Three Lessons from AT&T/Time Warner and Three Strategies for Future Vertical Transactions
The challenges that the government faces in litigating vertical mergers was illustrated in the DOJ’s recent loss in its challenge of AT&T’s proposed acquisition of Time Warner. The result provides guidance for how companies can improve their odds of obtaining antitrust approval for similar transactions.
The US Department of Justice’s (DOJ) loss in its challenge of AT&T’s proposed acquisition of Time Warner demonstrates the difficulties the government faces in litigating vertical mergers and provides a guide for how companies can improve their odds of obtaining antitrust approval for such transactions. This was the first litigated vertical merger case in four decades and the largest antitrust merger litigation under the Trump administration. Last week AT&T received the go ahead from Judge Richard J. Leon to proceed with the deal and the parties already closed the transaction. It is still unclear whether the DOJ will appeal the decision. Although this was a significant loss for the DOJ, Judge Leon’s opinion was narrowly tailored to the particular facts of the industry. Therefore it is questionable whether the opinion will have a significant impact on future vertical merger enforcement by the US antitrust regulators.
The DOJ’s main theory in the case was that the combination of AT&T’s video distribution services, namely DirecTV’s satellite TV offerings, and Time Warner’s video content would provide Time Warner with increased bargaining leverage when negotiating with other video distributors who are AT&T’s competitors. According to the DOJ, AT&T would have increased leverage over competitor video distributors because (1) some of the distributors’ customers would depart due to the lack of Time Warner’s networks in the distributor’s offering and (2) of the customers that left, some would sign up for AT&T’s competing video distribution services, DirecTV. Since both parties to the negotiation would recognize this change in negotiating position, AT&T’s prices for Time Warner content would increase.
Judge Leon held that the DOJ failed to meet its burden to show that AT&T’s acquisition of Time Warner would harm competition due to an increase in Time Warner’s bargaining leverage. Judge Leon did not dispute the DOJ’s theories on key legal principles, such as the relevant market, the burden of proof, and whether the DOJ’s bargaining model was a viable theory to challenge a transaction. Instead, he found that the facts did not support a finding that the transaction would lead to a substantial lessening of competition. First, the key documents used by the DOJ were regulatory filings by AT&T or Time Warner in prior vertical mergers in the video distribution industry. The statements in these regulatory filings were made in an effort to prevent a competitor from completing its acquisition. Even so, the statements only suggest that vertical integration “can” create an unfair advantage in negotiations, without saying that vertical integration “will” lead to increased prices for video content. Second, Judge Leon gave little weight to the testimony from AT&T’s competitors because, unlike with horizontal transactions, the affected “customers” of Time Warner were competitors of DirecTV and thus had a natural bias to oppose the transaction. In addition, Judge Leon found that the customer testimony was comprised largely of speculative statements that they would be harmed in negotiations without any quantitative analysis to support their assertions. Finally, Judge Leon found the DOJ’s economic analysis was based on flawed assumptions not supported by the record. Importantly, Judge Leon found that prior vertical mergers in the industry had not led to higher prices for customers.
The obvious question remains: what does this mean for other vertical transactions facing US antitrust review? For companies considering vertical mergers, there are three main takeaways from the case.
1. The DOJ Faces a High Burden to Prove Harm to Competition in Vertical Cases
Throughout the course of the trial, the differences in the legal standards governing a horizontal merger and a vertical merger became clear. Judge Leon’s opinion specifically notes that the DOJ’s “‘familiar’ horizontal merger playbook is of little use.” Of course what Judge Leon is referring to is the government’s typical strategy in horizontal merger cases, which is to establish a presumption of competitive harm by introducing evidence that a merger will lead to undue levels of market concentration. Essentially, if the government proves its market, it is almost home. Leon notes that because this presumption is not in play in a vertical case, the DOJ “must make a ‘fact-specific’ showing that the effect of the proposed merger ‘is likely to be anticompetitive.’” This showing is “highly complex” and “institution specific.” Unlike in a horizontal case where the main disputes often relate to market definition, in a vertical case the debate will center on the competitive effects analysis.
Further complicating matters, there are clear efficiencies in vertical transactions that the government does not dispute. Indeed, in AT&T/Time Warner the DOJ credited more than $350 million in annual efficiencies resulting from the elimination of double marginalization (EDM). Judge Leon refers to this type of efficiency as a “standard benefit” associated with vertical mergers because a merger between two companies operating at different levels in the supply chain almost automatically removes some margin. Since this type of efficiency is not disputed by the DOJ, any claimed price increase resulting from a vertical merger has to outweigh the claimed efficiencies.
