AT&T Time Warner Will Get Another Look

(Bloomberg Opinion) -- Programming note: Money Stuff will be off next week for vacation.

AT&T v. DOJ.

The way antitrust law works in the U.S. is that when two companies want to merge, they file a notice with the authorities, and the authorities have some time to figure out whether to challenge the merger. If they decide to challenge it because they think it is bad for competition, and the companies don’t want to settle, then the merger is put on hold and they go to court and fight it out. If the authorities win—if the court agrees that the merger is anticompetitive—then there’s no merger. If the companies win, then they merge.

The key thing is that, in most cases, they wait until the decision to close the merger. Because while it is a big disruptive pain to abandon a merger agreement that has been signed and announced, it is far more disruptive to abandon a merger that has already been closed. If you abandon a signed merger, the two companies just go their separate ways, battered and embarrassed. If you abandon a closed merger, there aren’t two companies. The selling shareholders have been cashed out, the legal entities have been merged, the stationery has been changed, the trade secrets have been shared, the egg can’t really be unscrambled. You can do a brand-new transaction—a spinout, an asset sale, a public offering—to break up the company, but that’s what you are doing: You are breaking up a company into two new ones, not just returning to the two previous companies. 

Anyway, back in 2016, AT&T Inc. signed an agreement to buy Time Warner Inc., and the U.S. Department of Justice decided that that would be anticompetitive, and AT&T and Time Warner strongly disagreed, and the merger sat around on hold while they prepared for trial, and they did the trial, and finally last month the Justice Department suffered a comprehensive and embarrassing loss. The thrust of the federal judge’s ruling was “come on Justice Department, get outta here; AT&T, go ahead and close your merger, and let’s not hear any more about antitrust concerns.” And the Justice Department curled up into a ball and sulked, and AT&T quickly closed the merger, and now a month later:

Rather than walk away, the Justice Department’s antitrust division took a big gamble Thursday, with a one-sentence notice of appeal filed in federal court in Washington. In doing so, it risks a second defeat that could lead to binding precedent that makes future merger challenges harder.

But the move offers a tempting shot at redemption after a humiliating loss handed down by U.S. District Judge Richard Leon.

AT&T is untroubled:

Chief Executive Officer Randall Stephenson said he expected the government to appeal the judge’s decision that allowed his company to acquire Time Warner last month. The move “doesn’t change anything -- the merger is closed,” he told reporters at a conference in Sun Valley, Idaho.

Intuitively, one problem for AT&T here is that if the Justice Department appeals and AT&T has already raised prices, its argument—central to the trial—that the merger would lead to lower prices for consumers seems … weakened? Really you gotta wait for the appeal deadline to pass before you start raising prices; doing it right after the verdict seems like a rookie mistake.

Another problem is that the trial judge arguably missed the point a bit during the trial, focusing mainly on the merger’s effect on bargaining over cable affiliate agreements rather than the potential effects on the mobile video market of giving a major mobile-phone network the power to privilege its own content on mobile devices. And while this is mostly the government’s fault—the Justice Department seems to have missed the point too—since the ruling, others have weighed in to explain clearly the potential consumer harms from the merger, harms that the government didn’t focus on. (Here is a scathing rebuttal from Nilay Patel, titled “The Court’s Decision to Let AT&T and Time Warner Merge Is Ridiculously Bad”; here is a more temperate but similar take from Ben Thompson.) Presumably the government, and the appeals court, could, you know, read those analyses. 

On the other hand, the point of a trial is to get out all the facts and arguments; price increases that happened after the trial, or arguments that the government forgot to make at trial, are not generally what you want to lead with on appeal. “As much as the Justice Department’s argument against the merger had merit and the thinking around antitrust needs updating, the judge was right that DOJ lawyers didn’t meet their burden of proof,” says my Bloomberg Opinion colleague Tara Lachapelle, and while that is in some sense a dumb way to decide whether a merger should be allowed, it’s the system we’ve got. It’s an adversarial system where it is the Justice Department’s job to make the case at trial—and preferably to make that case before the merger closes. After it closes, it really should be hard for the Justice Department to start over.

Activism v. passive.

Sometimes— yesterday, for instance—I like to compare investment management to dentistry. It is, I think, kind of weird that investment management is a profession with lots of well-trained well-compensated full-time professionals who devote their lives to picking the right stocks, but that at the same time lots of amateur hobbyists expect that they should be able to compete on a level playing field with those professionals. You do not see that expectation in dentistry. Dentistry is for the most part left to professional dentists, and people understand that if they just get a pair of pliers and go to town on their own teeth they will underperform the professionals.

But there is an important flaw in this analogy, which is that if you just decide to pull out a tooth at random—or if you decide to pull out the tooth that is most commonly pulled out of other people’s mouths—then you will, with very high likelihood, do a worse job than an average, or even very-far-below-average, professional dentist would do. In investing, that is straight-up not the case. The basic rule is that the average active investor will underperform the index of stocks in which she can invest, and the empirical results tend to show that the average professional active manager underperforms both the index and a random dart throw.

