AT&T-Time Warner case depends on economic analysis of must-see programming, prices

20 March 2018 2:33pm
Remote Control

16 March 2018. By Curtis Eichelberger.

The US Department of Justice next week will put to the test its claim that AT&T’s proposed $85.4 billion acquisition of Time Warner will lead to higher prices for Time Warner’s must-have content and drive up prices for millions of US consumers.

Pivotal to the government’s case is economist Carl Shapiro’s testimony that the deal will allow the combined company to increase the prices it charges competing distributors such as Comcast and Dish for Time Warner’s Turner content by about $731 million annually.

Assistant Attorney General Makan Delrahim reportedly demanded that AT&T divest its DirecTV satellite service or Time Warner’s Turner Broadcasting to permanently resolve the government’s antitrust concerns, but AT&T declined four settlement offers and Delrahim sued in November in DC federal court to block the deal.

Must-see TV

Shapiro will try to persuade US District Judge Richard Leon that prices for Turner content will go up following the deal.

Shapiro, a plain-speaking economist from the University of California at Berkeley known for his ability to make difficult concepts understandable to judges and juries, will seek to show that Turner’s content is so important to consumers that distributors such as Comcast, Charter, Cox and Dish risk losing subscribers without it.

This must-see TV would include Time Warner’s Home Box Office (HBO) — with hit movies and shows such as Game of Thrones — and Turner programming, including rights to the National Collegiate Athletic Association’s men’s basketball tournament, Major League Baseball and National Basketball Association games, as well as professional golf and Warner Bros.’ shows and library of films.

Another DOJ expert, John Hauser, contends that about 12 percent of subscribers would switch distributors if their current cable, satellite or online provider stopped offering Time Warner content.

AT&T argues that its content is important but not must-see, citing figures showing a fall in Turner networks’ percentage shares of viewership and of the top 500 television series from 2010 to 2014.

Diversion analysis

Using an economic model known as diversion analysis, the DOJ argues that if a competing distributor doesn’t accept a price increase for Time Warner content and is blacked out, some of those unhappy subscribers will switch to AT&T’s own DirecTV satellite service, allowing the company to generate subscriber revenue another way.

AT&T, however, says it maximizes profits by distributing content as widely as possible, not by withholding it. In addition, AT&T said it would commit for seven years after the deal closes to offer distributors baseball-style arbitration with no blackouts in the event they can’t agree on licensing terms.

AT&T and the government agree that the companies would likely decrease the price for Time Warner content on DirecTV, amounting to millions in savings annually. These savings are considered a pro-competitive effect of the merger.

AT&T lawyer Daniel Petrocelli previewed that argument during a status conference Feb. 16, saying the DOJ’s economic analysis finds that prices for DirecTV customers will go down with the merger, and prices for the customers at other distributors would go up modestly — about the cost of a “fancy coffee” from Starbucks every year.

DOJ attorney Craig Conrath shot back that the fancy cups of coffee can add up to hundreds of millions of dollars.

Shapiro, according to a DOJ brief, is prepared to testify that after the efficiencies are taken into account, consumers will pay an additional $436 million per year to their traditional pay-TV distributors to watch their favorite programs.

AT&T, argues that his model is too theoretical, and that the calculation amounts to an “insubstantial” increase of just 45 cents, or 0.4 percent, to a subscriber’s monthly bill.

Weaponizing HBO

The government argues that the merger would incentivize AT&T to withhold HBO from competing distributors, who use the premium pay channel to grow their market share and reduce churn. To attract new subscribers, the DOJ says, distributors often offer months of free or discounted HBO or embed it in select video packages. Such promotions are contingent on HBO’s approval and cooperation.

DOJ claims that post-merger, AT&T “would be far less inclined to allow rivals to use HBO to win subscribers from DirecTV, as AT&T would have a strong preference that subscribers access HBO content via DirecTV.”

AT&T said that two-thirds of video distributors don’t subscribe to HBO and that without assurances of wide distribution, content creators would leave HBO and go elsewhere.

Dish Network, DirecTV’s satellite competitor, is seen as most vulnerable to the possibility that AT&T will increase prices or withhold content. Dish is expected to be a key witness in the government’s case.

