Last night brought some blockbuster news for telecom giant AT&T (NYSE: T): A federal judge ruled in favor of the company, denying the U.S. government’s legal complaint seeking to block its proposed megamerger with Time Warner (NYSE: TWX). The Department of Justice had filed suit in November, arguing that if the deal was allowed to go through, U.S. consumers would ultimately be harmed. There would be less competition in the market for video programming and distribution, the DOJ said.
U.S. regulators failed to prove their case. Here’s what investors need to know.
The market is evolving and AT&T is trying to keep up
In his decision, federal Judge Richard Leon acknowledged the broader context of the deal. The market for video programming and distribution has been utterly upended over the past decade — and in more ways than one. Not only has cord-cutting continued unabated, putting significant pressure on subscription fees, but TV advertising revenues are also on the decline.
Tech companies are largely to blame. Over-the-top (OTT) video services like Netflix are becoming the new status quo, while Facebook and Alphabet subsidiary Google are vacuuming up digital advertising dollars as advertisers shift their budgets away from TV. The merger is as much about owning the underlying content as it is about cutting costs through synergies (estimated at $1 billion in annual synergies once everything settles down).
Generally speaking, antitrust regulators are more concerned with horizontal mergers than vertical mergers. In a horizontal merger, a company seeks to acquire a direct competitor — like the T-Mobile and Sprint merger that’s currently on the table. In a vertical merger, a company is looking to integrate other aspects of the value chain. It’s much harder to prove that a vertical merger will harm consumers. In fact, vertical mergers have potential to help consumers, if the combined company chooses to pass along some cost savings to consumers in the form of lower prices.
The burden of proof lay on the government, and it failed to convince Leon. The judge pointed to the DOJ’s own Non-Horizontal Merger Guidelines that say non-horizontal mergers “are less likely than horizontal mergers to create competitive problems.” That’s not to say that competition can’t be harmed, just that it’s less likely, which is why regulators tend to look at vertical mergers on a case-by-case basis.
The government argued that the combined company would hurt third-party distributors
The DOJ said that AT&T and Time Warner could “harm competition by slowing the growth of emerging, innovative online distributors,” referring to many of the OTT services that have sprouted in recent years, notably including AT&T’s own DIRECTV Now. AT&T was able to show that it is not trying to marginalize these services but is instead embracing them as consumer preferences shift.
Leon sided with AT&T on this argument.
The government argued that HBO would destroy its own business
HBO is one of Time Warner’s most valuable properties, with its stable of culture-defining shows like Game of Thrones, True Detective, and The Sopranos, among many others. The government argued that the combined company could strategically withhold HBO from competing distributors, which is often used as a promotional tool, in an effort to differentiate its service and potentially increase prices. But as a subscription-based service, HBO wants as many subscribers as possible, and many of those subscribers come from third-party distributors.
“[O]ur whole business is relying on our affiliates to promote us,” HBO Chief Revenue Officer Simon Sutton testified. “If we can’t do that, then our entire business model is destroyed.”
There’s more where that came from
The decision is a blow to the Trump administration, which some argued was trying to block the deal for political purposes related to Trump’s grudge against Time Warner’s CNN.
The $85 billion merger will now move forward, the latest in a long trend of telecom giants vertically integrating in an effort to own the underlying content that flows through their respective pipes. The court ruling has significant implications for other potential mergers that are waiting in the wings.
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