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The court’s decision to let AT&T and Time Warner merge is ridiculously bad

Let’s read 170 pages of dunking on Professor Carl Shapiro together

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Planet AT&T (internet wasteland)

AT&T and Time Warner won a historic court victory this week, convincing Judge Richard Leon in the US District Court for the District of Columbia that they should be able to merge over the antitrust objections of the Department of Justice. The deal, now finalized, combines one of the world’s largest telecom carriers with one of the world’s largest media organizations. The resulting company will have unparalleled market power over both content creation and distribution.

The decision surprised almost everyone — not necessarily that AT&T and Time Warner had won, but that Judge Leon allowed the merger to go through with no conditions or prohibitions on their behavior at all. In fact, Judge Leon’s opinion seems downright excited for the two companies, while systematically discounting the government’s case at every turn. Honestly, it’s a little strange.

And while the deal might be done now, I think it’s worthwhile for anyone who cares about how the government might restrain the power of giant media and tech companies to read and understand the government’s case and Judge Leon’s decision.

Judge Leon goes into detail about the business of the past but ignores the reality of the future

To spare you the pain of reading the 170-page opinion yourself, I went through and pulled out some highlights. You will note again and again that Judge Leon goes into incredible detail about the businesses of the past, like how the deal might affect cable TV negotiations, while naively glossing over the details of how media works in the present and future. (Buying Time Warner will allow AT&T to… put together clips of CNN to show on phones? Very innovative.) You will also note that the government put on what seems like a very, very weak case. Here’s my condensed summary:

  • First, Judge Leon says Netflix and Hulu and Google and Facebook are major competitors to AT&T and Time Warner, but both the government and the judge fail to note that all of them depend heavily on open access to AT&T’s network to reach consumers.
  • Then the government’s own expert witness bafflingly cuts down his side’s arguments repeatedly, claiming the merger will save AT&T customers hundreds of millions of dollars.
  • The government does not argue that AT&T preloading its own services and content onto phones and prioritizing their traffic outside of data caps will create an unfair advantage over Netflix. In fact, Netflix is never substantively mentioned again after the introductory section.
  • The judge does not understand that HBO Now and Netflix are both accessed by consumers in the exact same ways.
  • Judge Leon quotes Randall Stephenson calling this a “vision deal.” Twice.
  • AT&T points out — correctly! — that it wants to see more people use more data generally, so it’s fine with other video services.
  • But the government never makes the argument that AT&T will use its network to prioritize Time Warner content and services over competitors.
  • The judge doesn’t figure this out.
  • So the government loses.

Anyway, you can download the PDF of the decision here. Let’s take a look. (I’m going to block quote a lot, so just know that all the emphasis here is mine unless otherwise noted.)

So the first thing to know is that this is a trial court decision, and it was a bench trial. (There was no jury.) Judge Leon served as the primary fact-finder throughout the six-week trial and then issued this opinion. That’s unique in that the opinion explicitly lays out how he weighed the facts and the reasoning behind his decision; that’s not something you usually get from a jury.

And from the jump, it’s pretty clear Judge Leon thinks AT&T’s ideas about the future of content are pretty good, while the DOJ’s complaints about antitrust are pretty boring. Here’s Leon, glowingly writing about AT&T’s argument for the merger:

At the same time, Facebook’s and Google’s dominant digital advertising platforms have surpassed television advertising in revenue. Watching vertically integrated, data-informed entities thrive as television subscriptions and advertising revenues declined, AT&T and Time Warner concluded that each had a problem that the other could solve: Time Warner could provide AT&T with the ability to experiment with and develop innovative video content and advertising offerings for AT&T’s many video and wireless customers, and AT&T could afford Time Warner access to customer relationships and valuable data about its programming. Together, AT&T and Time Warner concluded that both companies could stop “chasing taillights” and catch up with the competition. Those are the circumstances that cause them to claim today that their merger will increase not only innovation, but competition in this marketplace for years to come.

