Economic Perspectives

Uncertain media future

Print edition : November 25, 2016

AT&T CEO Randall Stephenson and Time Warner Inc. CEO Jeff Bewkes discuss their proposed merger at the WSJD Live conference in Laguna Beach, California, on October 25. Photo: Mike Blake/REUTERS

A scene from "Game of Thrones". This popular TV serial is owned by Time Warner through its company HBO. Convergence of content and distribution can encourage anti-competitive practices; for instance, a content provider with exclusive assets can enter into special agreements with the distributor it is merged with. Photo: Macall B. Polay/AP/HBO

IN today’s troubled times, mega mergers are the norm. Announcements of marriages like that between AB Inbev and SABMiller in the beer industry or Bayer and Monsanto in the agribusiness sector attract attention that soon fades, even as the difficult task of getting clearances from the regulators continues. But the just-announced agreement between AT&T and Time Warner (TW) to merge, in an $85 billion deal, is likely to remain in public discussion for some time. If it does not, it should.

This is a mega merger not just in any industry like the production of cigarettes or beer but in the media business. There, it brings together a dominant content producer, Time Warner, with interests stretching from news to the movies, and a communications major, AT&T, which has the ability to deliver, through fixed line and wireless services, this content to subscribers in offices, homes and on the move.

In normal circumstances such power is viewed with suspicion because it inevitably leads to profiteering at the expense of the customer.

Financial Times (October 29, 2016) refers to a study by the European equities team at BNP Paribas Investment Partners whose findings suggest that even today, as in the late 19th century, across industries, concentration “allows scope for a cabal of powerful oligopolists to gouge prices and bank excess profit”. That should get those implementing anti-trust legislation worried. But in the AT&T-TW case, the power the proposed merger delivers will be scrutinised more closely if only because the media can shape public opinion and popular culture, with far-reaching political and social implications. Giving excessive power in that area to one or a few players is an altogether different ball game.

What the merger claims it will achieve, if cleared, is the seamless distribution of premium content. Obviously, AT&T believes and values that—it has not merely rushed this deal through at a politically explosive moment with the elections under way but has got Time Warner to agree to pay AT&T a break fee of $1.7 billion if it walks away from the agreement to sell elsewhere. AT&T, in turn, has promised to pay Time Warner $500 million if it is unable to win regulatory approval. After the merger, the expectation is that customers can not only choose their preferred package of channels and shows and enjoy videos on demand but access these seamlessly across devices at home or on the go since content will be delivered through both wireless and fixed lines.

For the merged entity, this increases demand for both the data services it provides as a telecommunications service provider and for the content it owns as a producer with substantial assets, some of which are exclusive. But exploiting this requires ensuring that subscribers are locked into both sides of the business: that is, they do not access the post-merger provider’s content through the lines of a separate carrier or access third-party content through the post-merger entity’s fixed or wireless lines.

Using the power of distribution to keep the competition out of content provision may be important for one more reason. If there are many competing content providers, viewership will be influenced significantly by the price charged for access. Thus, price competition can drive down revenues from subscription, forcing dependence on revenues from advertising to support the high cost of content. This is, for example, what different channels on YouTube are attempting. Given the way the Internet is evolving—with the top 10 beneficiaries accounting for 75 per cent of online advertising revenue in the United States, and a few dominant players such as the search engine Google and the social media platform Facebook acquiring much of that—the advertising revenue earning of regular content providers remains uncertain. So revenues from subscribers can be crucial, providing further impetus to the misuse of market power. Efforts to try and lock in consumers to both the data service and the exclusive content are more than likely.

Concentration will help those efforts, and thwarting it may be beyond regulatory intervention. In which case, it is best to prevent the merger in the first place. Not surprisingly, both main candidates in the U.S. presidential election have expressed strong or muted concerns about the merger, as have left-of-centre politicians such as Bernie Sanders and Elizabeth Warren.

