U.S. vs. AT&T: Merger Trial Opening Delivers Competing Visions of Industry's Future

Randall Stephenson - Time Warner News Conference - Getty - H 2017
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No one alive has the power of omniscience to say with absolute certainty what will occur tomorrow and beyond. But there are likelihoods, and on Thursday at the beginning of a trial of undeniable significance, the U.S. government began its effort to spell out what would happen should AT&T and Time Warner be allowed to wed. The government imagines the merger will mean a disastrous future of higher prices for consumers and less innovation. This version of the future competes with all the good that the merging parties predict will come upon an $85 billion deal that will reshape the media and entertainment ecosystem.

After observers lined up for several hours just to get a seat, two rooms in a D.C. federal courthouse were tightly packed for opening statements. In one room, attendees had only audio to follow what was happening. The trial might be about the future of media, but here, it was as if time was stuck in that old era when people huddled before their radio players to get the news. In the other room, the main event, AT&T chairman Randall Stephenson and Time Warner chairman Jeffrey Bewkes watched their company's fate being decided. Also present was Makan Delrahim, the Justice Department's antitrust chief, who once predicted this merger would pass regulatory scrutiny before surprising almost everyone — not President Donald Trump, of course — by going to court to block it.

The significance of this case stems not only from the possibility of creating a vertically-integrated behemoth and providing a guiding post for corporate executives as they pursue new mergers and acquisitions, but also due to its relative novelty. As Daniel Petrocelli, AT&T's attorney, pointed out in his opening statement, courts are well accustomed to examining horizontal mergers — that is, tie-ups between competitors — and can use mathematical formulas about marketplace concentration to measure the ability of a monopolist to harm competition. But vertical mergers — ones between a supplier and a distributor — are a rare breed of horse. There hasn't been an antitrust case aimed at preventing a vertical merger in decades. U.S. District Court Judge Richard Leon may have spent nearly the entire 21st century on the bench, but over the next six to eight weeks, he's like a 5-year-old jumping into the deep end of the pool.

So how will Judge Leon determine whether or not to allow the AT&T/Time Warner merger to happen? The question isn't an easy one. And in the months leading up to the trial, the judge has perhaps inadvertently given off outward signs of being less than comfortable with the task ahead. For example, he joked about not having a crystal ball. Both sides have picked up this comment.

Right at the top of his opening statement, the government's lead trial attorney Craig Conrath aimed to provide an answer to the judge about how he should look at this case. He pointed to Section 7 of the Clayton Act, which prohibits the acquisition of assets where “the effect of such acquisition may be substantially to lessen competition."

Conrath stressed how this meant that the judge ultimately had to make a prediction.

"Congress used 'may...' to emphasize probabilities instead of certainties," he said.

In his own remarks, Petrocelli echoed this point but slightly amended it.

"I agree with Conrath that we're not dealing with certainties, but also not ephemeral possibilities," said the defense attorney. 

Both sides started with a discussion of the applicable legal standards before the trial attorneys did what trial attorneys do: storytelling. It's an essential art when facts only go so far and is a particularly relevant exercise when jurisprudence calls for some imagination about a future uncertain.

The government's story begins with the value of Time Warner's content — Warner Bros., HBO and the Turner networks (TBS, TNT, CNN). Conrath made sure to mention Game of Thrones and the fact that HBO earned more Emmys than anyone else in the industry this past year. He also talked about March Madness and how a week ago, the University of Maryland Baltimore County pulled off one of the most shocking upsets in sports history by beating the University of Virginia.

"It was live on Turner," said Conrath. "There's no substitute for watching it live."

The story continues with an introduction of characters like Cox Communications content acquisition executive Suzanne Fenwick, who became the first to testify on Thursday. Even before she got on the witness stand to mention the prospect of a "horribly ugly deal," Conrath signaled how she and other negotiators in the media industry would be talking during the trial how Time Warner programming is a must-have for distributors and how that factored into the price to be paid.

"It all depends on bargaining leverage," continued Conrath. "And that depends on the alternative. For a distributor, it's a blackout. Before the merger, this was bad for both sides. After the merger, it's not all bad for AT&T as they are going to get some of those customers to sign with DirecTV. That changes the bargaining dynamic."