An excellent summary of AT&T’s pitch to its investors! But did you spot the glaring foundational error? Judge Leon thinks Facebook and Google are vertically integrated, data-informed competitors to AT&T and Time Warner. And that is sort of true, in that Google owns YouTube and pays for some premium content there, and Facebook is doing whatever doomed video thing Facebook is always doing.

Neither Facebook nor Google owns the actual connection to the consumer

But neither Facebook nor Google owns the ultimate distribution layer of the consumer connection to the internet. They aren’t the world’s largest telecom company. Neither is Netflix or Amazon or any of the other companies AT&T and Time Warner are afraid of. (Yes, I know Google owns Google Fiber, but that has been more failure than success.)

Tech companies might have vertically integrated the creation and production of content with consumer-facing apps and services, but they all depend on internet connections to reach their audiences. And those connections are increasingly wireless. AT&T and Time Warner aren’t trying to catch up to Netflix by merging; they’re trying to step ahead of them in line by marrying Time Warner’s content to AT&T’s network.

From the start, Judge Leon conflates internet platforms with internet providers

So, right away, Judge Leon has conflated internet platforms like Google and Netflix with internet providers like AT&T. Let’s see how he characterizes the government’s case.

According to the Government, consumers nationwide will be harmed by increased prices for access to Turner networks, notwithstanding the Government’s concession that this vertical merger would result in hundreds of millions of dollars in annual cost savings to AT&T’s customers and notwithstanding the fact that (unlike in “horizontal” mergers) no competitor will be eliminated by the merger’s proposed vertical integration.

The Department of Justice relied heavily on one expert in making its case: Professor Carl Shapiro, an economics professor at the University of California, Berkeley. It’s pretty clear Judge Leon doesn’t think much of Professor Shapiro; two separate sections of the opinion are specifically dedicated to tearing apart his arguments. But it’s also incredible that Shapiro gave AT&T the absolute gift of saying traditional merger analysis predicts this deal will result in cost savings to AT&T customers. Most smart industry observers are predicting the rise of new kinds of internet and content bundles after megadeals like this go down. It would be very surprising if those bundles were cheaper than AT&T’s current service offerings.

Moving on to the decision itself, Leon lays out some basics of how the video industry works. See if you can spot his foundational error again.

Some subscription-based video programming services are “vertically integrated,” meaning, in this context, that those services create or aggregate their content offerings and then distribute those offerings directly to consumers. Examples of those services include Netflix, Hulu, and Amazon Prime. Traditional video programmers, such as Turner, generally lack such “soup to nuts” integration of content creation and distribution; they are instead reliant upon video distributors to deliver their content offerings to consumers.

What Leon is trying to say here is that Netflix spends a lot of money producing original content and then delivers it to consumers in its own app, while Time Warner’s Turner TV division owns networks like CNN that are generally reliant on making a deal with a cable company for channel placement.

But there’s that error again: Netflix might make an app, but no one can use that app if they don’t have an internet connection. Netflix is just as reliant on the internet as Turner is on cable. We just don’t expect our ISPs to act like cable companies and prioritize some channels over others. And, of course, Time Warner networks like HBO also spend enormous sums of money on original programming and distribute it directly to consumers in apps, just like Netflix. In a country where net neutrality has just been repealed, owning the internet connection is a huge advantage, just like owning the cable network would be.

Netflix might make an app, but no one can use that app if they don’t have an internet connection

All of this is, of course, extremely obvious to anyone who has used a phone to watch anything in the past decade. It’s not clear how Judge Leon thinks any of this actually works, or if he realizes AT&T is the country’s largest wireless internet provider. But he’s not stopping, so neither are we.

Leon spends several pages describing the difference between traditional cable, “virtual” cable services like DirecTV Now, and subscription services on demand (SVOD) like Netflix. But at the end, read his discussion about why services like Netflix have thrived, and see if you can spot the same error yet again.

