Wharton's Herbert Hovenkamp, University of Michigan's Erik Gordon and Hemant Bhargava of UC-Davis discuss the AT&T-Time Warner decision.

In 2016, when AT&T announced its intention to acquire Time Warner — the owner of Warner Bros., CNN, HBO and the home of the Harry Potter film franchise — critics decried the $85 billion marriage as anti-competitive because it brings together two behemoths that could harm competitors and consumers. AT&T is the nation’s second-largest wireless carrier and owner of DirecTV and U-verse. It is also the largest pay TV provider among U.S. cable, satellite and telecom companies. Last winter, the U.S. government sued to block what it called one of the largest mergers in history: It is $108 billion when including net debt.

But AT&T prevailed in a knockout legal decision that not only cleared the way for the acquisition but also did not call for any restrictions on the deal. (The FCC did put conditions on Comcast’s 2011 purchase of NBCUniversal.) In another unusual step, U.S. District Judge Richard J. Leon in Washington, D.C., warned the Justice Department (DOJ) against using a “stay” to freeze the deal until it could appeal — thereby running out the clock on the acquisition. To do so “simply would be unjust” and would “undermine the faith in our system of justice,” he wrote in a June 12 court order. Two days later, AT&T closed its purchase of Time Warner.

The verdict didn’t surprise Gerald Faulhaber, Wharton emeritus professor of business economics and public policy. But “I’m surprised the antitrust division [of the DOJ] took this on as a case. I didn’t think they had a case.” That’s because the AT&T-Time Warner tie-up is a vertical merger where their businesses do not overlap. It’s not a horizontal merger where two competitors in the same business combine into one — such as T-Mobile buying Sprint. Antitrust harms in horizontal mergers are more straightforward to prove but it’s “very difficult” for vertical mergers, he said. Indeed, there hasn’t been a “serious” vertical merger court case brought by the DOJ in decades, he said.

The last litigated vertical merger case with a court opinion was in 1979 and the last time the government issued vertical merger guidelines was in 1984, said Herbert Hovenkamp, an antitrust expert who is a Wharton professor of legal studies and business ethics with a joint appointment at the Penn Law School. In contrast, horizontal merger guidelines were last revised in 2010. Also, he said that during the 1980s there was a “general hostility” towards vertical antitrust activity of all kinds and the government “lost interest.” And while a few vertical cases were brought to court, they almost always were settled by consent decree.

“I’m surprised the antitrust division [of the DOJ] took this on as a case. I didn’t think they had a case.”–Gerald Faulhaber

The DOJ defeat “leaves the government in a hole,” Hovenkamp noted during a discussion about the merger on the Knowledge at Wharton show on SiriusXM channel 111. (Listen to the podcast at the top of this page.) “We are desperate, at this point, to develop some new vertical merger guidelines with some usable theory.” He explained that “there has been plenty of academic theory written about vertical mergers … but it needs to be put into guidelines that are readable by judges, because the one thing we know from the horizontal guidelines is that the courts do follow them.”

In vertical mergers, the government generally does not go after the transaction itself but instead focuses on anti-competitive behavior, said Faulhaber, who had been chief economist at the Federal Communications Commission, which oversees the media and telecom sectors. But there could have been political pressure for the DOJ to act since President Trump had tweeted against the merger. The court didn’t reference any political influence, but “for me, that was in the background,” he said. As for Judge Leon’s “surprising” instruction to the government not to freeze the deal, Faulhaber said it meant the DOJ’s case lacked merit. “He’s right.”

The Government’s Case

In the lawsuit, the U.S. government evoked Section 7 of the Clayton Act, which bans acquisitions that would “substantially lessen competition,” to justify blocking the deal. But the judge wrote in his decision that while the DOJ did not have to prove the “certainty of harm,” pointing to the “mere possibility” is not enough. To win, it had to prove that the deal is “likely to lessen competition substantially.” In this regard, the government failed.

Hovenkamp said the government made three claims: The merger would lead to AT&T and Time Warner charging competitors higher prices to carry the latter’s content; it would — by itself or with Comcast — act to suppress the growth of online video providers; and it would prevent rivals from using Time Warner’s HBO as a promotional tool to get more subscribers. “The court rejected all three theories, not on principle … but rather because [the judge] didn’t think that the facts supported” the government’s claims.

