We don’t have a strong view on who will win on this argument and believe the case will likely be decided on the issue of the likelihood and scope of the harm, not the potential remedy."

He said that the reference in the government brief to concerns of MVPDs "‘about anticompetitive behavior when all conditions [on the 2011 Comcast-NBCU merger] expire this year’ …. certainly opens the door to private parties petitioning the [Department of Justice] and the courts to extend the conditions."

In a blog post, Free State Foundation fellow Theodore Bolema, a former trial attorney with Justice’s Antitrust Division, said that "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." He said that the Justice Department "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."

He added, "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."

As for the government brief’s reliance on the high value of HBO channels and their potential to be leveraged to the disadvantage of competitors, "those channels are already available in many different ways, including through the online SlingTV and Hulu services," Mr. Bolema said.

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