Those web-based companies are harnessing the power of the internet and data to provide lower-cost, better-tailored programming content directly to consumers. The dramatic growth of the leading SVODs in particular, including Netflix, Hulu, and Amazon Prime, can be traced in part to the value conferred by vertical integration —that is, to having content creation and aggregation as well as content distribution under the same roof.

Again, he’s saying Netflix and Amazon have apps. It doesn’t seem like making a better CNN app requires one of the largest mergers in history, but there’s more.

SVODs can use data about viewing habits to determine what programs are popular, and create more of that type of content. In addition, data informs marketing decisions, and allows SVODs to recommend content to users based on their revealed preferences, i.e., the shows they have watched in the past. Even more, data can inform scheduling choices, and enhance efforts at recapturing consumers who disconnect. Finally, and as discussed in more detail below, to the extent SVODs incorporate advertising into their platforms, data allows those ads to be more targeted and thus more lucrative.

Needing this merger to determine which shows are popular is very funny, of course; the entire TV industry runs on ratings. But all of this talk about data gets to the heart of why AT&T’s CEO has explicitly said he wants to buy Time Warner: harvesting data to sell more expensive ads to compete with Google and Facebook.

It doesn’t seem like making a better CNN app should require one of the largest mergers in history

Don’t worry, though, because Leon recaps a lot of testimony from Time Warner execs about how envious they are of Google and Facebook’s ability to target ads.

Although traditional programmers like Turner maintain “massive inventories of advertising,” they lack the type of fine-grained data necessary to generate targeted ads. Under the “spray and pray” approach, programmers instead sell ads based on “broad demographic data” about the viewers of a particular program. As a result. consumers regularly see ads for things that do not interest them, and advertisers pay to show ads that they know will be ineffective in motivating many in the audience… Jeff Bewkes, CEO of Time Warner, explained the explosion of digital advertising is “actually bad for” video distribution consumers, “because it means that ‘the financial support for all this programming on all these different channels gets pushed over toward subscription prices. And that’s a problem, because we think consumers are up to here with subscription prices.”

Good to know the outgoing CEO of Time Warner is selling the company for the good of consumers. Let’s skip ahead again several pages to Leon’s discussion of how Turner and HBO are doomed unless AT&T buys them.

The growth in digital advertising has also posed a particular challenge for Turner. Today, “advanced advertising” makes up less than 5% of Turner’s ad revenue —and it shows. This is because, as a “stuck in the middle wholesaler,” Turner for the most part lacks customer relationships, which supply critical data concerning consumer preferences —data that can be used to tailor advertisements to the end user. Without such data, Turner cannot tailor ads to particular consumers, making its ads less valuable than those carried on Google or Facebook.

And how has Turner tried to solve this problem? “In an effort to break out of its ‘trapped wholesaler’ role, Turner has made recent efforts to launch its own direct-to-consumer content offerings. The most notable of those offerings are FilmStruck, Boomerang, and Bleacher Report Live.”

If you are a Turner exec staring down the threat of Netflix and Facebook, and the best you can muster in return is an app no one uses (Boomerang), maybe the problem isn’t how much data you’re collecting.

Let’s all just laugh at Judge Leon drawing a laser-fine line between services like Netflix and HBO Now:

HBO content reaches consumers in four ways: (i) through MVPDs; (ii) through virtual MVPDs; (iii) through SVODs; and (iv) through HBO’s proprietary over-the-top product, HBO Now. In each case, the end-customer accesses HBO by way of a distributor — even for HBO Now, which is sold by digital distributors like Apple and Amazon.

I have read this line a dozen times, and I could not tell you what it means, apart from the fact that you can purchase HBO Now as a channel inside of Amazon Prime Video. But otherwise the experience of buying and using HBO Now and Netflix on every major platform is exactly the same: you download the app from an app store, and you either subscribe through the built-in payment system or the web. You can also watch HBO Now on the web, just like Netflix.

