Lessons from the AT&T/Time Warner Decision
June 18, 2018
On October 22, 2016, AT&T announced its $108 billion proposed acquisition of Time Warner. After a year-plus investigation, the Department of Justice (DOJ) filed suit to enjoin the merger, alleging that the transaction would substantially lessen competition in the national video programing and distribution market. On June 12, 2018, after a six-week trial, Judge Richard Leon of the U.S. District Court for the District of Columbia denied the DOJ's request, allowing the deal to proceed. Two days later, AT&T completed the acquisition.
The decision is likely to have significant ramifications, particularly in the media sector and potentially more broadly.1
Legal Framework and Court Decision
Section 7 of the Clayton Act prohibits mergers that may substantially lessen competition.2 In evaluating whether the AT&T/Time Warner transaction would violate Section 7, the court applied the traditional antitrust burden shifting framework, wherein: (i) the government must first show that the merger is likely to substantially lessen competition in a relevant product and geographic market; (ii) the merging parties rebut that burden by providing evidence of efficiencies that outweigh the merger's anticompetitive effects; and (iii) the government responds with additional evidence of anticompetitive effect. Here, the DOJ's case failed at the first step.
In a merger challenge involving head-to-head competitors (horizontal mergers), the DOJ generally has the benefit of a presumption of competitive harm if it can show that the combined company would control undue competitive market share. In this case, the DOJ did not have the benefit of that presumption because AT&T (a video distributor) and Time Warner (a video content provider) are not competitors. Instead, the DOJ was required to make a "fact-specific" showing that the transaction would harm competition.3 It failed to do so.
The DOJ alleged that AT&T's acquisition of Time Warner would harm competition in the three ways.
Increased Leverage from Important Turner Content
The DOJ's primary theory was that post-merger, Turner (owned by Time Warner) would have more leverage to extract higher prices from rival multichannel video programming distributors (MVPDs) because the combined company could partially offset the loss of advertising and fees from blackouts (i.e., the complete failure to license the content) by consumers switching to DirecTV (owned by AT&T), which would have Turner content.4
In support of the theory, the DOJ offered internal business documents, the defendants' prior regulatory statements, and competitor testimony. The court was unpersuaded, finding instead that, among other things, the DOJ's evidence (which it found was flawed in many respects) was contradicted by examples of AT&T's rival distributors successfully operating without Turner content.5
Foreclosure of Turner Content to Harm Virtual MVPDs
The court next rejected the DOJ's claim that AT&T, either acting unilaterally or in coordination with Comcast-NBCU, would foreclose or restrict "must have" Turner content and thereby harm competing virtual MVPDs. To support its claim, the DOJ again pointed to AT&T's business documents, this time from senior executives expressing "displeasure with Turner's relationships with its competitor virtual MVPDs" and purportedly showing the importance of Turner content to virtual MVPDs.6 Once again, the court dismissed the business documents as inconsistent with actual industry trends as well as AT&T's business incentive to obtain broad distribution of Turner content.
Withholding of HBO Promotions
The DOJ's final theory was that the merged company would foreclose competing MVPDs from using HBO as a promotional tool to attract and retain customers. The court held that this was "a gossamer thin claim," finding that the DOJ failed to explain why the merged entity would have any incentive to foreclose access to HBO-based promotions given HBO's dependence on promotion and third-party distribution.7 Further, the court found that the DOJ had offered insufficient evidence to show that HBO promotions were so valuable that withholding or restricting them would drive customers to AT&T, instead finding that "Netflix is an adequate substitute for HBO" and that "[p]ut simply, HBO is in the fight for its life."8
A Few Takeaways
The court's opinion was tied closely to its factual analysis and did not include broad legal rulings. For example, the court declined to reject the typical burden shifting approach or adopt a per se rule or a presumption that would apply to vertical cases (as the defendants proposed). Similarly, the court did not rule on whether the amount of claimed harm (a 27-cent per month increase in per subscriber prices) would, if proven, constitute a "substantial lessening of competition" as a matter of law under Section 7.9 That said, the case offers a few broader themes and takeaways.
Industry Dynamics Are Significant
The decision underscored that it is axiomatic that facts and market conditions matter in antitrust cases. As stated in the first line of the court's opinion: "If there were ever a case where the parties had a dramatically different assessment of the current state of the relevant market and a fundamentally different vision of its future development, this is the one."10 The defendants persuaded the court that their vision was correct.
Throughout, the court emphasized that the video distribution and video programming industries were experiencing "dramatic changes that are transforming the industry"—and that its decision had to factor in those changes.11 "Tectonic changes" in the video distribution and content industry included the increase of over-the-top, vertically integrated video content services (e.g., Netflix, Hulu, and Amazon Prime); the decline in MVPD subscriptions; the shift towards targeted, digital advertising offered by web-based competitors; and the increased investment in, and proliferation of, video programming content both by incumbent programmers and rising vertically integrated competitors.12 As the DOJ's Deputy Assistant Attorney General for Litigation Donald Kempf observed: "Some of the court's pronouncements about the dynamic nature of the industry and the way it's changing, and how you account for the presence of a different group of competitors . . . [were] used . . . as key factors in its analysis."13
While these industry trends were specific to the media industry, changing industry dynamics and trends are, of course, a factor in any antitrust analysis and, for this court, were key.
