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How the DOJ's Face-Off With AT&T Could Alter American Business

15/03/2018 6:36pm

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By Brent Kendall and Drew FitzGerald 

WASHINGTON -- The government accuses the company's chief executive of behaving like the disingenuous Captain Renault in the film "Casablanca." The company likens the government's case to a shaved Persian cat, "pale and thin."

A federal judge in Washington, D.C., next week will hear a case that may settle one of the biggest antitrust issues of modern times.

The face-off, between the Justice Department and AT&T Inc. over the company's $85 billion agreement to buy media giant Time Warner Inc., has broad ramifications for media, technology and other industries as well as for the government's powers to deter large-scale corporate consolidation.

It could determine whether antitrust enforcers will have real practical authority to challenge so-called vertical mergers involving two complementary companies that operate at different levels of the same industry. Typically, the government challenges unions of direct competitors that sell similar products and services, or horizontal mergers.

The ruling could affect major pending health-care mergers and may have ramifications for the tech economy. If the deal is allowed, AT&T argues, it could act as a bulwark against the power of digital media giants such as Alphabet Inc.'s Google and Facebook Inc. Or it could create an entertainment behemoth that holds consumers hostage, as the government insists.

The outcome could also affect how strongly the Trump administration, with its rival populist and pro-business factions, pursues the kind of vigorous antitrust enforcement that was a hallmark of the Obama administration.

The battle is unusual because AT&T and Time Warner aren't head-to-head competitors. They want to combine AT&T's video-distribution network with Time Warner's content -- from HBO's "Game of Thrones" to the NCAA basketball tournament -- in a move to integrate different links in the same supply chain.

"This will be the first court decision on a vertical merger in a very long time," said Wayne State University law professor Stephen Calkins, "and what the court says will be terribly important."

The case is a pivotal moment in a recurring clash between merger mania and government enforcement, and the drama has produced two lead actors: AT&T boss Randall Stephenson and U.S. antitrust chief Makan Delrahim.

Mr. Stephenson has come to personify the hard-charging executive whose approach to guiding a corporate titan through a rapidly changing landscape is to get bigger.

Mr. Delrahim emerged last year as a surprising foil, a Republican antitrust enforcer who moved swiftly to file suit against the deal -- the type of merger challenge some liberal officials longed to bring but never did.

The case comes as viewers are demanding more ways to watch video programming at lower prices. Millions have abandoned cable and satellite-TV contracts for other options. Some have turned to cheaper packages online. Others have dropped traditional programming entirely, finding their entertainment on Netflix Inc., Amazon.com Inc., Hulu and Alphabet Inc.'s YouTube. Younger customers increasingly watch video on phones, tablets and laptops.

The upheaval has left the pay-TV industry scrambling. Mr. Stephenson made a $49 billion play for video distribution by acquiring DirecTV, the top U.S. pay-TV satellite service, in 2015. He's now trying to make the company's wireless and video bundles more attractive to viewers and investors by adding Time Warner news, sports and entertainment assets to the package.

Given Mr. Delrahim's objections, the deal has been pending for 17 months, creating something of an industry chessboard frozen in time, with competitors uncertain of their next play. Antitrust fears in part prompted 21st Century Fox to spurn Comcast Corp.'s higher offer for most of its entertainment assets, The Wall Street Journal reported, citing people familiar with the discussions, choosing a $52.4 billion deal with Walt Disney Co. instead. (Journal parent company News Corp and 21st Century Fox share common ownership.) The prospect of a better-funded Time Warner is prompting other media executives to look for faster ways to grow.

If AT&T wins, it could embolden rivals such as Comcast and Verizon Communications Inc. and clear the way for a market dominated by internet-media hybrids. A loss could leave the media industry wide open as programmers and distributors search for ways to adapt to changing consumer tastes.

Question of competition

The case raises this central question: If AT&T buys Time Warner, would it lead to substantially less competition? Both sides lay out their arguments in court papers filed in the case.