HBO has the most opportunity to compete with Netflix

Of all of Time Warner’s major assets, HBO is the most like Netflix, and it has the most opportunity to compete with Netflix for user attention, content recommendations, and data collection. Letting AT&T stuff it full of mobile user data won’t help it compete better, but excluding it from data caps and prioritizing it on AT&T networks will. If Judge Leon believes HBO Now customers are intermediated by a distributor like Apple, then he should believe the exact same thing about Netflix. And it appears the government did not make that argument or point out that allowing AT&T to prioritize HBO will have a significant competitive impact on Netflix.

And AT&T and Time Warner were pretty explicit about that plan!

By acquiring Time Warner, AT&T executives testified, the company will immediately gain access to high-quality content and an extensive advertising inventory. Using its wireless network, AT&T intends to distribute Time Warner content through mobile devices. With such strong industry tailwinds in favor of mobile video consumption, this strategy will increase viewership, making Time Warner content “worth far more.” At the same time, AT&T will bring to bear its consumer relationships and data to begin to tailor Time Warner’s advertising and increase its value.

How did our nation’s antitrust lawyers at the Department of Justice argue against this plan?

As the Government concedes, that access will inure right away to the benefit of AT&T’s current video distribution subscribers. In particular, the Government’s own expert predicts that, due to a standard benefit of vertical integration, AT&T’s DirecTV and U-verse customers will pay a total of about $350 million less per year for their video distribution services.

Look, I don’t know Carl Shapiro, but I am very curious if he has ever once in his life experienced a cable bill going down.

Anyway, did AT&T offer any innovative new ideas at trial about what they’d do to compete better with Netflix after they buy Time Warner?

Of most relevance here, with the Time Warner assets, and without the interference of bargaining friction, AT&T will be able to deliver content to its customers in more innovative ways. The merged entity could, for instance, gather and edit individual news clips from CNN throughout the day —all tailored to a given user’s interests —and deliver that news to the wireless customer for viewing on his or her fifteen-minute break.

A lot of analysts have laughed at this line on Twitter in the past few days — CNN could do that right now, if it wanted to — but let me dull the fun with clear reality: what AT&T is describing here is bloatware on Android phones that is excused from data caps. If Judge Leon is worried about the hardship HBO Now faces from simply having to go through the App Store, imagine the horror he must feel about MSNBC and Fox News not getting preloaded placement on millions of devices to stream video for free.

AT&T’s entire plan is bloatware on Android phones that is excused from data caps

Let’s see if AT&T can make this worse.

At the same time, new, tailored forms of mobile content delivery — like the CNN clips teased above — will create additional advertising opportunities.

Great. Can you add a gloss of nonsense to this for the judge to uncritically reprint?

To sum it up, in the words of AT&T Chairman and CEO Randall Stephenson, defendants view the proposed merger as a “vision deal.”

Here is another vision:

ATT bloatware on ZTE Axon M
I hope you like preinstalled carrier software on your phone

We can pick up again with the judge noting that this is a “vertical” merger as opposed to a “horizontal” deal. In a horizontal deal, one competitor buys another and increases overall market power. Those types of deals are closely examined and regularly blocked. Think about AT&T trying to buy T-Mobile, for example. The number of wireless carriers in the market would have gone down.

But in a vertical deal, one company in the supply chain buys a company above or below it, keeping the number of competitors at both levels the same. Here, AT&T is a distributor, and Time Warner is a content producer. Combining them keeps both the number of distributors and content producers the same. That means it’s much harder for the government to block it, since it’s harder to prove anticompetitive effects. And as the judge notes, the DOJ hasn’t tried to block a vertical merger in four decades.