Comcast coordination

In addition to leading to higher prices, the DOJ says an AT&T-Time Warner merger will make it easier for AT&T to coordinate with Comcast and slow the growth of online distributors such as Dish Network’s Sling TV and Sony’s PlayStation Vue, which tend to be innovative and offer smaller, cheaper bundles.

The government says AT&T and Comcast will share a strong interest in slowing the entry of competing online distributors in order protect their existing business models, which produce high profit margins.

The DOJ says it has AT&T documents suggesting that after the merger, AT&T and Comcast would have an interest in leveraging their control of important content to protect their traditional distribution businesses.

Comcast-NBCU

Most antitrust attorneys thought the AT&T-Time Warner merger would be approved with a behavioral remedy, just as Comcast’s purchase of NBC Universal had been a few years earlier.

Comcast, a content distributor, bought NBCU, a content producer, in 2011 in a deal similar to the proposed merger of distributor AT&T and producer Time Warner. Such mergers combining companies at different points in a supply chain are referred to as vertical mergers.

On the surface, it was a similar case, and even had the same judge. There, the DOJ told Leon that the settlement was good for all and included rules to prevent Comcast from behaving illegally post-merger.

But there is one big difference between Comcast-NBCU and AT&T-Time Warner, which the DOJ is sure to highlight during the three-week trial.

In the 2011 Comcast-NBCU merger, the Federal Communications Commission — the government’s top communications regulator — played a key role in overseeing behavioral commitments outlined in the consent decree.

In the AT&T-Time Warner merger, the FCC allowed the companies to structure their transaction in a way that avoided a license transfer, thereby placing it outside the FCC’s purview. That means the DOJ would have to serve as both regulator and enforcer if the parties were to negotiate a behavioral remedy similar to the one agreed to by Comcast and NBCU.

Selective prosecution

Leon acknowledged that difference in a Feb. 20 opinion addressing the companies’ claim that they were subject to selective prosecution.

While Comcast-NBCU was resolved with a settlement, he wrote, “that settlement occurred in the context of ‘distinguishable legitimate prosecutorial factors’ — including FCC oversight — not present here”.

For all the talk about President Donald Trump’s dislike of Time Warner’s CNN and his comments during his candidacy about blocking the AT&T-Time Warner deal if he became president, most lawyers say the trial will avoid becoming a political circus.

AT&T claimed that the government’s prosecution was brought not because of any credible antitrust concerns but because of Trump’s animus toward CNN.

But Leon knocked that argument down in the Feb. 20 decision, which also denied AT&T’s request for logs of communications between the White House and the Attorney General’s office, and the AG’s office and the DOJ antitrust division, regarding the White House’s view of the merger.

“Defendants have fallen far short of establishing that this enforcement action was selective," said Leon, a George W. Bush 2002 appointee with a reputation for being tough on government lawyers.

A tough case

Leon's decision to nix the companies’ request for evidence of selective enforcement, however, doesn’t mean the DOJ’s case will be an easy one. There is no presumption of illegality in vertical mergers of this sort, the economics might not appear overwhelming, and the government bears the burden of proof.

However, lawyers say it would be a terrible blunder for AT&T to make the strategic decision that all it needs to do is show that the government hasn’t met its burden of proof.

Most argue that AT&T will have to offer an alternative narrative for why the merger won’t change incentives or in some way lead to price hikes for other distributors.

AT&T has said the deal is essential for the companies to keep pace with changes in how customers view their favorite shows and how companies profit from them.

The company also made it clear that its strategy is to show the court that the alleged harms in this deal can be resolved with an arbitration/no-blackout policy similar to the one Leon himself approved for Comcast-NBCU. Arguing over a proposed resolution, rather than just the legality of the merger, is known in antitrust parlance as “litigating the fix,” and AT&T has called the arbitration offer “fatal” to the government’s case.

The government says that the case isn’t about AT&T’s proposed remedy — which it argues doesn’t resolve the competitive problems with the deal — but instead, is about the legality or illegality of the merger. It sought to prevent the company from introducing evidence that their remedy as part of its defense during the trial, but Leon denied that request Tuesday.