In June, the US Department of Justice lost its lawsuit to block the merger between AT&T and Time Warner. Charles McConnell and Pallavi Guniganti explore how the changing landscape of content creation and distribution enabled the third-biggest telecommunications company in the world to buy what was once the largest media company.

INTERNET KILLED THE TV STAR

Many Americans – including their current president – believe the video programming and distribution industry is too concentrated. On the day, in 2016, when AT&T announced its US$85.4 billion acquisition of Time Warner, then presidential candidate Donald Trump called the deal “an example of the power structure I’m fighting”, and promised that his administration would not approve it “because it’s too much concentration of power in the hands of too few”. He also criticised the 2011 merger between cable and internet provider Comcast and the television and film conglomerate NBCUniversal – a deal that was conditionally cleared under the Obama administration – as concentrating “far too much power in one massive entity”.

The Department of Justice’s (DOJ) antitrust division argued during its quest to block the AT&T/Time Warner tie-up that just a few companies hold the keys to getting content into homes throughout the US. Consumers rely on traditional cable or satellite television companies and wireless communications providers to access content, and consolidation has hit both of those industries in the past decade. In some markets, there are only one or two choices for a television provider, and the wireless communications industry has just four meaningful competitors nationwide.

The DOJ identified AT&T as one of the companies that holds those keys, by providing communications and digital entertainment services, while distributing content to subscribers through its subsidiaries DirecTV and U-Verse. Although the DOJ conceded that there are a lot of options for content, it pointed out that Time Warner provides some uniquely “must have” programming in the US, including the 24-hour news network CNN, college basketball’s March Madness tournament, the NBA playoffs, other live sports on TNT and TBS, and HBO programmes such as Game of Thrones.

The government challenged the companies’ vertical merger based on a bargaining leverage theory that the merged company could use Time Warner’s “must have” Turner-owned content as a weapon when negotiating with content distributors, once Time Warner secured DirecTV as a guaranteed distributor. By threatening to withhold the Turner channels, Time Warner would force non-AT&T distributors to accept higher costs for the Turner content, the DOJ hypothesised. Those costs would then be passed onto the distributors’ customers, resulting in hundreds of millions of dollars in annual consumer harm.

“If there ever were an antitrust case where the parties had a dramatically different assessment of the current state of the relevant market and a fundamentally different vision of its future development, this is the one. Small wonder it had to go to trial!”
– Judge Richard Leon

That bargaining leverage theory sat front and centre throughout the trial. But the merging companies urged Judge Richard Leon to reject that hypothesis and instead take a close look at the competitive landscape of the media and telecommunications world, including the role of advertising.

AT&T and Time Warner touted their tie-up as a crucial step toward competing better in a rapidly evolving market that has seen the rise of major new players in the content creation and distribution spaces. This evolution, which was triggered by the invention and development of high-speed internet, has left traditional content creators and distributors scrambling to deal with declining video subscriptions and stagnant television advertising revenues.

Competition with FANGH

Five companies that increasingly dominate consumers’ attention spans were referenced during opening arguments, then made a written appearance in the first two pages of Judge Leon’s opinion. Though the normal shorthand for Facebook, Amazon, Apple, Netflix & Google is the FAANG

companies, the judge left out Apple – which continues to be known primarily for hardware – and swapped in Hulu. The government downplayed the FANGH companies’ significance to the relevant market of multichannel video distribution, even as the defendants highlighted the behemoth size of their individual revenue streams and content creation budgets when compared to those of AT&T and Time Warner.

For several years, US antitrust agencies have been fending off claims by merging companies that entry by one or more major internet companies would keep their market competitive. A precursor to this now commonplace argument came in the 2011 H&R Block/TaxAct merger litigation, when the companies said hybrid products, blending traditional full-service tax preparation with online “do it yourself” offerings, were a basis to broaden the definition of the market to include the DIY products. The claim of incipient competition from internet companies threatening the market share of H&R Block and TaxAct dominated their defence of the deal.

“Facebook and Google have developed new ways to use data to create effective and lucrative digital advertisements.”
– JUDGE RICHARD LEON

Two years later, Bazaarvoice justified its acquisition of PowerReviews – its primary competitor in providing software for ratings and reviews – by pointing to user created reviews on Amazon, Google and Facebook as part of the relevant market.