And Professor Shapiro, the DOJ’s expert witness, didn’t do the government any favors because the judge once again notes that he testified basically against the government’s own case:

Further complicating the Government’s challenge is the recognition among academics, courts, and antitrust enforcement authorities alike that “many vertical mergers create vertical integration efficiencies between purchasers and sellers.” The proposed merger reflects that principle: the Government’s chief economic expert, Professor Shapiro, predicts that the merger, if consummated, would lead to $352 million in annual cost savings on the part of AT&T’s customers.

Nailed it, Carl.

Anyway, here, now, on page 60, the judge lays out the DOJ’s arguments against the merger (his emphasis):

First and foremost, the Government argues that the challenged merger would enable Turner to charge AT&T’s rival distributors — and ultimately consumers — higher prices for its content on account of its post-merger relationship with AT&T.

Second, the Government contends that the challenged merger will substantially lessen competition by creating an increased risk that the merged firm will act, either unilaterally or in coordination with Comcast-NBCU, to thwart the rise of the lower-cost, consumer-friendly virtual MVPDs that are threatening the traditional pay-TV model.

Finally, the Government alleges that the merged entity could harm competition by preventing AT&T’s rival distributors from using HBO as a promotional tool to attract and retain customers.

I’m going to skip the first argument, because it is 90 pages of boring discussion about the nature of pay-cable negotiations, and that is a dying business no one cares about. Let’s jump to the second, after first gazing at this extremely gleeful use of an exclamation point in a historic antitrust opinion:

I will then evaluate whether the Government has carried its burden to show a likelihood that the challenged merger will result in a substantial lessening of competition. For the reasons discussed in detail below, I have concluded that the answer to that question is no !

Alright. Let’s pick up again on page 150 with the second argument, that AT&T will block virtual MVPDs like Sling and YouTube TV from showing Time Warner channels like CNN.

According to the Government, the challenged merger would give AT&T the “ability to harm competition by slowing the growth of emerging, innovative online distributors” — that is, virtual MVPDs. AT&T could do so, the Government asserts, either acting on its own (under the “unilateral theory”) or in coordination with Comcast- NBCU (under the “coordination theory”). Defendants counter that the evidence does not support the Government’s virtual MVPD theories. Far from showing that AT&T is trying to marginalize virtual MVPDS, defendants claim that the trial demonstrated that AT&T is embracing those providers —even launching and supporting a successful virtual MVPD, DirecTV Now.

So the DOJ claimed that AT&T would collude with Comcast to block out rivals to services like DirecTV Now, and AT&T’s argument in defense was that it… launched DirecTV Now. Got it.

The Government first claims that AT&T has an incentive to harm innovative virtual MVPDs and could act unilaterally on that incentive by foreclosing or restricting virtual MVPDs’ access to “must-have” Turner content.

Here is where it’s pretty clear the DOJ made a bad case. AT&T and Time Warner don’t harm Sling or YouTube TV by withholding CNN and other channels. It can license the channels, collect the fees, and still prioritize DirecTV on the AT&T network and excuse it from data caps. But this argument does not appear to have been made. Instead, AT&T was left free to counter by arguing that having lots of video services on its networks is good because it drives data usage:

Increased video consumption is lucrative for AT&T because viewers consume more data on the wireless network. This leads customers to “buy up” on data plans, get more devices, or connect more devices to the network — all “good for AT&T’s business.”... Notably, the benefits associated with AT&T customers accessing virtual MVPD content continue to accrue even when they use DirecTV Now’s competitors like Sling and YouTube TV.

It appears the DOJ never pointed out the simplest thing AT&T can do: preinstall its own services and exclude them from data caps, and the judge took AT&T’s arguments at face value. So that argument failed. How about the government’s entertaining conspiracy theory that AT&T will coordinate with Comcast to kill rival streaming services?

Unfortunately for the Government, however, neither that expert testimony nor its other evidence is even close to sufficient to support its coordination claim.

