On February 26, 2019, a panel of the United States Court of Appeals for the District of Columbia Circuit unanimously affirmed the district court’s denial of a Department of Justice (DOJ) bid to permanently enjoin AT&T’s acquisition of Time Warner.
The court held that the district court had not committed error in concluding that 1) what it termed the “real world” evidence showed that it was unlikely that Time Warner would be able to raise prices to rival video distributors, 2) the analysis of the government’s expert economist was flawed, because of errors in the model’s inputs and its failure to account for Time Warner’s irrevocable offers to engage in “baseball-style” arbitration to resolve licensing disputes, and 3) the views of the complaining competing distributors deserved little weight because they were “speculative.”
Notably, the court declined to adopt general standards for the review of vertical mergers, and chose to limit its opinion to determining whether the district court’s decision was clearly erroneous, which is the general standard of appellate review. However, it is possible to draw important conclusions from the court’s opinions.
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First, the decision is consistent with the long-standing preference of courts to rely to a greater degree on evidence about the actual performance of the market at issue and to a lesser extent on economic modeling that is not tightly based on market facts.
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Second, the court’s opinion did not adopt legal standards that would impede the government from challenging vertical transactions in the future when there is specific evidence that the transaction is likely to result in higher prices. (In contrast, the court strongly indicated that general assertions that a vertical transaction would result in increased bargaining leverage were not sufficient.)
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Third, in its discussion of the arbitration offer, the court showed a willingness to credit behavioral remedies in analyzing whether a vertical transaction is likely to harm competition. Both the antitrust agencies and merging parties will need to take this willingness into account when they assess litigation risk in the future.
Background and Trial Court Decision
The DOJ’s suit was a rare challenge to a “vertical” merger combing two companies operating at different levels of a supply chain. AT&T is a video distribution company that operates two traditional multi-channel video programming distributors (“MVPDs”), DirecTV (a satellite programming provider), and U-verse (a cable programming provider).1 Time Warner is a video content creator and programmer that operates three units: Warner Bros., Turner Broadcasting, and HBO.2 Turner packages content into several channels or networks (such as TNT, TBS, and CNN) and licenses it to MVPDs.3
At trial, the DOJ argued that the acquisition would violate Section 7 of the Clayton Act and harm competition in three ways. First, the DOJ alleged that, after the acquisition, Turner would have greater bargaining leverage to extract higher fees from rival MVPDs because lost advertising and fees resulting from a “blackout” (where programming is pulled from an MVPD because no license agreement is reached) would be partially offset by revenue from subscribers switching to AT&T’s MVPDs.4 Second, the DOJ alleged that AT&T, either unilaterally or in conjunction with Comcast-NBCU, would interfere with the development of virtual MVPDs (such as Sling TV or YouTube TV) through unfavorable licensing practices.5 Finally, the DOJ alleged that AT&T would prevent rival MVPDs from using HBO as a promotional tool to attract and retain customers.6
On June 12, 2018, Judge Richard Leon of the U.S. District Court for the District of Columbia ruled in favor of the merging parties on all three theories. The district court applied the standard burden-shifting framework set out in United States v. Baker Hughes,7 whereby the government must first establish a prima facie case that a merger will substantially lessen competition in the relevant market. In horizontal mergers, this burden may be met through evidence of significant increases in concentration in the relevant market. This structural presumption is unavailable in vertical merger cases, where concentrations do not change immediately after the merger, and so the government must make a “fact-specific” showing that the merger would likely harm competition.8 Once this initial showing is made, the burden shifts to the merging parties to produce evidence that the procompetitive effects of the merger outweigh any anticompetitive effects. Upon rebuttal, the “burden of producing additional evidence of anticompetitive effects shifts to the government, and merges with the ultimate burden of persuasion, which remains with the government at all times.”9
Judge Leon ruled that for each of its three theories, the government had failed to clear the first hurdle of the Baker Hughes framework and could not “[meet] its burden of establishing, through ‘case-specific evidence,’ that the merger of AT&T and Time Warner, at this time and in this remarkably dynamic industry, is likely to substantially lessen competition in the manner it predicts.”10 A more detailed analysis of the trial court’s decision is available here.
