The Disney-Fox Deal: Why It’s About Going Directly to the Consumer

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Wharton's Herbert Hovenkamp and Hemant Bhargava of UC-Davis discuss the strategy behind the Disney-Fox deal.

The Simpsons may be headed to Disneyland. Last month, the U.S. Justice Department gave its blessing — some said fairly quickly — to Disney’s acquisition of 21st Century Fox in a deal valued at $71.3 billion. The approval paves the way for the creation of a mega-behemoth entertainment company, combining many top-flight content brands and two of the world’s largest movie studios whose films all together commanded half of all box office receipts year-to-date, according to Box Office Mojo.

“It was an extremely quick decision, particularly when you look at the market share numbers of these firms, at least in some markets, which puts them pretty close to the line,” said Herbert Hovenkamp, a Wharton legal studies and business ethics professor with a joint appointment at the Penn Law School, on the Knowledge@Wharton show on SiriusXM channel 111. “It’s the kind of merger that you would think the government would actually take its time evaluating.”

Antitrust authorities took about half a year to clear the deal, after requiring that Disney divest Fox’s 22 regional sports networks. The transaction is a horizontal merger that combines two competitors in the same market. Meanwhile, the DOJ took two years to evaluate AT&T’s acquisition of Time Warner — a vertical merger. Vertical mergers historically have been more likely to gain approval because they involve players in different parts of the supply chain. But authorities greenlit the Disney-Fox deal and rebuffed AT&T. (The phone company took the government to court and won.)

According to Hovenkamp, there’s a growing feeling on the part of some merger scholars that deal guidelines have become “a little bit too lenient” based on some retrospective studies that have looked at approved mergers in the past that had come too close to the line of being anti-competitive. “Those studies have determined that a fairly high percentage of those mergers have resulted in higher prices.” While one explanation for higher prices could be an improvement in product quality, he noted, nonetheless there is some agreement that standards have gotten a bit looser.

The New York Times editorial board said the swift approval of Disney-Fox was “stunning” when similar deals usually take twice the time to scrutinize. The paper noted that the DOJ also only required one condition for approval — the sale of the regional sports networks — even though Disney-Fox accounts for half of national box office revenue this year and about a third of all scripted, as opposed to reality, TV shows. The Writers Guild of America West opined that “the antitrust concerns raised by this deal are obvious and significant.” Disney and Fox are part of an “oligopolistic” industry, it said, and this deal “will make matters even worse.”

“It was an extremely quick decision, particularly when you look at the market share numbers of these firms, at least in some markets, which puts them pretty close to the line.” –Herbert Hovenkamp

Disney-Fox would own Walt Disney Studios (Marvel, Lucasfilm, Pixar); Disney theme parks and hotels; ABC TV stations; A&E networks; Disney Channels; ESPN, Disney products and stores, music and publishing; Twentieth Century Fox studio; Fox’s TV production (“The Simpsons,” “Modern Family,” “This is Us”); cable networks FX, FXX, FXM and National Geographic channels; Star India; more than 350 international channels; 39.1% of pay TV provider Sky; controlling ownership of Hulu; and other assets. Their movie slate would include Avatar, new and earlier Star Wars films and unites Fox’s Marvel films — X-Men, Fantastic Four and Deadpool — with Disney’s Marvel properties. (Fox is spinning off its broadcasting and cable networks and the bulk of its sports channels.)

Disney-Fox have set a date of July 27 for shareholders to vote on the transaction. But it’s not a done deal. Comcast is also interested in the Fox assets, and could still grab the company from Disney by raising its rival bid of $65 billion. Comcast’s involvement had forced Disney to up its latest offer from $52.4 billion. But Disney has the advantage of already having the DOJ’s approval on the deal, experts say. There is no guarantee Comcast will get approval as well, given that the government tried to block the AT&T-Time Warner merger.

Disney’s Direct-to-consumer Plan

Hemant Bhargava, chair in technology management at the University of California, Davis, agreed that the Disney-Fox merger approval was “extremely quick.” But he said it could be because antitrust authorities see the boundaries of the market changing. Traditional media firms like Disney and Fox see viewers cutting the cord and moving to online offerings. “And so, even though they may both have 27% of the market collectively, perhaps the DOJ recognizes that there are new players who are beginning to become more powerful,” he noted.

There’s a host of new online video subscription services available, with the largest being Amazon Prime Video, Google’s YouTube and Netflix. Apple is planning to join the ranks as well. So it’s no surprise that traditional media is consolidating to better compete. “Certainly, Netflix will have a bigger competitor in Disney-Fox,” Bhargava said. Disney has said it plans to expand the offerings of Hulu, a Netflix rival, since it will have a controlling interest in the online video platform after acquiring Fox. (Hulu’s other owners are Comcast’s NBCUniversal and AT&T’s Time Warner.)

Indeed, Disney’s main reason for buying Fox is to have additional branded content for online, direct-to-consumer content services. “This acquisition reflects a changing media landscape increasingly defined by transformative technology and evolving consumer expectations,” said Disney CEO Bob Iger during a conference call with analysts to discuss the acquisition. “It will allow us to greatly accelerate our direct-to-consumer strategy. … We believe creating a direct-to-consumer relationship is vital to the future of our media businesses, and it’s our highest priority.”

