Regulatory Roadblock for AT&T and Time Warner -- What Investors Need to Know

11/30/17

Courtesy of Motley Fool

The Department of Justice (DOJ) recently announced that it will sue AT&T (NYSE:T) and Time Warner (NYSE:TWX) to stop their planned $85 billion merger.

On this episode of Industry Focus: Consumer Goods, Vincent Shen is joined by Motley Fool contributor Daniel Kline to discuss the fallout from the DOJ decision. They examine why the government believes this deal is not in the best interest of competition (nor consumers) and why a previous buyout may have changed regulators' attitudes toward this merger.

A full transcript follows the video.

This video was recorded on Nov. 21, 2017.

Vincent Shen: The first story we're going to talk about here, it revisits some news that we covered over a year ago in Oct. 2016, when telecommunications giant AT&T announced that it would be acquiring Time Warner. The approximately $85 billion deal would put together Time Warner's content creation business with the massive reach and distribution of AT&T. If you think about their television networks -- TNT, TBS, CNN, among many others. There's also HBO and the Warner Brothers film studio. So those major businesses from Time Warner could be leveraged across AT&T's own offerings, AT&T, of course, serving millions of paid-TV subscribers, wireless customers, and internet subscribers across the U.S. and abroad.

The deal was expected to close by the end of this year, but there's always potential for regulatory authorities to step in. Well, after months of rumors and speculation about what the Justice Department might do, they have officially announced that they will be suing to block the deal. Dan, I can't say this was a surprise to me, given some comments from the current administration regarding this deal, and other issues that regulators have encountered with a prior similar acquisition, which we'll talk about in a bit. But why is the Justice Department stepping in here? What's got them worried about this?

Dan Kline: It's not a surprise, but it does reflect a new reality. It used to be Republican-controlled governments would generally allow this type of merger. And what we're seeing here is a vague "it's too big" policy. It used to be, to block a merger, there had to be competitive reasons. If one wireless carrier was buying another wireless carrier, and that meant there were less choices, that would be a clear reason to block it. In this case, the Department of Justice a few weeks back had said that they wanted AT&T to either sell TBS [Turner] Group, which is TBS and CNN and a whole bunch of other cable channels, or to get rid of DirecTV, in order to allow the merger to go through. It wasn't a direct, "Hey, if you buy this, you'll own too much of the market." It's more of a broad, "Wow, if these two companies combine, they're pretty powerful, and they have kind of a lot of pricing ability, and can force some things down other companies' throats." It's not a traditional Republican way of thinking. But it has been pretty consistent from this Department of Justice and administration.

Shen: Yeah. This is going to be the big case for the authorities in this administration, their first big deal. It's interesting to see how the enforcement model has changed. I should mention, this would be considered more of a vertical integration. You have the content creators combining with the distributors. If it was two studios, for example, combining, we could see more of the traditional competitive concerns. But legal experts have already begun to weigh in on the coming legal battle, and there seems to be a consensus that it might be tougher for the Justice Department to lobby against this vertical integration, because blocked mergers in the past have typically been among direct competitors. There's some precedent for this AT&T Time Warner deal, when five or six years ago, Comcast (NASDAQ:CMCSA) took over NBC Universal. There were some issues there.

Kline: Yeah. It's really a direct comparison. When Comcast and Universal got together, there were some concessions made. The problem is, and we've talked about this personally, is, let's say AT&T and Time Warner agree to some concessions. They're not going to raise prices, they're going to use an outside committee to determine how much another cable company pays for HBO, all of those things sound great on paper, but the reality is, it's sort of like if your 16 year-old agrees to do certain things -- I'm going to study more, I'm going to be better, I'm going to come in before curfew ... if you buy me a car. And then you buy the car. Once the car is there, there's very little you can do to enforce all of those concessions. And that's what we found, historically, whenever big cable or big wireless or any of these companies say, "Yeah, we'll give more low-cost options, we'll do all these things." When push comes to shove, maybe they don't happen, and there's very little that the Department of Justice can do after the fact.

Shen: Yeah, I think that's a big part of this. The enforcement model has definitely evolved from some of the lessons they've learned from that Comcast- NBC deal. Again, that very much mirrors this AT&T-Time Warner potential merger. The regulars previously required Comcast to agree to behavioral concessions before they agreed to the deal, but not surprisingly, Comcast failed to deliver on many of those until they were essentially brought back to court and compelled to do so. So now regulators are looking for more what's referred to as structural concessions, where you're either selling off a business, spinning something off, before the Justice Department wants to approve the deal. The Turner segment at Time Warner, as you mentioned, or the DirecTV satellite arm at AT&T, had been named specifically as potential candidates that could be spun off in order to help the approval process for this deal. But it seems like the leadership at the two companies have indicated they have absolutely zero intention of agreeing to those kinds of concessions.

Kline: AT&T, which is in the driver's seat in terms of the merger, has basically said, "We're not going to do that." And the reality is, they have a pretty strong case, when you read what some of the legal experts think. Even if you look at Comcast and NBC Universal, the market has changed. And the idea that DirecTV offers you some sort of singular distribution, that really doesn't ring as true when you look at the internet and all the different ways people have to get content. So in a market where there's more choices, I can see why consumers wouldn't want this deal to happen, but I really can't see the regulatory basis to not allow it.

Shen: Yeah. So the agreement between these two companies, between AT&T and Time Warner, it's valid through next April, and we should know by then whether or not the deal is successful, either with some changes, or halted entirely. There is a breakup fee of $500 million due to Time Warner, actually pretty small given the size of this deal, if the deal falls through. We'll have updates for Fools when we know more.

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