In 2016, the federal judge ruling on the challenge to the Staples/Office Depot merger began his opinion: “Drawing an analogy to the fate of penguins whose destinies appear doomed in the face of uncertain environmental changes, defendant Staples and defendant Office Depot argue they are like ‘penguins on a melting iceberg’, struggling to survive in an increasingly digitised world and an office-supply industry soon to be revolutionised by new entrants like Amazon Business.”

That same year, Los Angeles Times owner Tribune Publishing said its purchase of two suburban newspapers would hurt neither readers nor advertisers because both could go online. It said local news readers could switch to Google News, Apple News, search engines or various media, while advertisers could go to many of the same sites in order to reach those readers.

Every single one of those arguments failed. Federal judges from California to Washington, DC, rejected merging companies’ claims that their deals would not harm competition because of rivalry from internet businesses.

In contrast, Judge Leon ultimately sided with AT&T and Time Warner’s por- trayal of the FANGH factor. On the second page of his opinion he wrote: “Vertically integrated entities like Netflix, Hulu and Amazon have achieved remarkable success in creating and providing affordable, on-demand video content directly to viewers over the internet. Meanwhile, web giants Facebook and Google have developed new ways to use data to create effective – and lucrative – digital advertisements tailored to the individual consumer.”

An example of this internet insurgency could be seen exactly one month after Judge Leon’s ruling: on 12 July, Netflix shattered HBO’s streak of 17 consecutive years of receiving the most Emmy nominations, which recognise the best of US prime-time television programming.

“While traditional MVPDs are losing subscribers, Netflix added two million subscribers in the last quarter alone.”
– JUDGE RICHARD LEON

To further illustrate such shifts in the industry, some argue that lines are beginning to blur between telecommunications and media companies. The five companies Judge Leon referenced – and a slew of others – are finding innovative ways to deliver large volumes of content to consumers, which directly threatens incumbents such as AT&T and Time Warner.

In the end, the judge accepted the companies’ claim that those “tectonic changes” in the marketplace drove AT&T to purchase Time Warner.

Judge Leon said he accepted the government’s proposed product market for the purposes of deciding the case, but that doing so did not obligate him “to ignore the rising role of SVODs [subscription-based video-on-demand services] in the broader multichannel video programming and distribution market”.

Throughout the trial, the government tried to convince him that companies such as Netflix do not belong in the relevant market because its product is not a substitute for Time Warner’s content.

“We just watching Netflix, she ain’t got no cable, okay though.”

– DJ Khaled, “I’m the One”

A vast majority of Netflix subscribers also have traditional pay-television subscriptions, the DOJ argued; if anything, Netflix and others are complementary to a DirecTV or Comcast Xfinity subscription. The government’s economic expert, Carl Shapiro, pointed in his report to past state- ments by distributors such as AT&T and Charter that described Netflix and Hulu as complements to traditional cable, while regarding Sling and other “skinny” bundles, which still include live television programming, as actual substitutes.

Original content by Netflix and Amazon “has evidently not been sufficient to prevent Turner and other major video content aggregators from significantly raising their affiliate fees over time, including via escalator clauses commonly imposed in existing contracts with MVPDs,” Shapiro wrote. He said the cost of Turner content had risen because it is unique, valuable and highly desired by consumers, particularly the live events and sports programming.

“I therefore do not expect that the presence and growth of Netflix, Amazon and other creators of video content will be sufficient to deter or counteract the Turner fee increases that I predict would result from the merger between AT&T

and Time Warner,” the DOJ’s expert concluded. His rebuttal of AT&T’s expert testimony continued to hammer this point: original programming from Netflix, Amazon and Hulu is all very well, but traditional programmers such as Time Warner still command rising affiliate fees for their content.

One of the first things Judge Leon did in the background discussion of the industry he included in his ruling – which touches on the bargaining theory – was lay out the two ways programmers such as Turner make money. He said they do so through affiliate fees from packaging the content and licensing it to distributors; and through the sale of advertising seen during the programming. Traditionally, Turner’s revenues from each have been roughly equal, Judge Leon explained. Both affiliate fees and advertising revenue depend on the broad distribution of Turner’s content. Because of that need for broad distribution, the judge gave significant weight to the testimony of Time Warner executives who denied they would have any increased leverage through the threat of blackouts. This aspect of the government’s theory “does not make sense as a matter of logic and, more importantly, that has not been supported by sufficient real-world evidence,” he wrote.

AT&T, Time Warner and the FANGHs