Disney has just launched ESPN+, a new $4.99 a month streaming service, and plans to offer another next year that will house Disney, Pixar, Star Wars and Marvel movies plus exclusive films and TV shows. As part of this development, Disney has said it plans to stop licensing Disney movies to Netflix starting in 2019. “We believe that in order to be in the [online subscription video] business for the long run … we ultimately need to take back control of our content,” Iger said. Netflix grew by licensing older content from companies like Disney. But now Netflix has gotten so big that it is challenging the big media companies themselves.

“[Even] though they may both have 27% of the market collectively, perhaps the DOJ recognizes that there are new players who are beginning to become more powerful.” –Hemant Bhargava

Iger said the plan was for EPSN+ and the upcoming Disney online service to cost “substantially below” the fee for Netflix. ESPN+ is an add-on subscription that will not fully replicate the ESPN cable channel content while the new Disney service would have “much less” volume of content than Netflix, he noted. As for Hulu, Iger said he plans to make it the home of programming geared for adult viewers from TV and cable networks. It will also house movies that are not part of the Disney subscription service. For now, he said, Disney will offer these three content portals as standalone services instead of a bundle so viewers can pick and choose.

“One of the big, big advantages of this merger” is that it strengthens Disney’s online streaming services, Bhargava said. “The primary synergy is going to be that they become a bigger content player in this industry and they can sign up subscribers and get this recurring revenue.” Traditional media companies’ revenue sources — licensing, affiliate fees from cable, satellite and telecom TV companies and ratings-based ad revenue — are in jeopardy as viewers continue to cut the cord or watch content online. By launching online video services that charge monthly, Disney-Fox can get this “predictable” revenue regularly, he added.

Bhargava believes Disney has three paths it can take: offer a streaming service but still distribute content through cable, satellite and telecom TV providers; become another Netflix and just do streaming where viewers can only get their bundled content exclusively through Disney-Fox; or focus on becoming a larger content company and license their shows and movies. “I think what they would do right away is to offer their own streaming service and then still be available elsewhere,” he said. “What Disney would be looking forward to is that they become the primary content place or the supplier for” millions of viewers.

Too Many Subscriptions?

But Hovenkamp said one thing that horizontal and vertical media mergers have in common is the risk of “excessive siloing.” “One of the things people fear about excessive concentration in this market is that too many of these companies are going to try to bottle up their own content … and they’re going to be reluctant to share that content with others,” he said. “What that means for consumers is that if you want a big range of content, you may have to subscribe to more than one service.” For example, CBS All Access exclusively has “The Good Fight,” a spinoff of the popular legal drama “The Good Wife,” as well as “Star Trek Discovery,” which is the next saga of the science fiction series.

If consumers have to subscribe to multiple services just to get all the content they want, eventually they’re going to push back against escalating media bills. “We usually think of antitrust as a consumer welfare principle,” Hovenkamp said. “We look at the interest of consumers first, and that interest is not merely in low prices, it’s also in quality and variety. And [consumers] have come to expect a big variety.” On the flip side, with so much competition in online video services, companies tend to keep some content exclusively to get people to sign up, Bhargava said.

When considering antitrust, “[we] look at the interest of consumers first, and that interest is not merely in low prices, it’s also in quality and variety. And [consumers] have come to expect a big variety.” –Herbert Hovenkamp

Disney’s Iger said the company is already developing movies and TV series for its online video streaming services. “I’ve talked about a Star Wars series, Marvel series,” he told analysts. “We’re creating a series based on the Monsters Inc. characters, for instance. There’s a High School Musical series.” Iger said Disney will have to invest in these new ventures while “weaning ourselves off the Netflix deal” since it will forgo licensing revenue by ending the two companies’ agreement. “It’s going to take a reset of sorts.”

As for Disney-Fox’s impact on movie theaters, “I think Disney already extracts higher percentage fees when a movie is seen inside a cinema house than from all the other studios,” Bhargava said. “Disney and Fox will have a hugely bigger stick with which to play that fight … Together, they will be even more powerful.” According to The Wall Street Journal, Disney not only had strict requirements for cinemas if they wanted to show Star Wars: The Last Jedi but took 65% of the ticket revenue, “a new high for a Hollywood studio.” If a movie theater violated the terms, Disney would hike that commission to 70%, the paper said.

Bhargava said it might even be conceivable that Disney-Fox could eventually run their own movie theaters. Recently, Netflix reportedly considered buying Landmark Theaters, according to The Los Angeles Times. “I think there are current regulations against that, but that would be another area to watch,” he said. The Supreme Court ruling in the U.S. v. Paramount Pictures case in 1948 put legal roadblocks around studios owning theaters as they would control both the content creation and distribution process.

Another area Disney-Fox could dive into would be gaming, Bhargava said. “Look at other areas of content consumption where Disney could increase its power and ability to fight against Netflix and other firms,” he said. “We talked about movies, TV shows, but gaming is a huge area of content consumption. And Disney could strike deals there.” Comcast could do the same as it competes with a combined AT&T-Time Warner, Bhargava added. “Go after things that involve interactive gaming or other areas where people’s eyeballs are shifting towards.”

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