“There has been plenty of academic theory written about vertical mergers … but it needs to be put into guidelines that are readable by judges.”–Herbert Hovenkamp

The judge said the government failed to convince the court that the merger would result in AT&T and Time Warner charging rivals higher prices or hampering access to “must have” content. Not only are Time Warner’s HBO and CNN popular, its TNT and TBS are sought after for live sporting events including portions of NCAA March Madness, and some MLB and NBA playoff games. But Time Warner can raise prices even without AT&T, Faulhaber pointed out. Also, AT&T and Time Warner would hurt themselves financially if they blocked rivals from getting content. “They’re not going to [license] CNN to Comcast?” he asked, rhetorically.

Whether or not one agrees with the court’s ruling, the AT&T-Time Warner case will be influential, said University of Michigan professor Erik Gordon, who joined Hovenkamp on the radio show. Here, the judge saw that conditions in the media and entertainment business were changing — AT&T is losing video subscribers and ad revenue is shifting to Facebook and Google. AT&T was cast “as the victim,” he said. “He sort of applauded this merger as maybe making AT&T more competitive, given the changes. So I think the case is influential in that sense, but it’s not the end of antitrust law.”

Big Tech vs. Big Media

Indeed, big shifts in the media landscape have made it less certain that the AT&T-Time Warner merger would actually lead to higher prices for consumers, said Hemant Bhargava, a technology management professor at the University of California at Davis on the radio show. There are theories behind why this merger could raise prices, but then again there also are alternate theories why they would not, he noted. “That’s really important to keep in mind — that this is an area where it’s pretty hard to predict the outcomes because so much is changing in these markets.”

In 2017, the once-growing cable, satellite and telecom providers together lost three million video subscribers, the court said. In contrast, Netflix added two million U.S. subscribers just in the last quarter. Also, the court noted that 20% of U.S. households have cut the cord on cable or pared back consumption by subscribing to smaller TV bundles. Meanwhile, Amazon Prime Video, Hulu, YouTube and others are growing while Apple is preparing to enter the content business. In advertising, traditional TV is ceding ground, too. In 2016, U.S. digital ads surpassed TV ads for the first time, with around 60% going to Facebook and Google, the court said.

In light of competition from Big Tech, incumbents are chasing M&A. Comcast just announced a $65 billion, all-cash bid for parts of 21st Century Fox. It hopes to spoil a $52.4 billion agreement Fox struck last year to sell its assets to Disney. And other merger deals might emerge, especially after the AT&T verdict. Historically, Hovenkamp said, a government legal loss would trigger merger activity in the affected industry. But he added that companies tend to read too much into it. That’s a mistake. “The government has lost cases where, within two or three years, it has bounced back, and it’s had long winning streaks,” he said.

“This is an area where it’s pretty hard to predict the outcomes because so much is changing in these markets.”–Hemant Bhargava

Besides, Faulhaber said, companies that combine content with distribution under one roof haven’t had a good track record of creating value that is greater than the sum of its parts. AOL-Time Warner was widely considered to be disastrous and had to separate. Time Warner also at one time had its own cable division — Time Warner Cable — but it didn’t do much for the company so it was spun off. (It was bought by Charter Communications.)

Disney owns ABC, but is the TV network beneficial to Disney and vice versa? “I don’t see it,” Faulhaber said. Sony bought a movie studio in the 1980s, but “what’s the value?” At least, Comcast was successful with NBCUniversal in that the acquisition did not destroy value, he said. But Faulhaber would rather incumbents focus on fixing problems with their core businesses. “You need to respond to that instead of getting into a new business,” he said.

Fresh from its merger, AT&T already wants to show that buying Time Warner is worth the hefty price tag — and will be good for consumers. CEO Randall Stephenson told CNBC on June 15 that the carrier is leveraging its content, extensive wireless network, upcoming 5G technology and vast advertising inventory to build a “modern media” company. To start, the company is launching “AT&T Watch” TV — a skinny TV bundle focused on entertainment and without sports that will be free for its unlimited data wireless customers and $15 a month for other consumers. “Those are the kinds of things that you’re going to see,” Stephenson said.