May 10, 2011 7:53 PM

Handicapping "Uncle" T-Mo on the DoJ Merger Track

It's that time of year again--Triple Crown Season--with the first leg, the Kentucky Derby being won by "unthinkable" 20:1 longshot, Animal Kingdom.  Interestingly, the jockey aboard Animal Kingdom, John Velasquez, was supposed to ride one of the top favorites, Uncle Mo, before that horse was scratched the day before the Derby.

Ironically, Velasquez won his first Derby aboard a horse that most handicappers had dismissed as "unthinkable" with the most superficial of glances (Animal Kingdom had never raced on dirt), ignoring the fact that he had won his last two races on artificial surfaces (which closely resemble the dry track of Churchill Downs on the day of the Derby).  The lesson: sometimes it pays to resist the temptation to make a cursory judgment, based on the most obvious, and potentially irrelevant, information and do a little more analytical handicapping.  

With this recent lesson in mind, let's disregard (for a moment) that some have called the AT&T/T-Mo merger "unthinkable", based only on the casual observation that the number 2 national mobile wireless carrier is proposing to acquire the number 4 national mobile wireless carrier (notwithstanding whether "nationwide" is even a relevant market).  Instead, let's take a little deeper look at the Department of Justice's past performances with mergers similar to AT&T's pairing with "uncle" T-Mo.  Hopefully, this handicapping exercise might offer (at least) a thoughtful conjecture about the competitive effects of this merger.

If you're not familiar with horse handicapping, there are only a few basic principles.  The most important principle of handicapping is that mature horses generally run "true to form."  Another (somewhat obvious) aspect of handicapping is that you never get a perfect prior snapshot of the race you are looking at--the horses are always different, as are the tracks, the surface conditions, and distance.  Therefore, you have to analyze a race based on the past performances that seem most analogous to the race you are looking at.

So, let's give this a try, and try to see if we can get some insights into how "uncle" T-Mo might run on the DoJ Merger Guidelines course.  At first glance, it might be tempting to just go back and look at the last big wireless merger--Verizon/Alltel--and place bets based on that merger.  As superficially attractive as this merger might be, it's misleadingly obvious.  

Here's why I'm not going with VZ/Alltel,  First, the mergers might have different motivations, and, therefore, expected competitive effects.  In the present case, it seems clear that the T-Mo acquisition was entirely motivated by AT&T's spectrum starvation, and T-Mo's capital crunch.  As such, the merger may have output enhancing effects that were not part of the VZ/Alltel analysis.  Second, VZ/Alltel was analyzed by different Antitrust Division leadership (the deal was approved before the last presidential election).  Third, the last wireless deal was analyzed under the 1997 Horizontal Merger Guidelines (the 2010 Guidelines aren't a big change, but they do put "effects" front and center, and aren't as stringent on product market definition).  Finally, the VZ/Alltel Complaint relied on the fact that VZ and Alltel were each other's closest rival in every market subject to divestiture. Para. 17. This indicates heavy reliance on the "unilateral effects" theory.  Guidelines, Section 6.

The "unilateral effects" theory is based on the premise that in a differentiated market, market shares are a proxy for consumer preference.  Thus, if a firm is acquiring its next-closest substitute, it can profitably raise prices on the preferred service and capture most "lost" sales even holding prices constant for services of the next-best rival.  In the present merger, AT&T explains why the facts here do not support a "unilateral effects" theory. See Carlton Declaration

Since we don't have an "apples-to-apples" comparison of wireless mergers based on new and old Guidelines/Division leadership/similar facts, I'm going to go with the most recent "similar" past performance:  the Continental acquisition of United Airlines, consummated in September of 2010--after the new Guidelines were adopted, and analyzed by current Division leadership.  Why this merger?  

Well, for antitrust purposes, the airline industry is a good industry to compare to wireless in that the service being offered (the "product market") is very similar: the transportation of people (or information) from one point to another.  The "product market" is the same throughout the country, and the same between firms.  And, the geographic markets are all similarly local:  a traveler living in Charlotte is not going to drive 4 hours to Atlanta just to take advantage of a larger number of carriers flying to Los Angeles.  Wireless service is no different, and the Antitrust Division has always defined geographic markets by smaller local areas.  

So, given the similarities, let's apply the Continental/United analysis to AT&T/T-Mo.  According to a post-announcement study by GAO, the Continental/United combination would reduce the number of competitors from 5 to 4 on 387 city pair routes, from 4 to 3 on 454 routes, from 3 to 2 on 120 routes, and from 2 to 1 on 10 routes.  The outcome?  The merged firm got approval after agreeing to "fix it first" (fixing the problem prior to consummation) by leasing 36 slots at Newark.

AT&T, on the other hand, has only identified 29 markets (where the FCC spectrum screen has been reached) that would even go from 4 to 3 as a result of the merger.  See Appendix C.  Even looking back to the VZ/Alltel merger, the DoJ seemed to view 3 as the number of competitors that a market would need in order to be effectively competitive. See para. 13.  

This seems more than reasonable because, there is no evidence that "nationwide" carriers (like AT&T and T-Mobile) practice geographic price discrimination.  Thus, the post-merger firm will still have to set prices based on the average number of competitors in which most of their potential customers reside.  In other words, if 90% of the potential customers have 5 or more choices of providers, then prices are set based on these market conditions.  The other 10% of the post-merger firm's customers receive the benefits of the more competitive market prices.

So, if antitrust enforcers run true to form--and they should (which is the main reason for having "guidelines")--I would have AT&T/T-Mo as more of a favorite than Uncle Mo would have been had he run.  While there will certainly be some markets in which the post merger firm exceeds what the government may regard as tolerable spectrum/concentration thresholds, these will be a small minority of markets. 

Thus, through a little handicapping, we can see why AT&T's $3 billion "break up" bet makes sense. And, what makes more sense?  The public wins when AT&T's bet pays--in the form of increased wireless broadband capacity that otherwise would not be available to consumers anywhere near as quickly from either firm separately.

Leave a comment