End of Net Neutrality Puts AT&T–Time Warner Merger on Ice

Trump administration shifts antitrust enforcement strategy
December 21, 2017 Updated: December 23, 2017

News Analysis

AT&T’s proposed $85 billion merger with Time Warner, and the U.S. Department of Justice’s lawsuit to block the acquisition, sets up an intriguing battle showcasing the government’s new antitrust strategy that could reshape the media and telecom industry.

With the Federal Communications Commission (FCC)’s repeal of net neutrality laws on Dec. 14, the government gains additional leverage in its suit against the merger.

Last-ditch settlement talks between AT&T Inc. and the Department of Justice (DOJ) fell apart, according to a Dec. 15 court document reviewed by Reuters, setting up a high-stakes courtroom battle set to begin March 19, 2018.

AT&T sees the proposed merger as a boon to consumers. The deal combines a massive distribution network with an established content provider in Time Warner Inc.

AT&T, one of the biggest telecom companies in the United States, operates a large fiber-optics network, owns the country’s No. 2 wireless provider, and is a leading satellite television distributor through DirecTV. Time Warner has a movie empire—with hits such as the “Harry Potter” franchise and the DC Comics superhero movies—as well as valuable TV properties, including HBO and Turner Broadcasting, which owns CNN.

The DOJ last challenged a vertical merger around 40 years ago.

Randall Stephenson, AT&T’s CEO, said the deal would give customers “unmatched choice, quality, value, and experiences” from the closer partnership between content producers and content distributors. The company envisioned the deal would be relatively straightforward to approve, given it’s not a horizontal merger and doesn’t eliminate any existing competitors. There’s existing precedence of a similar merger, with the 2011 tie up of Comcast and NBC Universal.

Vertical Integration

The DOJ’s chief complaint is that an AT&T–Time Warner merger would hinder competition and increase prices for consumers—specifically, that the new company would force its rival TV distributors to pay more to access HBO and Turner content.

Makan Delrahim, the DOJ’s new head of antitrust enforcement, is asking for a divestment of DirectTV or Turner Broadcasting before the merger can be approved, a request that AT&T and Time Warner have rejected.

In response, AT&T general counsel David McAtee called the DOJ’s lawsuit a “radical and inexplicable departure from decades of antitrust precedent.”

And McAtee is correct: DOJ’s challenge is a sharp departure from the way the Justice Department has handled antitrust enforcement in the last few decades. The DOJ last challenged a vertical merger around 40 years ago.

The proposed AT&T–Time Warner deal is textbook vertical integration, in which companies at different points of the supply chain merge. Time Warner produces content for consumers, and AT&T provides consumers access to such content—and content from other producers. A horizontal integration, in contrast, is where companies in the same slice of the supply chain merge, such as the proposed merger of Walt Disney Co. and 21st Century Fox (both are content producers).

While the AT&T–Time Warner tie up does not reduce the number of media content producers or distributors, it does put competitors in both industries in a more difficult position.

American consumers often decry the rising cost of cable TV subscriptions from distributors such as Comcast, AT&T, Verizon, and Charter Spectrum (formerly Time Warner Cable). But in the existing business model, distributors have very little say over prices. Distributors must pay content providers and TV networks, such as HBO, CNN, and ESPN, to carry content channels.

Because of the demand for programming, content providers dictate the prices distributors must pay, and force distributors to bundle less popular networks with more popular ones. If distributors balk at paying such high prices or unnecessary bundles, they risk not carrying the most popular channels and ultimately losing customers. While content producers aren’t directly consumer-facing, they ultimately command the price of distribution and how much consumers pay.

This means AT&T would have a vested interest in promoting the content it would own via its distribution platforms, while squeezing alternative providers. It could cause lower prices on DirecTV or U-verse (its fiber optic network), while charging competing distributors higher carriage rates for its programming.

Is this anti-competitive? The current DOJ administration believes so.

A Break from Tradition

At the turn of the last century, when the original “trustbuster” Theodore Roosevelt arrived on the scene, vertical integrations were illegal. But since the 1980s, they’ve become legal by default, often in the context of greater regulatory oversight and with promises from companies to not engage in anti-competitive behavior.

That was the premise when the DOJ approved the 2011 merger between NBC Universal and Comcast. The approval came with many conditions, and Comcast has already been fined with violating one of them.

But that strategy may be a thing of the past. A recent speech by the DOJ’s Delrahim suggests a potential shift in how the U.S. government will view antitrust matters going forward.

“Antitrust is law enforcement; it’s not regulation,” Delrahim said at the American Bar Association’s Antitrust Fall Forum on Nov. 16.

“Unfortunately, behavioral remedies often fail to do that. Instead of protecting the competition that might be lost in an unlawful merger, a behavioral remedy supplants competition with regulation; it replaces disaggregated decision-making with central planning.”

Delrahim argued that the recent trend of allowing anticompetitive mergers to occur, then applying conditions and restrictions on the resulting company and overseeing the company’s activities to ensure good behavior, is inherently cumbersome and intrusive. It creates more regulation, places a heavy demand on the government to monitor, and can result in costly subsequent litigation.

In other words, it’s much more efficient and effective to prevent questionable mergers from occurring in the first place.

Impact of Net Neutrality

The FCC rolled back net neutrality laws on Dec. 14. In one fell swoop, the repeal of net neutrality rules has tilted the balance in DOJ’s favor in its case against AT&T–Time Warner.

Net neutrality, enacted in 2015 under the Obama administration, is a set of rules that prevents internet service providers from giving bandwidth preference to one content provider over another. For instance, under net neutrality, a service provider such as Comcast could not throttle the streaming speed of pornography websites and boost the speed of its own content produced by NBC.

With net neutrality repealed, the DOJ just gained a new and powerful argument against the proposed merger. Going forward, AT&T–Time Warner would be able and incentivized to slow the streaming and download speeds of content from its competitors, while HBO content streaming via DirecTV would enjoy higher bandwidth.

The sudden repeal of net neutrality essentially realizes the government’s assertion against the proposed merger.