AT&T-Time Warner ruling a milestone for vertical mergers

AT&T-Time Warner ruling a milestone for vertical mergers
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The antitrust court ruling allowing the AT&T-Time Warner merger to proceed is a watershed event for vertical mergers, in which a buyer and a supplier combine. But what remains to be seen is what the future holds for the Justice Department’s enforcement of other vertical mergers and alliances in the deal pipeline.

For investment professionals and merger and acquisition (M&A) specialists, predicting how the Department of Justice (DOJ) or Federal Trade Commission (FTC) might react to a horizontal transaction among companies that largely occupy the same space (e.g., United Airlines and Continental Airlines) is relatively straightforward.

This is partly because these agencies have published guidelines on such transactions, and there is an extensive string of precedent in the horizontal merger field.

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The need for predictive analytics behind such transactions cannot be underestimated. A proposed transaction can generate much uncertainty in the capital markets and among the employee bases of both firms; not being able to predict how an agency might respond to a proposed transaction can be an unacceptable risk for any transaction.

 

But vertical mergers are another type of deal entirely, which is what makes the AT&T-Time Warner ruling so significant.

Given the amount of industry consolidation — whether in media, grocery chains, airlines and other sectors — in the United States and abroad, it is not surprising that firms are thinking outside the “horizontal box” in M&A and evaluating acquisition and merger candidates in their vertical space.

This was precisely the strategic thinking that led to AT&T’s plan to acquire Time Warner, first announced in October 2016.

The federal competition regulatory scheme, requiring merging parties of a certain size to seek pre-merger clearance for transactions exceeding a specified amount, was a novel approach when first implemented in 1976.

Since then, its wisdom has been recognized by most countries, and it is now commonplace to make such filings throughout the world. In the vast majority of these transactions, there is no competitive overlap between the merging parties; the enforcement agencies collect the non-refundable filing fee and move on to the next transaction.

In the United States, the primary concern for regulators is assessing the probability of a “substantial lessening of competition in a relevant market” arising from the proposed transaction, according to the government’s enabling statute, Section 7 of the Clayton Act.

Most federal government challenges, from either the DOJ’s Antitrust Division or the FTC, to proposed transactions arise from horizontal combinations of competitors. In fact, in the last 40 years, the government has not litigated a vertical merger or alliance — that is, until it brought suit against AT&T in its proposed acquisition of Time Warner.

The ensuing conundrum faced by private parties, including AT&T and Time Warner, to a vertical alliance challenge has been complicated not only by the lack of any track record of government challenges but also a dearth of published guidelines on the factors used by the FTC or DOJ to “evaluate” these cases.

The only guidelines are veiled references to vertical mergers published by the agencies more than 20 years ago, and most would agree that those “guidelines” are not pertinent to the current economic climate and market structure in the United States today.

A firm’s ability to innovate and stay ahead of the curve may be a paramount driver in a planned vertical alliance. This was surely the case in AT&T-Time Warner, with both parties claiming they were in the midst of a veritable explosion of new innovative video content and advertising offerings.

But without clear guidance from DOJ or FTC on the role, degree and effect of innovation, as well as other relevant topics, the decision-making process to commence a vertical transaction becomes essentially a crapshoot.

Unfortunately for AT&T and Time Warner, the dice rolled by DOJ’s Antitrust Division came up craps as the government launched a litigation attack on the transaction, seeking a preliminary injunction in the federal district for the District of Columbia to block the deal.

The government based its objections on three theories, which Judge Richard J. Leon, in his 172-page decision, gave little to no credence to — e.g., that the merged entity would allegedly leverage its supposed power to enforce higher prices on non-AT&T cable providers or black them out entirely from Time Warner content.

He further found that DOJ’s economic theory, while flawed, also was not supported by sufficient real-world evidence.

Judge Leon concluded that given the heavy burden on the parties during this two-year investigation, the DOJ should not seek to stay the ruling and allow the parties to finally consummate the transaction. Whether the DOJ abides by the court’s admonition remains to be seen.

However, it is critical in the near term that the DOJ and FTC provide some immediate clarity to other parties seeking to entertain vertical alliances on how such M&A strategies will be viewed and evaluated.

Mark McCareins is a clinical professor of business law in the strategy department where he teaches courses on antitrust and business law at the Kellogg School of Management at Northwestern University.