Originally published in Law360
As the world knows, U.S. District Judge Richard Leon delivered a resounding win for AT&T / Time Warner in June in the first vertical merger injunction proceeding in roughly 40 years. While only one judge’s opinion, and the U.S. Department of Justice is appealing the decision, it is significant because the government brings so few vertical cases. This case made brutally clear how hard it is for the government to win a merger case without a presumption of a substantial lessening of competition under United States v. Philadelphia Nat'l Bank. While Judge Leon took care to make his opinion narrow, the nature of his evaluation of the government’s evidence, to see if it actually supported the economic model the government offered to prove anticompetitive impacts, may reverberate in situations involving competitive theories beyond vertical mergers. One example is the antitrust assessment of acquisitions of a noncontrolling partial interest in a rival. Thus, this narrow opinion may have broader impacts.
In a horizontal merger, the underlying theory of harm is fairly straightforward. The transaction reduces the number of competing firms by one. If there are not many firms in the market, and if the combination will substantially increase concentration, then the U.S. Supreme Court’s Philadelphia National Bank opinion provides the government a presumption that the transaction will substantially lessen competition. When the government wins the product market fight and obtains this presumption of competitive harm, it makes its prima facie case and invariably wins.
In AT&T, the government agreed it was not entitled to the Philadelphia National Bank presumption in a vertical merger case. But vertical mergers are not the only nonhorizontal mergers. The government has brought a number of cases, normally through consent settlements, in which the competitive concern arose from a company’s acquisition of a partial, noncontrolling interest in a rival. This theory, which arose several decades ago, was captured in Section 13 of the 2010 Horizontal Merger Guidelines. Under the guidelines, a partial but controlling acquisition is analyzed like a standard horizontal transaction. The guidelines, however, note that a partial, noncontrolling acquisition can still raise concerns. Partial interests can give the acquiring firm the ability to influence the competitive conduct of the acquired firm through board or other representation, and they may also provide access to competitively sensitive information of the acquired firm. Even without those control or information rights, the guidelines state that a partial acquisition can “lessen competition by reducing the incentive of the acquiring firm to compete. Acquiring even a minority position in a rival might significantly blunt the incentive of the acquiring firm to compete aggressively because it shares in the losses thereby inflicted on that rival.” The agencies have brought cases using this partial interest theory. In essence, the guidelines indicate that a firm with an interest in a rival may pull its competitive punches. Under this theory, a firm that raises prices on its own products, thereby losing some sales, may recapture some of those lost sales through its interest in a rival that picks up some of those diverted sales. Some economists have attempted to model this, through what they refer to as a modified HHI, or MHHI, which is effectively an HHI calculation, but discounted to account for the partial interest rather than a full combination of the competing businesses.
The theory of changed competitive incentives through partial ownership interests is similar to the DOJ’s theory of competitive harm in the AT&T case, as presented by its expert economist. The DOJ’s theory in AT&T boiled down to the following. Time Warner’s Turner Broadcasting business engages in negotiations with distributors such as cable companies. An item of leverage in these negotiations is the potential to not sign an agreement, which would make the distributor lose access to Turner content (CNN, TBS, etc.) until the dispute is resolved. This is referred to as “going dark.” Going dark hurts both parties. The distributor may lose some customers who drop their cable subscription when not provided the content they want, and Turner would immediately lose revenue with fewer subscriptions and lower advertising rates because its content is not being distributed. The DOJ’s case was premised on the notion that because AT&T owns DirecTV, if AT&T also owned Turner then some of the subscribers lost by a distributor who went dark with Turner would be gained by DirecTV. Thus, the DOJ asserted that because some Turner losses would be recaptured on the DirecTV side of the ledger, Turner would negotiate more aggressively and raise prices to distributors. The downside of Turner pushing too hard of a bargain and “going dark” with a distributor would be mitigated by the profits that its post-merger parent, AT&T, would pick up at DirecTV.