Mr. Delrahim's team says yes. The deal would mean higher prices and sluggish innovation, the department says in the filings, and "American consumers will end up paying hundreds of millions of dollars more than they do now to watch their favorite programs on TV."

The department acknowledges AT&T and Time Warner aren't direct rivals, but argues the deal could broadly harm the public because the merged firm would have too much power in the pay-TV ecosystem. It says Time Warner's content, especially the Turner networks -- including TBS, TNT, CNN, Cartoon Network and truTV -- are competitively significant, with consumers expecting pay-TV packages will include those channels.

If AT&T owns Time Warner, it could threaten to withhold the Turner channels from rivals of DirecTV unless they pay higher fees, a move that would ultimately lead to higher consumer cable bills, the department alleges. It says AT&T could limit the ability of rivals to offer promotions on Time Warner's HBO, the most popular premium television channel, as a way to add subscribers or retain current customers.

On the innovation front, the department says an independent Time Warner has been eager to offer its channels as part of online packages that break from the traditional cable model but wouldn't be so willing under AT&T. "With the merger, Time Warner would turn from friend to foe," it says in filings.

AT&T rival Comcast is likely to come up frequently in the case. An AT&T victory, the Justice Department says, would give it and Comcast a stranglehold on the industry. But the department in 2011 allowed Comcast to take control of NBCUniversal, creating an integrated giant similar to what AT&T now wants to become.

The Justice Department under Barack Obama allowed the Comcast deal after imposing restrictions on Comcast's business tactics after the merger. The department leadership under Mr. Delrahim has made clear it opposes the approval of mergers based on those types of "behavioral" conditions.

AT&T and Time Warner say in court filings there is no valid legal argument for preventing the combination of complementary companies. They deny anyone's customers would pay more for TV and refute the idea that anything they do will stop customers from cutting the cable cord. "AT&T and Time Warner aren't seeking to hold back the tide, as the government asserts, but to ride an irresistible wave," the companies say.

AT&T says it would lose money withholding Time Warner programming from rival pay-TV distributors. As an assurance, the company offered rival video distributors the opportunity, for seven years, to let an arbitrator pick appropriate fees for the Turner channels if negotiations fail. The Justice Department says the arbitration offer doesn't remedy the merger's harms to competition.

Where Mr. Delrahim and the government see a behemoth in the making, Mr. Stephenson and the companies envision the emergence of a streamlined rival ready to take on already-powerful competitors. The deal, they say in court filings, would give Time Warner access to AT&T's infrastructure for selling directly to consumers and, equally important, would provide Time Warner personalized data about AT&T customers' interests and preferences.

By joining forces, the companies have said publicly and in court documents, they can create a unique platform that allows advertisers to buy commercials targeted to specific viewers, creating an alternative to Google and Facebook, which have built businesses using consumer data to sell targeted ads.

Bad blood

High-stakes litigation always tends to produce bad blood, but the level of hostility in the AT&T case has been pronounced. Messrs. Stephenson and Delrahim have taken public shots at one another, even if rarely referring to each other by name.

Mr. Stephenson on multiple occasions has publicly questioned Mr. Delrahim's motives and cited a television interview from 2016 in which Mr. Delrahim, then a private-practice lawyer, suggested the deal wouldn't face insurmountable antitrust hurdles.

The two also have appeared to express fundamentally different recollections of their own face-to-face conversations. Mr. Stephenson has said publicly he never offered to sell CNN, a constant target of criticism by President Donald Trump, as a carrot to win Justice Department approval.

Mr. Delrahim, in a sworn legal affidavit obtained by the Journal under the Freedom of Information Act, said Mr. Stephenson indeed asked him whether the department would approve the deal if AT&T sold CNN.

Mr. Delrahim in a November appearance made what was interpreted as a clear reference to AT&T, saying the public should beware when an incumbent company promises "to help you against the evils of dynamic competition from Netflix, Amazon, Google, Facebook."