D.C. Circuit Upholds Conclusion That DOJ Failed to Prove Increased Bargaining Leverage
The DOJ appealed only the district court’s findings as to the bargaining leverage claim. The district court’s analysis was heavily fact-driven. At trial, the DOJ presented evidence of prior statements and internal documents from AT&T claiming that vertical integration may provide an incentive to increase prices as well as third-party testimony that the merger would increase Turner’s bargaining leverage.11 The DOJ also relied on an expert opinion from Professor Carl Shapiro describing a quantitative model based on Nash bargaining theory. Professor Shapiro’s model predicted that Turner’s increased bargaining leverage would result in an annual fee increase of $587 million set against cost savings of $352 million for AT&T arising from eliminating double marginalization through the integration.12 AT&T and Time Warner, on the other hand, presented testimony from executives’ past experience in negotiating programming licensing agreements, econometric analysis from Professor Dennis Carlton showing that prior vertical integrations in the MVPD market had not produced price increases, and critiques of Professor Shapiro’s model by Professor Carlton and Professor Peter Rossi.13
The district court placed great weight on the historical, real-world evidence presented by the merging parties and discounted testimony from third parties regarding Turner’s post-merger bargaining strength as “speculative.”14 The court credited Professor Carlton’s econometric model showing a lack of prior price increases over Professor Shapiro’s bargaining model because the former was better grounded in real-world evidence.15 In addition, the court found that Professor Shapiro’s model was not sufficiently reliable to make probative predictions of competitive harm because of errors in the model’s inputs and its failure to account for Turner’s irrevocable offers to engage in “baseball-style” arbitration in case of licensing disputes.16 The court concluded that the DOJ had failed to show that the merger would result in “any raised costs” for rival MVPDs or for consumers and thus did not reach the question of whether those costs outweighed the efficiencies that Professor Shapiro conceded.17
On appeal, the DOJ argued that the district court’s decision was clearly erroneous because it misapplied economic principles by “discard[ing] the economics of bargaining” and “fail[ing] to apply the foundational principle of corporate-wide profit maximization.”18 The DOJ further argued that the district court “used internally inconsistent logic when evaluating industry evidence” and erred in rejecting Professor Shapiro’s quantitative model.19 The D.C. Circuit rejected each of the DOJ’s challenges, finding no clear error in the district court’s reasoning.
Misapplication of Economic Principles: Nash Bargaining Theory
Nash bargaining theory can be used to predict the outcomes of two-party bargaining situations where both parties are better off if any agreement is reached based on each party’s relative loss if negotiations fail (i.e., each party’s bargaining leverage).20 Professor Shapiro’s model applied Nash bargaining theory to show that Turner’s bargaining leverage would increase because long-term blackouts would be less costly for the merged company. The court of appeals rejected DOJ’s contention that the district court had disregarded the economic theory of bargaining, finding that the district court had simply rejected the predictions of Professor Shapiro’s model in light of other record evidence.21
The court of appeals gave more credit to the DOJ’s argument that the district court had wrongly focused on whether long-term blackouts would actually occur after the merger rather than focusing on how Turner’s bargaining leverage to threaten such a blackout would change.22 The DOJ pointed to several statements that, taken in isolation, could be read to suggest that the court viewed the actual likelihood of a long-term blackout to be relevant in and of itself.23 The court of appeals instead considered these statements to support the district court’s view that reducing the cost of a very unlikely situation would not materially increase Turner’s bargaining leverage, consistent with testimony from executives from the merging parties that the district court credited.24 The district court thus did not reject Nash bargaining theory; it “reached a fact-specific conclusion based on real-world evidence that, contrary to the Nash bargaining theory and government expert opinion on increased content costs, the post-merger cost of a long-term blackout would not sufficiently change to enable Turner Broadcasting to secure higher affiliate fees.”25