Randall Stephenson, the CEO of AT&T, while welcoming the scrutiny of the merger before it is cleared by the relevant agencies, is confident that it will go through. He gives two reasons. The first is that this is a vertical merger between a content producer and a distributor, and not a horizontal one between two media production or telecom companies. Thus, excessive concentration in one market does not result. However, despite that, the convergence of content and distribution can encourage anti-competitive practices. The distributor may privilege distribution of the content offered by the provider it owns. Or, the content provider with exclusive assets (such as rights to the superheroes Batman, Superman and Wonder Woman, besides the Harry Potter series and the Game of Thrones serial) can enter into special agreements with the distributor it is merged with. In Stephenson’s view, this may not always make business sense. Moreover, the prospects of privileged distribution are also low because the debate on “net neutrality”, or privileging carriage of some content and not others, has been settled. Temporarily yes, but a transformed media business can bring the issue back to the table.

Similar merger

The second reason for Stephenson’s confidence is that, five years ago, a similar merger—between the distribution company Comcast, which was the leading provider of video and Internet services, and the content generator NBCUniversal, which controlled, among much else, broadcast stations, cable channels such as E! and the Universal movie studio —had received regulatory approval after a 13-month scrutiny process. The approval was subject to conditions that required Comcast to provide to its online competitors access to the same content it offered to others and allow the transmission of content of other providers through the wires it controlled. The result of the merger was a media giant, NBCUniversal LLC, that was a content-producing and -distributing empire.

But there could be lessons to be learnt from that experience. In March 2016, the consumer advocacy group Public Knowledge petitioned the Federal Communications Commission saying that NBCUniversal had exempted its own live TV service “Stream TV”, which it said was being offered to Comcast Internet service subscribers, from the data caps and metering that applied to other online video services using its Internet pipe. But, Stephenson still asks why, if Comcast-NBC was possible in 2011, the AT&T-TW deal should not go through in 2016 when the evidence is that convergence is a technological and economic imperative.

But the real significance of the Comcast-NBC precedent lies in whether it renders obsolete the lesson from one other merger that involved Time Warner in the past. Close to 17 years ago, in the age of the dot-com bubble, Time Warner decided to accept a deal to merge with the then dial-up Internet services provider AOL. The idea was that Time Warner would get an online presence in a period of change and AOL would get access to Time Warner content, besides its cable network. But soon the Internet bubble went bust, AOL’s market value fell from $226 billion to $20 billion, and it had to take a goodwill write-off of around $99 billion (from Rita Gunther McGrath in Fortune Insider Network commentary, January 10, 2015).

Things are indeed different now, argue protagonists of the deal. Wireless or wired broadband access rather than dial-up access is the norm now. And while after the early 2000s, Google and Facebook easily usurped the benefits of the Internet, especially online advertising revenues, now with Time Warner content and its broadband reach, the new merged entity could stand up to the Internet giants, which are ageing. Comcast’s success in the stock market, outperforming the S&P index, is presented as proof that merging content with distribution is a different story now.

However, as Bharat Anand points out in Harvard Business Review (October 28, 2016), one problem is the high price that AT&T is paying to acquire Time Warner, which at $107.5 a share is around 35 per cent more than its recent trading value. This implies that the merged entity would have to increase earnings quite substantially to ensure a reasonable return. That, argues Anand, may have been easier if AT&T contractually acquired Time Warner content, which in any case cannot be exclusive to it. In addition, regulators may not ignore discriminatory pricing of content to stifle the competition.

Moreover, the leaders of the Internet are the competitors AT&T has to face: Apple is using HBO content, Twitter streams National Football League games live, Amazon and Facebook are looking to offer video content. In fact, Apple had considered acquiring Time Warner but did not take it forward, possibly with good reason. So the new entity does face two major challenges. First, it will have to get past the regulators. And the second, it must ensure that, even if for reasons different, the merged entity must not prove a business failure. Both of them are difficult to face.