As a matter of economic theory, this change in bargaining leverage makes sense. The DOJ’s bargaining model presumed that a vertically integrated firm would operate its businesses to maximize the profits of the overall enterprise. Judge Leon agreed with the concept but found the evidence contradicted the theory. “The Court accepts ... the Government’s ... argument that, generally, a ‘firm with multiple divisions will act to maximize profits across them,’ [but that] profit-maximization premise is not inconsistent, however, with the witness testimony that the identity of a programmer’s owner has not affected affiliate negotiations in real-world instances of vertical integration.” In short, the DOJ’s case was built on the premise that a profit-maximizing firm would accept losses Turner would incur by going dark to capture new subscribers, and increased revenue, at Direct TV. The “real-world evidence,” however, undercut that premise. Hence, “to borrow a line from one of my able colleagues, ‘antitrust theory and speculation cannot trump facts.’” Antitrust practitioners know that economics are critically important to cases, but Judge Leon’s opinion provides a refreshing reminder that the economic theory is only as good as the underlying facts.
The DOJ’s theory of competitive harm is similar to the theory of competitive harm in cases of passive equity interests because both are premised on a business line competing less aggressively, and raising prices to customers, based on the potential to recapture some lost revenue in a second business line. This recapture potentially changes the bargaining or pricing leverage of a party in a way that can harm consumers. In a vertical merger case, the second business line is another operating unit controlled by the same parent company (e.g., AT&T’s DirecTV). In a partial equity interest case, the second business line is an independent company in which the acquiring company holds a minority interest.
Under this theory of harm, antitrust concerns can arise through partial ownership even where control is not transferred. For example, assume WidgetCorp, a widget supplier, acquires a passive, 20 percent minority interest in rival BigConglomerate, which operates a widget division and several other businesses. There are two other widget competitors of note. Under the passive equity interest economic theory, the government economic modeling may show that WidgetCorp will be inclined to price more aggressively after taking the 20 percent interest in BigConglomerate. For those sales that it makes at the higher price, WidgetCorp makes higher profits. For those sales that are lost, BigConglomerate will pick up some of those sales, and WidgetCorp will obtain some benefit because of its interest in BigConglomerate. Thus, theory says WidgetCorp’s interest in BigConglomerate will decrease WidgetCorp’s competitive incentives, prices will rise and consumers will be harmed. This was the DOJ’s theory in AT&T. But how would a court deal with this partial interest theory? The AT&T opinion provides parties with a solid basis to push back against the economic theory of harm if the “real world facts” leave the theory unmoored from reality in a way that eliminates the theory’s probative value.
To develop these real-world facts, evidence from documents and testimony from WidgetCorp employees must be gathered, as well as evidence from other sources. This evidence will answer important questions, such as the following:
- Will the facts support the model assumption that a company will choose to forego own-firm profits? In order for the economic model to work, WidgetCorp has to reduce its own sales and profits from the competitive level and hope to have enough recapture from its BigConglomerate holdings to make the strategy profit maximizing when viewed as a whole. Is that a realistic scenario when WidgetCorp employees likely are compensated based on the sales and profitability of the business they operate? Is a year-end review likely to get a sales manager a good bonus when it says ‘I raised prices and lost three accounts, but BigConglomerate won one of the accounts, so our company made more money because we own a piece of BigConglomerate?’ This seems implausible. In many cases, a client likely will have strong real-world facts to undercut the economic model’s assumptions that the firm will pull its punches. However, in more extreme cases, the government may have a stronger case. For example, if the facts show there are only two competitors and one takes a 49 percent interest in its only rival, it may be more plausible to assume this could alter the firm’s competitive incentives.
- Will the facts demonstrate that a company can rely on recapturing benefits of diversion? Under the economic theory, WidgetCorp will reduce its own profits in order to inflate the profits of BigConglomerate, and WidgetCorp’s overall position will be improved through that process. This raises a host of real-world questions if, as is likely, WidgetCorp has an interest in BigConglomerate, but does not have a right to the distribution of BigConglomerate’s purportedly increased profits. WidgetCorp may need to hope that the increased profits to BigConglomerate increases the value of the stock WidgetCorp holds in BigConglomerate, and that WidgetCorp can capture that increase whenever it ultimately sells its shares, perhaps years later. Also, the overlapping widget business may only be a part of BigConglomerate’s business, so the share price can be impacted by many factors other than the performance of the overlapping business. Of course, a business’ stock value can be buffeted by many other independent factors such as a recession, a bear market, a trade war impacting the business, or other events.