As a result, the government asserts, Time Warner will be able to extort higher prices, which means that cable bills will rise. How much? Relying on a model from economist Carl Shapiro at the University of California, Berkeley, the government believes cable subscribers across the country will pay about $400 million more per year.

That sounds a lot, but it's also about $6 a year for each subscriber. No matter. Shapiro gave the story of hard-working Americans struggling to save every dollar and how laws like the Clayton Act allowed the government to guard every penny.

"When defendants try to say it's just a fancy cup of coffee, that's not just an attack on this case, but also an attack on federal law enforcement," said Conrath.

In his own opening, Petrocelli took a shot at Shapiro's model as deeply flawed. The defense attorney raised four points: First, Petrocelli said the expert's conclusions were based on a manipulated consumer survey showing that the mere threat of losing a network like CNN or TBS would cause 12.5 percent of people to switch cable providers. In reality, nobody wants to stay home from work and wait for the cable guy to show up. Petrocelli says that historical evidence is more like 0.5 percent. Second, Shapiro assumes that 10 percent will be cutting the cord. Petrocelli says it should be double that. Third, Petrocelli says that Shapiro never updated his model to AT&T's current profit margins on its customers. And finally, Shapiro allegedly ignored how Time Warner is locked into multiyear contracts with various cable companies.

Petrocelli says if you correct any one of these things, it basically eliminates the asserted price increase. And he says that if you correct all of these things, it amounts to a half a billion dollar price decrease for American consumers.

So only a billion dollars off.

Thursday also offered a competing vision of innovation.

Conrath highlighted the rise of virtual MVPDs, a fancy word for live television streamers. These include Dish Sling and Playstation Vue, which can entice cord-cutters with lower price points for so-called "skinny bundles" of live programming.

"They have the potential to be disruptive," says Conrath. "AT&T has incentive to slow them down. The evidence will show they also have the ability."

Again, that's because Time Warner content is supposedly so valuable that every distributor needs it.

"The merger will take a tool needed to compete and turn it into a weapon," says Conrath, adding that while the defendants once pointed to YouTube TV as not having Turner content to refute this contention, the situation changed in February for YouTube TV. "It turns out Turner programming is important."

As for the other big tech companies like Amazon and Facebook, Conrath says the truth is they have come to market dominance by doing things like providing a better way to buy books or offering people a way to connect on social media. He says the big tech companies are small potatoes in the TV business, and regardless, the Justice Department attorney says the need to grow larger is not, and has never been, a good justification under competition law.

"How do you prevent a harmful merger?" Conrath finished. "You block it. That's what we are asking the court to do."

Of course, AT&T and Time Warner have an entirely different take on the state of the marketplace and what it means to innovate. To be quite frank, it could come across as an unnerving story given the scandal facing Facebook at the moment over how a political firm took the social media giant's user data to influence the last presidential election.

According to Petrocelli, the importance of Google, Facebook and Amazon isn't that they are competing in television per se, but rather from how they are collecting information about consumers and attacking the advertising market. 

"The government ignores this completely," he says. "[These tech giants] can feed me targeted, relevant ads. They are now moving to the TV business and taking ads away."

Petrocelli calls Time Warner a "trapped wholeseller" without a relationship with the consumer. He asserts, and will have Stephenson and Bewkes testify as much, that the merger is needed so that the combination of Time Warner content and AT&T infrastructure can better capture what consumers want. With better data, Petrocelli asserts that the merged company will deliver better programming and better advertisements.

And so how does this impact the price model?

Well, according to the defense attorney, more money coming in from advertising "relieves the pressure" on consumers having to themselves pay more for live television.

Petrocelli adds that AT&T is in the wireless business and would like to give mobile consumers new ways to enjoy content, but it needs to own content to make it happen. Further, the attorney points to the existence of DirecTV Now, AT&T's own virtual MVPD, to ridicule the government's "preposterous" notion that the defendants want to slow down this newer delivery system.

"We're not trying to suppress or impede transformation," says the attorney. "It's the government who is stuck in the past." 

As it turns out, for all those tuning into the trial, be it on loudspeakers or via blogs, no discussion of the media industry's future will ever happen without a nod to what came yesterday and the time before that. That's not a probability. It's a certainty.