Misapplication of Economic Principles: Corporate-Wide Profit Maximization
The DOJ contended that the district court failed to appreciate the principle that a business with multiple divisions will maximize total profits across all divisions.26 The court of appeals noted that the conclusion that the merged firm would not be able to increase profits by raising prices in licensing negotiations was consistent with testimony that, in past cases, the identity of a programmer’s owner had not affected licensing negotiations.27 The conclusion that it is in a programmer’s interest to broadly license content, even after a merger with a distributor, is consistent with the company-wide profit maximization principle.28
Evaluation of Industry Evidence
The DOJ also argued that the district court erred by discounting testimony from third-party distributors as being conflicted by “self-interest” while crediting testimony from Comcast-NBCU and Time Warner executives as “undermin[ing] the persuasiveness of the [g]overnment’s proof.”29 The DOJ asserted that self-interest existed on both sides of the issue and that discounting testimony from one side and not the other reflected “internally inconsistent logic” by the district court.30 The court of appeals gave little credit to the DOJ’s argument, noting that the district court had explained that the third-party distributors’ testimony “consisted of speculative concerns” lacking any analysis or factual basis for key assumptions.31 Conversely, the court of appeals highlighted the district court’s opinion that the Time Warner executives’ testimony focused on “previous experience when working within a vertically integrated company.”32
Rejection of Professor Shapiro’s Quantitative Model
Lastly, the DOJ argued that the district court clearly erred in rejecting Professor Shapiro’s quantitative bargaining model, which found fee increases for rival distributors and price increases to consumers. Although the district court accepted Professor Shapiro’s testimony that the merger would create $352 million in cost savings, it found insufficient evidence to support Professor Shapiro’s conclusion that the merger would lead to “any” increased costs for distributors or consumers.33 In rejecting DOJ’s clear-error contention, the court of appeals explained that the district court found that Professor Shapiro’s model failed to account for 1) long-term contracts, 2) post-litigation offers of arbitration agreements, and 3) the “ever-increasing competitiveness” of the video programming and distribution industry.34
Significant Weight Placed on Post-Litigation Arbitration Offers
Notably, the court of appeals placed significant weight on irrevocable offers to engage in “baseball-style” arbitration for licensing disputes with a “no blackout” guarantee while arbitration is pending that Turner made to approximately 1,000 distributors after the DOJ filed its suit. The district court concluded, based in part on analysis of the Comcast/NBC Universal merger and Professor Carlton’s econometric study, that these agreements would have “real-world effect.”35 The court of appeals reasoned that “the government’s challenges to the district court’s treatment of its economic theories becomes largely irrelevant” during the period covered by the offers because, as Professor Shapiro acknowledged, his model would have to be modified to take them into account.36
No Holding on Appropriate Framework for Evaluating Vertical Mergers
Several amici urged the court of appeals to take this case as an opportunity to clarify the appropriate legal framework for evaluating vertical mergers. The Baker Hughes framework applied by the district court was developed in the context of a horizontal merger, and the merging parties suggested in pre-trial briefing that it was not appropriate in vertical merger cases. Specifically, the merging parties contended that vertical mergers should be presumed to generate procompetitive efficiencies and that the government should therefore bear the burdens of production and persuasion to show otherwise.37
Although the court of appeals noted the relative dearth of judicial decisions on vertical merger analysis and the wide range of opinions as to the appropriate standards for evaluating them, it declined to opine one way or another on the appropriateness of the Baker Hughes standard because neither party raised the issue on appeal.38 The court further noted that it saw “no error” in the district court’s choice to apply Baker Hughes,39 which future courts may take as tacit approval of the framework in vertical merger cases.