Just like in AT&T, the government would need to deal with a host of confounding factors to support an economic model predicting harm to consumers from a passive partial equity interest shareholding. If the evidence contradicts the underlying model assumption that a company will pull its punches based on its ownership interest in a rival, the MHHI economic model may lack a foundation, as Judge Leon found with the DOJ’s economic model in AT&T. In a partial equity interest case, just like in a vertical merger, the government is not entitled to the shortcut of a presumption of anticompetitive harm. Instead, the government will need to bring forth evidence of anticompetitive effects in order to make a prima facie case. AT&T shows just how hard that is. The AT&T case could reasonably embolden parties to put the government to its proof if the government raises a competitive concern based on a company’s passive, partial equity interest in a rival. While Judge Leon was careful to note that his opinion was narrow and focused on the facts of the case, his evaluation of the evidence undercut the government’s theoretical economic model of harm in a way that may have broader application in other circumstances in which the government does not benefit from a presumption of anticompetitive harm. Judge Leon has provided a playbook parties can use in a variety of cases unless the DOJ’s appeal fundamentally reverses his opinion.
Jon B. Dubrow is a partner at McDermott Will & Emery LLP. He thanks associate Matthew Evola for his assistance.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
 374 U.S. 321 (1963)
 Horizontal Merger Guidelines, Section 13; see also Fed. Energy Reg. Comm’n, Comment of the Federal Trade Commission, Docket No. RM09-16-000 (March 29, 2010), https://www.ftc.gov/sites/default/files/documents/advocacy_documents/ftc-comment-federal-energy-regulatory-commission-concerning-rulemaking-competitive-assessments/v090008ferc.pdf (“[L]egal and economic scholarship, judicial decisions, and the work of the federal antitrust agencies consistently teach that partial acquisitions can change the competitive incentives of the acquiring and acquired firms, even when the acquiring firm does not gain control or influence over the acquired firm. Such transactions can also create opportunities and incentives for information sharing that facilitates collusion.”).
 See, e.g., In re T. C. Group L.L.C., No. 061-0197, 2007 WL 293866 (Fed. Trade Comm’n Jan. 24, 2007) (alleging a substantial lessening of competition in the market for gasoline and light petroleum resulting from Carlyle and Riverstone’s proposed investment in Kinder Morgan Inc.); U.S. v. Dairy Farmers of Am. Inc., 423 F.3d 850 (6th Cir. 2005) (reversing district court decision that acquisition of non-controlling partial ownership generally doesn’t raise antitrust concerns).
 Daniel P. O’Brien & Steven C. Salop, Competitive Effects of Partial Ownership: Financial Interest and Corporate Control, 67 Antitrust L.J. 559 at 595 (2000).
 United States v. AT&T Inc., No. CV 17-2511 (RJL), 2018 WL 2930849, at *46 (D.D.C. June 12, 2018).
 Id. at *45 (citation omitted).
 Note, this article focuses on the competitive implications of passive equity interests. If the interest is not passive, but provides some control rights or enables information flows, a partial interest raises different and more straightforward issues.
 Judge Leon took on this issue in AT&T, noting that, “To start, various industry witnesses testified that the identity of a programmer’s owner does not affect the negotiating dynamic. Indeed, this opinion by Professor Shapiro runs contrary to all of the real-world testimony during the trial from those who have actually negotiated on behalf of vertically integrated companies.” AT&T, 2018 WL 2930849, at *46.
 See Jon B. Dubrow, Challenging the Economic Incentive Analysis of Competitive Effects in Acquisitions of Passive Minority Interests, 69 Antitrust L. J. Vol. 69 (2001).
 This could apply not only in passive, partial equity cases, but also to other theories, such as the current ongoing academic debate regarding the competitive implications of cross ownership. If the court rejected DOJ’s theory of harm in AT&T, is it likely to accept that an investment company holding a one or two percent interest in several competing companies, like the major US airlines, is anticompetitive? See Eric Posner, Fiona Scott Morton, and E. Glen Weyl, A Proposal to Limit the Anticompetitive Power of Institutional Investors, 81 Antitrust L. J. No. 3 (2017).