Summary of the case and practice pointers
On June 12, 2018, the United States District Court for the District of Columbia rejected the United States Department of Justice’s efforts to block a vertical merger between AT&T Inc. and Time Warner Inc. In denying the government’s motion to enjoin the transaction, Judge Richard J. Leon completely rejected the government’s primary theory that the combined entity would unfairly gain bargaining leverage in the video programming and distribution market in virtually every local market on a nationwide basis. The court also rejected the government’s alternate theories that the transaction would slow the growth of emerging, innovative online distributors and would enable AT&T to restrict distributors from using free HBO as a promotional tool. The court’s 172-page opinion ended with its preemptive recommendation that the government not seek a stay of the district court’s order pending appeal because further delaying the consummation of the merger could serve to scuttle the transaction (since it is required to close by June 21).
Historically, vertical mergers have been rarely challenged because they do not remove a competitor from the market and they often present procompetitive benefits, such as efficiencies. Neither party disputed that this transaction eliminated double marginalization—the economic concept where two separate entities in the supply chain need to make a profit off the same product. Here, for example, a combined AT&T could make a single profit through programming and distribution, rather than having to pay Time Warner a licensing fee so that AT&T’s subsidiary (DirecTV) could display content to its subscribers. The government conceded at trial that the merger would have some pro-competitive benefits, including lowering the price of DirecTV enough to give DirecTV customers $352 million in annual savings. But, the government insisted that the anticompetitive aspects of the deal outweighed those benefits.
The government’s primary argument was based on an economic bargaining theory that the merger would allow AT&T to increase its rivals' costs by leveraging Time Warner’s “must-have” content. The government explained that a combined AT&T/Time Warner would own Turner Broadcasting System. Turner owns popular sports and news offerings including CNN, TBS, and TNT, which are considered “must haves” by the distributors of video content. The government argued that the combined AT&T/Time Warner could increase its fees to other distributors by credibly threatening a program “blackout,” where Turner would refuse to provide distributors its valuable content unless they agreed to pay increased fees.
This was the first time a federal court examined the increased-bargaining leverage theory in the context of a vertical merger. The DOJ had previously considered using this theory to block the Comcast-Time Warner Cable merger, but Comcast called off that merger before the DOJ filed a complaint. Judge Leon did not determine whether increasing bargaining power can cause competitive harm in a vertical context. Instead, he concluded that the government failed to prove that the merger would increase Turner’s bargaining power in the first place. The judge pointed to evidence in the record showing that blackouts, while routinely threatened, are rarely carried out because they are costly for every party involved. Contrary to the government’s theoretical bargaining theory argument, the court found that the defendants established that withholding Turner content would not be economically rational due to the attendant losses in significant advertising and affiliate fee revenues. Thus, the court squarely rejected the government’s primary rationale for its bargaining theory argument.
In rejecting the government’s evidence in support of its bargaining theory, the court found that statements contained in certain of the defendants’ business documents that referenced increasing bargaining power as one possible outcome of a vertical merger in other transactions were not relevant to the facts of this particular merger. The court also determined that the government’s reliance on documents drafted by low-level employees with no decision-making authority was misplaced and that many of the employee and corporate statements relied on by the government were taken out of context. Finally, the judge concluded that the testimony of third-party competitors who had expressed concern over the potential for AT&T’s increased bargaining power had little probative value because their concerns were largely speculative, not supported by any facts and highly biased.
Judge Leon gave substantial weight, however, to evidence that showed three prior vertical integrations between programmers and distributors did not affect fee negotiations or content price. Those integrations were News Corp.’s acquisition of part of DirecTV in 2003, the 2009 split of Time Warner from Time Warner Cable, and the 2011 combination of Comcast and NBCU. Judge Leon credited the testimony of executives in vertically integrated firms who stated that integrated firms do not weaponize their programming content during affiliate negotiations.