Ordinary Course Documents Were Unpersuasive
As is typical in merger cases, the government cited ordinary course business documents as evidence of the defendants' intentions and the transaction's likely effects. In recent cases, this approach has been very successful. Here, however, the court characterized the ordinary course documents (at least those that were accepted as evidence) as "informal speculation" having "such marginal probative value that they cannot bear the weight the Government seeks to place on them."14 In doing so, the court repeated the admonition against "'rummage[ing] through business records' for 'tidbits that will sound impressive (or aggressive)' [because it] undermines efforts to ensure 'accuracy of decisions.'"15
The DOJ will not end its reliance on ordinary course business documents, which, as reflected in the Horizontal Merger Guidelines, are considered "highly informative in evaluating the likely effects of a merger," and the court's decision will not change that approach.16 Nonetheless, the court's decision shows the limitations of that documentary evidence when the materials are written by lower level employees, appear only in draft decks, or are easily discounted in the context of the broader industry dynamics.
Complex Economic Modeling Rejected
The court spent considerable ink parsing through the government expert's economic bargaining model, which the court described as a "Rube Goldberg machine" lacking in reliability and factual credibility.17
The government's expert used two models, an economic bargaining model to generate predicted content prices to video distributors, and a merger simulation model which plugged in the content cost increases to generate predicted price increases to consumers. The economic bargaining model took center stage.18 In that model, the expert sought to quantify the benefits that AT&T would gain as a result of a long-term, post-merger blackout of Turner content on AT&T's rival distributors. AT&T's benefits, he claimed, corresponded to the distributors' increased content prices.
The court was not persuaded and instead found that: (i) the model could not accurately predict an increase in Time Warner's bargaining leverage because it rested on assumptions that were contradicted by the evidence; and (ii) the critical inputs used in the model were undermined by real-world evidence.
The bargaining model assumed that the post-merger entity would have increased ability and incentive, based on increased leverage, to extract higher prices from rival MVPDs. This meant that blackouts would be less detrimental to Turner than pre-merger, given that the lost advertising and license fee revenues from the blackout would be partially offset by consumers switching from rival MVPDs to DirecTV where they could find Turner content. The court determined that testimony from those who had actually negotiated contracts on behalf of vertically integrated content companies contradicted this assumption, and instead showed that the identity of a programmer's owner does not affect the negotiating dynamic and that a long-term blackout was infeasible.
The court also concluded that testimony and documentary evidence undermined the bargaining model's three critical inputs: (i) long-term subscriber loss rate; (ii) diversion rate; and (iii) AT&T's margin for video customers. With respect to the long-term subscriber loss rate, the court noted that "there has never been a long-term blackout of Turner content; thus there was no 'real-world' evidence on which to base [a] projected subscriber loss rate."19 The court then found that the data and evidence on which the subscriber loss rate was based were unreliable and contradicted by testimony.20 Similarly, the court found that there was insufficient evidence or reliable data to support the model's diversion rate and AT&T's profit margin for video customers.
Natural Experiments Supported by Testimony More Persuasive
In contrast, the court was persuaded by the merging parties' economic analysis of prior transactions. Specifically, the defendants' economist undertook a regression analysis of previous vertical mergers, including News Corp's acquisition of part of DirecTV, the Time Warner split from Time Warner Cable, and Comcast's acquisition of NBCU. This analysis showed that vertical integration did not lead to higher content prices.
The defendants' economic conclusion was reinforced by the credible third-party and Time Warner executives' testimony that vertical integration does not affect content licensing negotiations. The court rejected the DOJ's argument that testimony of Time Warner executives was potentially biased. Instead, the court concluded: "To be sure, neither [defendants' economist's] econometric analysis nor the testimony . . . provides 'perfect evidence' . . . But when weighed against the relatively weak documentary and third-party testimonial evidence proffered by the Government in support of its increased-leverage theory, the real-world evidence . . . further undermines the persuasiveness of the Government's proof."21
The court did not base its decision on the defendants' efficiencies given its conclusion that the Government failed to establish any anticompetitive harm. It is nonetheless notable that the court expressed confidence that the defendants would obtain most, if not all, of their projected cost synergies because AT&T had been successful in realizing efficiencies in prior acquisitions.22
Behavioral Commitments Relevant
In a footnote, the court criticized the DOJ for failing to account for the effect of Turner's commitments to arbitrate content cost disputes and not to impose blackouts.23 As the court explained, Time Warner's commitment was yet another "reason to be skeptical of the Government's increased-leverage theory of competitive harm," albeit "extra icing on a cake already frosted."24
The biggest question is the one that only time will resolve with certainty—whether the loss will make the DOJ more cautious in bringing future merger challenges (and particularly for vertical mergers) going forward. Conventional wisdom is that the decision—at least in the near-term—is a positive sign for parties seeking to consummate vertical merger deals. This is particularly true if the DOJ continues to maintain that behavioral remedies—the typical method of resolving harm resulting from vertical transactions—are unavailable as tools in its toolkit.
For more information about the court's decision, the AT&T/Time Warner transaction, or any related matter, please contact Jamillia Ferris, Scott Sher, Josh Soven, or any member of the antitrust practice at Wilson Sonsini Goodrich & Rosati.