The Justice Department in a brief last week mocked Mr. Stephenson's professed surprise at getting sued, noting the CEO previously said AT&T had been making litigation preparations from the outset. The government compared him to Captain Renault, the corrupt Vichy police prefect in the film "Casablanca," quoting his famous line, "I'm shocked, shocked to find that gambling is going on in here!"

People close to AT&T's management say the department's lawsuit surprised Mr. Stephenson, a lifelong Republican often vexed by Mr. Trump's unpredictable statements.

AT&T, in its own brief, said the department's legal arguments fell apart in trial preparations, writing: "Now, what remains of the government's case, 'like a Persian cat with its fur shaved, is alarmingly pale and thin,' " borrowing a turn of phrase from a 1992 case.

That choice of words raised eyebrows among some people close to Mr. Delrahim, who is of Persian descent.

U.S. District Judge Richard Leon will hear opening arguments March 19. This isn't a jury trial. The judge alone, who oversaw the Comcast-NBCU settlement, will decide the merger's fate.

The Justice Department presents its case first, with a roster of witnesses likely to include officials from rival companies.

AT&T and Time Warner will spend a good portion of their defense on testimony from their own executives, including Mr. Stephenson and Time Warner CEO Jeff Bewkes, about what they see as the deal's benefits.

Each side has hired economic experts who have conducted studies that offer dueling claims about how the merger will affect prices, consumers and cost savings. The government is relying upon University of California, Berkeley, business and economics professor Carl Shapiro, who served as a top Justice Department antitrust official in the Obama administration. AT&T has turned to University of Chicago economics professor Dennis Carlton, who has provided expert testimony in antitrust cases for more than 30 years.

Judge Leon, a George W. Bush appointee, is expected to rule in the next few months. The companies extended their merger agreement from April 22 to June 21 to give him more time.

Mr. Trump's comments hang over the case. After AT&T announced the deal in October 2016, Candidate Trump unequivocally said his administration would never allow the deal to be approved. After the department filed its lawsuit, Mr. Trump said he shouldn't comment on the litigation, then added: "Personally, I've always felt that that was a deal that's not good for the country. I think your pricing is going to go up."

There is no shortage of observers who believe Mr. Trump's position was motivated not by antitrust principles but by his distaste for CNN, whose news coverage he has criticized fiercely. Mr. Stephenson has called the tensions between Mr. Trump and CNN the "elephant in the room" when it comes to deciphering why the Justice Department sued.

Mr. Delrahim has publicly said Mr. Trump and the White House didn't influence his decision to sue AT&T. The telecom giant laid the groundwork to make Mr. Trump's comments an issue in the trial, but Judge Leon denied AT&T's request to access certain internal government communications about the deal. The company hadn't shown it had been especially singled out for disfavored treatment, the judge concluded.

Judge Leon's ruling could be a career-defining moment for Messrs. Delrahim and Stephenson. Both, in a sense, have pushed all of their poker chips to the middle of the table.

The AT&T head has made clear the Time Warner acquisition is integral to his vision for the company -- and equally clear he believes the government is treating AT&T unfairly. The bespectacled Oklahoman has spent his 35-year career at AT&T and its predecessor companies. His tenure as CEO includes a 2011 loss to the Justice Department that scuttled a $39 billion bid for wireless rival T-Mobile, a failure that cost AT&T more than $4 billion.

Mr. Delrahim previously served in the department's antitrust division in the George W. Bush administration. With the AT&T case, he brought one of the most consequential merger lawsuits in a generation within weeks of taking office last fall, under highly unusual circumstances because of Mr. Trump's comments about the deal.

The Justice Department has been riding a decade's momentum in court, with Obama antitrust enforcers succeeding in blocking several deals in which major rivals sought to merge.

Mr. Delrahim's opening act could either take that momentum to historical heights or deliver a painful blow to the department at a time when a new wave of deal making could be on the horizon.

Write to Brent Kendall at brent.kendall@wsj.com and Drew FitzGerald at andrew.fitzgerald@wsj.com

 

(END) Dow Jones Newswires

March 15, 2018 14:21 ET (18:21 GMT)

Copyright (c) 2018 Dow Jones & Company, Inc.

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