This is a rather significant marketing problem for those active managers. If you go to 100 big active investment managers and ask them what they do all day, they will talk about their teams of highly educated and experienced analysts who work long hours doing deep sophisticated research into understanding the economy and the companies in which they invest, and you will be impressed. And 98 of them will be telling you the truth (there are slackers, and Ponzis). But nonetheless, when you combine all of their performance, it will be worse than the brick-stupid dirt-cheap strategy of just buying all the stocks and forgetting about it. 

It would be quite natural for you to conclude from this that the activity of researching and picking investments—the job that all of those brilliant analysts put all those long hours into doing—is worthless, a pure waste of skill and effort. This is not true—someone does need to analyze investments and allocate capital, the indexes simply aggregate and free-ride off all those analysts’ valuable efforts, etc.—but it is true (enough) for you. The stock-picking is valuable for the world, but that’s not a reason for you to pay for it. 

On the other hand if you are an investment manager you need some approach to solving this marketing problem. One quite straightforward approach is to market to people who don’t know this stuff, though over time, as indexing has gotten more popular, this approach is harder. Another straightforward approach is to explain that you are different: The aggregate performance of active managers is bad but yours is good; the average educated experienced hard-working analyst adds no value but yours are extra educated and extra experienced and work extra hard. Or you could pivot to passive investing, or smart beta, or something similar. Or you could pivot to the thing where you write down the list of stocks that you want to buy, call it an “index,” and then market yourself to investors as an “index fund” but with high fees.

But a particularly promising approach is to change the skill set that you are selling. If the skill of picking stocks is devalued, because it turns out it can be done better by an index than by the average stock-picker, then you want to move into some closely allied line of work that can’t be done by an index.

For instance, once you have picked companies to invest in—which any monkey or index could do—you can call them up and tell them how to change their businesses to increase their stock price. No index could do that (index funds could, I guess, but they don’t especially), and it does intuitively seem like a monkey would be at least as bad at pushing for change in a boardroom as he would be at, you know, dentistry. I suppose a primatologist could teach a monkey the American Sign Language for “lever up to buy back more stock” and then let him loose in the boardrooms of America, and that monkey might make for a decent activist, but that is not a fair comparison. The skill set of activism is subtle and multifaceted; if the board doesn’t let him into the room, is the monkey going to type a letter full of cutting witticisms and file it with a 13D?

Here is a Wall Street Journal article about how “activists are launching campaigns at a record pace as the rise in passive investing pressures fund managers to find new ways to beat the market,” and how “almost 20% of new campaigns this year have been initiated by first-time activists”:

As active stock pickers fall behind passive investors, the appeal of shareholder activists and their ability to effect stock-enhancing change has grown, said Greg Taxin of Spotlight Advisors LLC.

“Activism has proven over a long stretch of time to be an effective way to generate alpha,” said Mr. Taxin, who advises companies and has also worked with first-time activists including Blackwells Capital LLC in its campaign at Supervalu Inc. “In a world where active stock picking is viewed skeptically by many, this strategy has an understandable explanation for why it ought to outperform.”

I would de-emphasize the stuff about “alpha” in that quote and focus instead on the stuff about “an understandable explanation for why it ought to outperform.” The point here is not actually that investing with activists makes you more money than investing with regular stock-pickers. (“An activist hedge fund index tracked by HFR Inc. returned 5.5% last year compared with the S&P 500’s 22% rise with dividends.”) The point is that investing with activists allows you to pay professional investment managers for some skill other than picking stocks, which, if you are skeptical about the value of picking stocks, is a satisfying thing to do.

This is one symptom, by the way; there are others. Take the rise of the unicorns and the vast pools of money sloshing around in venture capital and private equity. (Or um crypto I guess, though there are index funds there.) The marketing pitch for those funds isn’t just that they outperform public equity investments—they don’t always—but also that they demonstrate a skill that isn’t public stock-picking. That skill is increasingly devalued these days, but the underlying bits that go into it—the fancy education and long experience and deep research of the analysts—still look, on their own, impressive. The trick is to apply them to something that cannot yet be done by an index. 

Facebook v. SEC.

In 2015, Facebook Inc. discovered that Cambridge Analytica had improperly come into possession of user data on millions of Facebook users. In March 2018, Facebook users discovered this, as journalists broke the story and as Facebook eventually disclosed it. Facebook’s stock dropped on the news, losing almost 14 percent of its value ($25.70 per share) over the week after the Cambridge Analytica story came out.  

There is an argument that Facebook users whose data was obtained by Cambridge Analytica were victimized by that sharing, though it is not exactly clear how; there is also an argument that American democracy was a victim of Cambridge Analytica’s use of that data for political purposes, though it is not exactly clear if that’s true. But Facebook’s shareholders were definitely, in a dumb and limited but easily measurable sense, victims of all of this: They bought the stock at a high price not knowing about the Cambridge Analytica breach, and then when they found out about it the stock price fell, and they lost money. When shareholders lose money because a public company didn’t tell them an important fact, there are clear and much-used enforcement mechanisms to punish the company (i.e. the shareholders again, but don’t worry about that) and get some money back for the shareholders (from themselves, but don’t worry about that).