In future cases, the DOJ will need substantial evidence from ordinary course business documents, more testimony from uninterested third party witnesses, and sound economic analysis of the likely competitive harms to be successful in a vertical merger challenge. Vertical cases, especially those not based on a foreclosure theory, cannot rely on simply alleging that the combined entity has an important product or a high market share. Rather the government needs to show clear harms that outweigh the credited efficiencies. Overall, this means that a vertical merger case presents more difficulties for the DOJ than a horizontal case and poses a higher risk for the agency should the case go to trial.
2. The Effectiveness of Increased Bargaining Leverage as a Theory of Vertical Harm Remains Uncertain
The DOJ’s theory in AT&T/Time Warner generally differs from its prior vertical merger enforcement. The main difference is that the DOJ did not allege that the merger would result in either foreclosing a vital input from downstream competitors or foreclosing a group of customers from upstream competitors. Instead the DOJ’s main theory was that AT&T’s ownership of Time Warner would provide Time Warner with increased bargaining leverage in negotiations with video distributors who are AT&T’s competitors. This theory posits that by raising costs to AT&T’s rivals, the proposed acquisition would harm competition and lead to price increases overall. The DOJ did not allege that AT&T would not continue to supply Time Warner content to its competitors.
As Judge Leon notes in his opinion, the DOJ could not point “to any prior trials in federal district court in which the Antitrust Division has successfully used this increased-leverage theory to block a proposed vertical merger.” (The US Federal Trade Commission [FTC] has used this theory to challenge several horizontal hospital transactions.) After this decision, it remains true that no court has ever blocked a vertical merger where the government’s theory is based on alleged increased costs to a rival without additional foreclosure allegations.
Nonetheless, Judge Leon did not reject an increased bargaining leverage theory as the basis for a vertical merger challenge. His opinion merely found that the facts here do not support a conclusion that there would, in fact, be increased bargaining leverage leading to higher prices or that this would outweigh any efficiencies. In the future, the DOJ will likely look for cases with stronger facts, including evidence of price increases from prior vertical mergers in the industry and more substantial economic analysis to show anticompetitive effects. However, for now, the effectiveness of an increased bargaining leverage theory, without additional foreclosure allegations, remains quite uncertain.
3. DOJ and FTC May Be More Open to Conduct Remedies to Address Vertical Concerns When Presented with Litigation Risk
Since taking control of the Antitrust Division, Assistant Attorney General (AAG) Makan Delrahim has made his mark through a stricter policy on vertical merger remedies. Previously, the DOJ and FTC frequently accepted conduct remedies, such as non-discrimination commitments and information firewalls, to address potential concerns in vertical transactions. AAG Delrahim has made it clear that these types of remedies are strongly disfavored since they result in significant government oversight in an industry. The Trump administration views antitrust as law enforcement and does not want to take on a regulatory role in an industry due to a consent decree with continued monitoring of conduct remedies.
AT&T/Time Warner ended up as the test case for this new policy on vertical merger enforcement. The DOJ sought a structural remedy in the form of an injunction preventing the parties from merging or requiring a divestiture of Time Warner’s key assets in Turner Broadcasting. In doing so, the DOJ ignored behavioral commitments made by AT&T in the form of an arbitration agreement that it sent shortly before the DOJ filed its complaint to all relevant Time Warner customers. This arbitration agreement mirrored behavioral remedies used by the DOJ in prior cases in this industry.
With the court’s ruling against the DOJ, it is possible that the DOJ and FTC will be more cautious with vertical merger enforcement going forward since additional unfavorable precedent could harm the Trump administration’s larger policy goals. In cases where the proof of vertical harm is not abundantly clear, the DOJ and the FTC are faced with the choice to (1) accept conduct remedies; (2) spend significant agency resources to litigate the transaction, with the potential to generate additional bad precedent; or (3) clear the transaction. This is a difficult choice, but the AT&T/Time Warner ruling may make the litigation option less appealing.
With these lessons in mind, parties to vertical transactions should consider the following strategies to improve the odds of obtaining US antitrust clearance:
It is critical that merging parties have a strong, well-supported pro-competitive story. Judge Leon’s opinion demonstrates the importance for merging parties to document and conduct a thorough efficiencies analysis. The regulators and courts are likely to give greater deference to the cost savings in vertical mergers as compared to horizontal mergers.
In dynamic industries, where new technology or new competitors, are having an impact on competition, the merging parties’ internal documents should reflect the new changes or competition. Although Judge Leon did not dispute the DOJ’s alleged product market, he spent a large portion of the opinion discussing how the media industry was changing due to new competition from companies, such as Netflix, Google and others. These findings appeared to influence Judge Leon’s views on the benefits and rationale of the transaction.
Because the government’s witnesses for vertical merger challenges are typically competitors, merging parties should consider early in the review whether they can address the competitors’ concerns through a long-term contractual commitment or similar type of remedy. Although the US antitrust regulators may be reluctant to enter into a formal settlement with behavioral remedies, the US antitrust regulators are less likely to challenge a vertical merger without competitor complaints and testimony.