The government’s use of a highly regarded expert witness to support its increased-leverage theory of harm was insufficient because the court found that the factual evidence squarely contradicted the expert’s conclusions and the assumptions incorporated into his economic model.
The court’s order ended with an unusual step of preemptively denying a stay of the order and urging the government not to seek a stay of the merger pending appeal. The judge opined that the harm done to AT&T by delaying the merger would exceed the harm done to the government by allowing the merger to proceed until an appellate review finished. Judge Leon explained that delaying the merger any longer would “cause certain irreparable harm to the defendants” and that even seeking such a delay would “undermine the faith in our system of justice of not only of the defendants, but their millions of shareholders and the business community at large.”
Although the court’s opinion does not contain any novel antitrust theories, the court’s analysis of the evidence presented during trial provides us with an opportunity to offer some important practice pointers to consider.
- Be careful when drafting internal documents that discuss a contemplated transaction. The government supported its case and quoted from documents drafted by employees of the transacting parties. Although the court in this case rejected many of these documents and discounted others on various grounds (e.g., they were drafted by lower level employees, they lacked adequate foundation and were taken out of context) this caused significant distractions at trial and most likely prolonged the investigation.
- Expert testimony must be supported by facts. The court completely discounted the government’s highly acclaimed economist because his report was based largely on economic theory and not supported by actual facts.
- Use favorable examples of past experience to support your position. Each transaction and the prevailing market conditions could affect your next transaction. Here, the court found it critical that prior vertical mergers between video programmers and distributors did not result in higher prices. This further undercut the government economist’s theoretical model.
- Impact on bargaining theory markets. The court rejected the government’s bargaining theory argument because it was based on a hypothetical theory that a vertically integrated programmer/distributor could threaten programming blackouts as a way to secure higher fees. But, according to the evidence relied upon by the court, that rarely, if ever, happens in the video programming/distributing industry because it is not economically feasible. The court’s rigorous analysis of this issue could have implications in other industries where rates, fees or prices are heavily negotiated. For example, insurers in hospital mergers routinely complain about “must have hospitals” in their networks and a combined hospital’s threat to pull out of a network as a means to secure higher fees. Such assertions could come under increased judicial scrutiny.
- Third-party bias. Witnesses with a stake in the outcome of a merger are biased. Their testimony will be more reliable if focused on historic facts rather than future predictions. The court discounted much of the third-party competitors’ testimony because those competitors had an incentive to prevent a rival’s merger. In contrast, the court credited the biased testimony of the Time Warner executive witnesses because they testified about how Time Warner had operated in the past as an integrated company.
- Reverse Breakup Fees. Usually, breakup fees are paid by the seller to the buyer to mitigate the buyer’s risk associated with the time, expense, and opportunity cost of pursuing a deal and deter third-party bidders. Reverse breakup fees (paid by the buyer to the seller) shift a portion of the costs the target company incurs during the merger review process. The antitrust reverse breakup fee in this transaction was relatively small--$500 million for an $85 billion transaction. This is probably the risk of an enforcement challenge to a vertical merger was considered remote. We may be entering a time where enforcement agencies increasingly decide to investigate and challenge vertical mergers, especially in highly concentrated markets. Therefore, reverse breakup fees in vertical mergers should be carefully considered.
We look forward to the opportunity to discuss the foregoing with you.
Read the United States of America v. AT&T Inc., et al. memorandum opinion.
 Jeff Bliss, DOJ Examining Bargaining-Leverage Economic Theory in Comcast-Time Warner Cable Review, MLEX (Oct. 28, 2014), available at http://awa2015.concurrences.com/IMG/pdf/mlexcomcastbargaining-1.pdf. (accessed June 14, 2018).
Gerald A. Stein is a senior counsel and a member of the firm’s Antitrust and Competition group. He was formerly an attorney in the Bureau of Competition (Northeast Region) of the Federal Trade Commission from 2009 to 2018.
Mark Angland is an associate who formerly was a research fellow at the American Antitrust Institute.