Why AT&T-Time Warner Win Opens the Dealmaking Gates: QuickTake

(Bloomberg) -- For decades, U.S. antitrust enforcers had worried mostly about mergers between direct competitors that might lead to higher consumer prices. They were less bothered by deals between companies that are in related businesses but that don’t compete directly. The Justice Department sought to change that when it tried to block the $85 billion merger between AT&T Inc. and Time Warner Inc. The challenge raised the possibility that similar types of combinations could hit a roadblock, slowing down the pace of dealmaking. But a June 12 federal court ruling allowing the two companies to join could open the floodgates for more of these so-called vertical mergers.

1. What are the different types of mergers?

Horizontal and vertical. In the horizontal kind, a company buys one of its competitors. Imagine if Toyota Motor Corp. bought General Motors Co., or Apple Inc. acquired Samsung Electronics Co. These are the types of deals that have raised antitrust worries in the past. Vertical deals, on the other hand, unite companies that operate at different levels of production or distribution, as is the case with AT&T and Time Warner. Think of Toyota or Apple buying one of their many parts suppliers. These deals don’t increase concentration in an industry because they don’t combine head-to-head rivals.

2. Why the new worry about vertical mergers? 

In theory, they can make a company more efficient by giving it cost advantages over rivals. Those lower costs can be passed on to customers in the form of lower prices. Yet vertical deals also can threaten competition by, for example, giving a company the power to raise the operating costs of its rivals.

3. What was the problem with the AT&T deal?

The Justice Department claimed AT&T could charge higher rates for, say, Time Warner’s TNT, which broadcasts March Madness college basketball games. That could push up costs for rival distributors such as Dish Network Corp., which presumably would pass on any higher costs to its customers. An economist hired by the Department estimated it could mean at least $285 million in higher customer bills annually. AT&T said the government’s projection was riddled with errors and, when corrected, resulted in a projected price decrease for consumers. The telecoms company also sees the combination of its distribution networks with Time Warner’s content as pro-competitive, allowing it to go toe-to-toe with Silicon Valley giants such as Netflix Inc. and Amazon.com Inc.

4. Why is this coming up now? 

Enforcers have long recognized that vertical deals can present a host of problems that harm competition. It’s just that they tended to fix them through settlements in which companies agreed to restrictions on how they would conduct business in the future. When Comcast Corp. bought NBCUniversal in 2011 -- a vertical deal that united Comcast’s distribution with NBCUniversal’s content -- Comcast agreed to dozens of conditions. Many had to do with content licensing to address the government’s view that Comcast would be able to harm online-video rivals like Netflix or Amazon by raising the cost of content or withholding it altogether. President Donald Trump’s Justice Department views those kinds of fixes skeptically, a stance welcomed by those who say the conditions don’t work.

5. Why don’t enforcers like horizontal deals? 

They potentially give an acquirer market power, depending on the shape of the industry. By taking out a competitor, the buyer may be able to raise prices on its own or in coordination with the remaining players. The Justice Department and the Federal Trade Commission have successfully challenged many of these types of deals. For example, the Justice Department in early 2017 stopped two health-insurance mergers -- Anthem Inc.’s proposed takeover of Cigna Corp. and Aetna Inc.’s deal with Humana Inc.

6. What other mergers might draw extra scrutiny? 

CVS Health Corp.’s $68 billion bid for Aetna Inc., also a vertical merger, could be next in the U.S.’s crosshairs. It has the potential to reshape how Americans receive health care by uniting CVS’s pharmacies and drop-in clinics with an insurer. The companies say the deal would make basic care more convenient and less costly, but there’s also the risk that CVS might steer Aetna’s insured members to its pharmacies whether or not they live or work near one. Similar issues could arise in yet another vertical health-care deal, the proposed $54 billion merger of insurer Cigna Corp. and drug-benefits manager Express Scripts Holding Co.

7. What about other media deals?

Walt Disney Co.’s $52.4 billion acquisition offer for many of 21st Century Fox Inc.’s assets is mostly a horizontal combination. It combines two of Hollywood’s biggest studios, and by combining its ESPN network with Fox’s 22 regional cable networks devoted to sports, Disney could force distributors to buy bigger bundles of content. It remains to be seen if the Justice Department will now argue that would hurt rivals such as Dish Network’s Sling TV that are only interested in individual channels. Comcast, the biggest U.S. cable-TV operator with about 26 million customers getting its broadband service, is now expected to bid for the same Fox assets. That combination of programming with distribution raises both vertical and horizontal antitrust concerns.

8. What’s behind the new activism? 

Trump’s antitrust chief, Makan Delrahim, wanted to throw out the playbook for resolving antitrust concerns in vertical deals. Days before suing AT&T and Time Warner, he criticized the behavioral settlements that enforcers have used to set requirements on how a company operates. Such conditions mean that the government must become a roving regulator to closely monitor a company’s affairs, he said. These settlements are hard to enforce, eventually expire and ultimately aren’t a real fix for competition problems, Delrahim told antitrust lawyers in Washington. He tested that view on the AT&T-Time Warner deal: Instead of negotiating a behavioral fix, he sought the sale of Time Warner’s Turner Broadcasting unit or DirecTV, AT&T’s satellite-TV operator.

9. So now the sky’s the limit on mergers?

Delrahim’s preference for asset sales over behavioral fixes could still raise the bar for getting vertical deals approved. Meanwhile, he has his hands full with other pending horizontal deals, including the proposed $26.5 billion combination of T Mobile US Inc. and Sprint Corp. But analyzing whether antitrust is entering a new era is made tougher by politics. The Time Warner lawsuit sparked a lot of speculation that the decision to block the deal wasn’t motivated by antitrust concerns but by Trump’s disdain for CNN, part of Time Warner’s Turner Broadcasting unit. In the trial, the judge ruled against letting AT&T use Trump’s criticism to undermine the Justice Department’s credibility in bringing the case. Still, Delrahim will have to establish a longer track record to quell doubts, legal and political, about his approach to vertical mergers.

The Reference Shelf

• Bloomberg QuickTake explainers on Big Tech’s challenge to antitrust enforcers and on the European Union’s tougher approach.
  A Bloomberg explainer on the Sky-Fox-Disney-Comcast bidding wars.
• A Bloomberg News article on the European Union’s antitrust case against Google. 
• Northeastern University economist John Kwoka documents the drop-off in U.S. merger enforcement.
• The University of Chicago’s Stigler Center summarizes research on growing concentration in the economy.
• An American Antitrust Institute paper in support of more vigorous enforcement over vertical mergers, especially AT&T-Time Warner. 
• One scholar’s guide to vertical mergers and competitive effects. 
• Analysis of the conditions placed on the Comcast-NBCUniversal vertical merger.

To contact the reporter on this story: David McLaughlin in Washington at dmclaughlin9@bloomberg.net

To contact the editors responsible for this story: Sara Forden at sforden@bloomberg.net, Paula Dwyer

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