And so in fact shareholders are suing and the Securities and Exchange Commission has opened an investigation. Specifically:

The SEC is probing whether Facebook should have disclosed to shareholders its knowledge of the Cambridge Analytica violation in 2015, when it learned that Aleksandr Kogan, a professor at the University of Cambridge, had improperly shared data with Cambridge Analytica in 2014 for as many as 87 million Facebook users.

If it should have—if it knew or should have known that the information was material, etc.—and didn’t, then it will be in trouble.

Traditionally the misdeed that is being investigated here is called “securities fraud,” though that is perhaps a harsh term for “forgetting to tell investors about a bad thing that happened.” But there is frequently a companion misdeed to this sort of “securities fraud,” and it is called “insider trading.” If a company’s chief executive officer knows about a bad thing, and neither he nor the company discloses it, and he sells stock to shareholders who are kept in the dark, and he gets more money for his stock than he would have if the shareholders knew about it, then that seems, viewed in the harshest possible light, bad, and in fact there is precedent for the authorities throwing in insider-trading charges in those circumstances.

The thing is, 2015 to 2018 is kind of a long time. A lot happened in that time, presumably mostly while Facebook wasn’t thinking a lot about Cambridge Analytica. In mid-2015, Mark Zuckerberg owned about 426 million shares of Facebook. By April 2018, that number was down to about 401 million, as Zuckerberg sold shares as part of his plan, announced in December 2015, to give away 99 percent of his wealth to his Chan Zuckerberg Initiative. At today’s prices, the 25 million shares he sold are worth about $5.1 billion. And those shares lost about $637 million in value during that week in March when the Cambridge Analytica story came out. The shareholders who bought shares from Zuckerberg, and then lost money when the story came out, might feel particularly aggrieved. (Or they would, if stock-exchange transactions weren’t anonymous.) 

Now, let me be clear: This is stupid. Obviously Mark Zuckerberg wasn’t selling stock after he found out about Cambridge Analytica, but before the public did, because he wanted to limit his losses by taking advantage of buyers who didn’t know what he knew. For one thing, he kept almost all of his stock; the 25 million shares were just a tiny sliver of his holdings. For another thing, the stock has recovered nicely; it’s currently trading above where it was before the Cambridge Analytica story broke—in fact at an all-time high—so he didn’t really avoid any losses (and in fact missed out on gains). Also he sold the stock to give away the proceeds.

But I write a lot these days about how securities law is a sort of catch-all form of law enforcement, how companies that suffer data breaches or allow sexual harassment or misprice chickens or cause climate change can all be punished under the general heading of “securities fraud.” I find it strange and mechanical: It is a convenient way to punish any sort of bad behavior, but it sends weird messages about who the victims of that behavior are and how the rule of law should work. And if you take it too seriously, if you apply it too mechanically, then isn’t everything not just securities fraud but also insider trading? 

Blockchain blockchain blockchain.

The basic case for using the blockchain is that it provides a secure decentralized trustless record of transactions. In most of the uses that people propose for the blockchain, this is a little pointless. For one thing, you have trust: If you are using the blockchain to computerize loans or derivatives or cargo shipping or bananas, you are imposing it on existing networks in which counterparties have already built up cultures and intermediaries and enforcement mechanisms that allow them to trust each other enough to transact. For another thing, a trustless record of transactions is often not exactly what you need: If you have a blockchain for cargo, and the blockchain properly records all the documents and approvals as your cargo container makes its way across the globe, and but someone somewhere along the way saws a hole into the container and takes out all the cargo, then properly auditing the documents only does you so much good. The blockchain is good for self-contained computerized transactions—like keeping track of your Bitcoins—but it takes an extra step to apply it to physical goods in the world.

Anyway here is a blockchain use case I can get behind:

Anheuser-Busch InBev, AT&T Inc., Kellogg Co., Bayer AG and Nestle SA are among advertisers that are starting to use the nascent technology to figure out whether their ads are viewed by real people, not computer-generated bots, and how much of their spending is siphoned off by middlemen.

Online advertising is the perfect application for blockchain: It is complicated, nobody trusts anyone else, and it occurs entirely on computers. It’s the rare sort of problem that it actually makes sense to solve with a blockchain.

Things happen.

Bank Shares Hit as Citi, Wells Fargo Disappoint, JPMorgan Beats. Global Regulators Push for Faster Transition Away From Libor. Trump says Brexit blueprint will kill any UK-US trade deal. U.S. Banks Could Lose Out Under U.K.’s Brexit Plan. Big Four London Law Firms' Profits Rise as Brexit Approaches. ‘The Last Bet-the-Company Situation’: Q&A With Elon Musk. Commerce Secretary Ross to Sell All Stocks After Ethics Office Warning. Billionaire Steven Cohen Invests in Crypto Hedge Fund. Kodak KashMiner, the Bitcoin cloud mining scheme that … never existed. “While diversity of opinion and background is really important for many students, it would make little sense to try to game the system to get into an M.B.A. program where you and your peers wouldn't at least share a core personality trait like kindness.”

©2018 Bloomberg L.P.

Stay Updated With View News On BloombergQuint