Oh. Well, let’s look at it anyway. Welcome our friend Carl Shapiro:

When questioned at trial about the Government’s coordinated effects theory, Professor Shapiro conceded that he had no “way of accessing [sic] the probability” of coordination and thus had not attempted to “quantify any risk whatsoever” that the predicted coordination “could occur.” Accordingly, Professor Shapiro confirmed that he was “not in a position to say”’ that coordination is “more likely to happen than not,” and indeed was not even prepared to say that there’s a “one percent chance that coordination will happen” as a result of the challenged merger.

Love this dude. Anyway, remember those 90 pages of cable blackout weeds we skipped? It turns out, the government argued that AT&T and Comcast would collude to… black out their networks from rival streaming services. Which no one has any incentive to do because they would just want to collect all those licensing fees anyway. The judge remains puzzled by this argument:

The Government has not explained why either company would be willing to forgo those affiliate fees and advertising revenues from virtual MVPDs. Nor has the Government proffered any expert analysis, for example. of how those economics could, or would, change assuming a coordinated blackout of both Turner and NBCU.

And both Comcast and AT&T execs argued at trial that they, um, dislike each other.

AT&T’s John Stankey, who will be responsible for running Time Warner should the challenged merger proceed, emphatically (and credibly) stated at trial that he could not “even imagine” aligning with Comcast given the companies’ history of dealings, adding, “I’m not going to cooperate with somebody I don’t like.” AT&T CEO Randall Stephenson testified similarly, responding to a question about the Government’s coordination theory as follows: “You probably have to live in this industry every day like I do to appreciate what a stretch that is. We compete with Comcast in the marketplace. The individual that runs communication company, he wakes up every day trying to think, how do I win in the marketplace against Comcast?”

Hit me with another exclamation point, Leon:

Nowhere does the Government explain why AT&T would deploy valuable Time Warner content to prop up a rival’s businessmodel, while harming its own. Go figure !

There is one reasonable theory of coordination, but it doesn’t come up in the opinion: AT&T and Verizon are both giants in mobile broadband. And while they don’t like each other and don’t coordinate, their pricing plans and fee increases mirror each other. It’s a duopoly, and it’s only been since T-Mobile emerged as a brash challenger brand that either has significantly reacted to competition. You could model that against AT&T and Comcast in any number of ways, but the judge ignored most of the DOJ’s arguments to that effect.

Both Comcast and AT&T execs argued at trial that they dislike each other

Okay, last argument: that AT&T will restrict access to HBO in order to hurt rival cable networks and streaming services. Hey, how thin does Judge Leon think this argument is?

The basic idea, the Government tells us, is that rival distributors’ use of HBO in promotions will tend to draw potential customers to those MVPDs and away from AT&T, thereby giving AT&T reason to withhold or restrict its consent to use HBO in marketing, discounts, and bundles. At the risk of stating the obvious. this is a gossamer thin claim.

Alright, then. Do you want to dunk on HBO a little just for good measure?

Second, the Government fails to establish that HBO promotions are so valuable that withholding or restricting them will drive customers to AT&T. Put differently, the Government has failed to show that the marketplace substitutes for HBO are “inferior, inadequate, or more costly.”

Look, Westworld was getting too complicated anyway. Just watch any other channel. They’re all the same. And with that, the judge rules that the HBO argument fails as well.

All that’s left is the wrap-up (Judge Leon: “The Court has now spoken and the defendants have won.”), but we can leave that be.

the DOJ and the judge don’t really understand how video on the internet works or is going to work

Since the Department of Justice has decided against asking for a stay while it decides whether to appeal, this merger is going through for now. (Frankly, I’m shocked President Trump didn’t command the DOJ to appeal in a tweet, or even tweet about this at all.) But just looking at the arguments and reasoning here, it’s clear that neither the DOJ nor the judge really understands how video on the internet works, or is going to work, especially as the world shifts to mobile and net neutrality goes away.

And I would love to be there when Judge Leon tries to watch Netflix on his AT&T phone next year and sees a bloatware pop-up reminding him that HBO Now is free to stream instead.