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Mergers & Acquisitions

AT&T/Time Warner 1 – US DOJ 0

 6 min read / 

On October 22nd, 2016, AT&T proposed acquiring Time Warner, including its debt, for an estimated $108bn. This vertical merger sought to integrate the supply chains of video programming and distribution, creating economies of scale in the industry. This was, however, swiftly blocked by the United States Department of Justice due to potential antitrust issues. The DOJ alleged that the integration of the video programming and distribution companies would result in the combined entity gaining unfair leverage over its competitors. On November 20th, 2017, the DOJ filed a lawsuit against AT&T, DirecTV (a subsidiary of AT&T) and Time Warner to be “permanently enjoined from carrying out the proposed merger and related transactions” under Section 7 of the Clayton Act.

However, on June 12th, 2018, in his 172-page judgment of USA v AT&T Inc., et al., Judge Richard J. Leon of the US District Court for the District of Columbia rejected the DOJ’s allegations. This was followed up by his recommendation against the government seeking a stay of the district court’s order pending appeal in fear of delaying the merger from going through before its stipulated deadline of June 21st, 2018.

All of this begets the questions: Why the merger? Are the companies seeking an anticompetitive advantage? Or is this borne out of the intention to stay relevant?

The Relationship Between AT&T and Time Warner

In the video programming and distribution industry, there are three stages in the supply chain: content creation, content aggregation and content distribution.

Time Warner’s Warner Bros. creates content while Time Warner’s video programmers, Turner Broadcasting System and HBO, acquire and aggregate content into networks before licensing them to distributors such as AT&T for an affiliate fee. Along with televised advertising, these are the only two revenue streams for video programmers.

As such, the negotiations for these affiliate fees, concerning over a hundred factors and a value of over $1bn, are highly contested. If both parties are unable to reach an agreement on the fee, there will be a “blackout” – a situation where the distributor loses the rights to display the programmer’s content to its subscribers.

A traditional Multichannel Video Programming Distributor (MVPD), like AT&T, distributes the licensed content through satellite dishes or cable lines and its revenue stream is thus dependent on the number of subscriptions it has.

Though traditional MVPDs are still the dominant choice for television content in American households, subscription numbers are steadily declining. This drags revenues down, which in turn drags affiliate fee revenues down.

New Kids on the Block

This fall can be attributed to another type of distributor known as Subscription Video on Demand services (SVODs) entering the industry. SVODs like Netflix, Hulu, and Amazon Prime incorporate a top-down integrated business model, bringing content creation, aggregation and distribution together.

They compete against traditional MVPDs by providing their services through the internet. As such, their web and mobile-based video offerings are catering to audiences worldwide, unlike most traditional MVPDs.

Similarly, SVODs’ integrated business model allows them to compete against traditional players through their access to consumer data. With access to consumer viewing habits, SVODs’ programmers can determine and generate more popular programs and stay informed regarding scheduling, marketing and advertising choices. Traditional programmers are often unable to secure consumer data in their affiliate negotiations, for it is the distributor that owns customer relationships and hence, the data.

A fully integrated system gives SVODs yet another edge by reducing the ‘bargaining friction’ found in affiliate negotiations on innovative content rights. While traditional programmers and distributors struggle to assign value to such rights at arms-length negotiations, SVODs have paved the way in innovation. This can be seen in their development of “download rights” – enabling users to download content to their devices to view the m anywhere without wireless access.

SVODs’ use of the internet, along with the synergies stemming from their vertical integration, have thus allowed them to take over segments of the market, providing traditional programmers and MVPDs with fierce, unprecedented competition in recent years.

Why AT&T and Time Warner Need Each Other

All of this, along with a shifting trend from television marketing to digital marketing, points towards the merger being a response to trends in the industry. Time Warner has highly sought-after content offerings and an extensive advertising inventory, while AT&T has consumer relationships, data, and a sizeable wireless business. A vertical merger would allow AT&T to distribute Time Warner’s content on mobile devices – a strong industry trend, which would increase viewership and value while Time Warner could increase their advertising revenue by tailoring their advertisements to consumer data provided by AT&T.

More importantly, the reduction of ‘bargaining friction’ would allow the combined entity to develop more innovative products. As testified by AT&T executive John Stankey, one example could be in the form of CNN news clips gathered, edited and delivered to a wireless user for viewing during his 15-minute break, all tailored towards his interests.

Indeed, the DOJ’s own economist expert, Carl Shapiro, estimated that just through the standard benefit of vertical integration alone, subscribers to DirecTV and Uverse (subsidiaries of AT&T) will have annual total savings of up to $350m for their distribution services. The DOJ however, focuses on the antitrust aspects.

The DOJ’s Claims

The DOJ’s main argument hinged upon an economic bargaining theory that the merger would allow AT&T to increase its rival distributors’ costs by leveraging on Time Warner’s highly sought-after content.

Time Warner owns Turner Broadcasting Systems who in turn operates highly-sought after networks including CNN, TNT and TBS. As such, every distributor and competitor of AT&T seek the licensing rights to Turner’s network. The DOJ asserts that the moment AT&T acquires Turner’s highly sought-after content, AT&T will leverage Turner’s content to force AT&T’s competitors to pay more for the licensing rights to Turner’s content. If AT&T’s competitors refuse, AT&T will have Turner commit ‘blackouts.’ As Turner’s content is deemed must-have by every distributor, they will inevitably cave.

However, as the DOJ’s primary argument was based on theory and not fact, they failed to prove it. Though acknowledging it as a common negotiating tool, Judge Leon rejected the DOJ’s argument for there had been no concrete evidence that Time Warner would participate or had actively participated in blackouts. This as reasoned by Judge Leon, is because it is significantly detrimental to both parties when a blackout occurs. As such, blackouts lasting longer than one month have rarely taken place in the industry. Judge Leon further went on to provide evidence of three previous vertical mergers within the same industry and how they did not affect fee negotiations or content pricing, thus denying the enjoinment.

Stay Relevant

AT&T and Time Warner’s merger proposal has been alleged to eliminate competition. It, however, appears that it is themselves that they are trying to prevent from being eliminated in a rapidly-changing market.

The days of satellite and cable may be numbered, but there is no reason why traditional players in the industry should suffer a similar fate.

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