Let’s talk about AT&T proposal to merge with T-Mobile. Why do the parties involved still consider this merger viable?
Executives at AT&T seemed to think this merger was a good idea many months ago. For all I know, that might have been the right conclusion with the information they had then. But that was then, and this is now, and too much information has come to light to hold that conclusion any longer. Based on what we know now the proposal does not make business sense.
This blog post will argue what should be obvious to any close observer of events, and certainly to the management at AT&T. There is not a viable business case for this merger any longer.
This blog post also will argue that executives at T-Mobile should begin planning to run their business as a stand-alone entity. They always had a viable business, but that holds even more so now, since they will get a reasonable infusion of cash from the break-up of this deal.
How did the executives at AT&T get into the present pickle? They took a strategic gamble with the US legal system and lost. In their own internal deliberations today they should be acknowledging the loss, and — for lack of a better phrase — simply move on. That is what their business needs.
So I am puzzled. Why haven’t all the parties declared victory and gone home? This post will consider the question.
Let’s recap. From the outset this merger was puzzling to anyone who knows antitrust. The proposed merger combines the second largest and fourth largest firms in a market where the four largest firms have more than 80% market share.
The problems come straight out of a textbook. US firms do not, and cannot, get anything they want during a merger. They have to meet a test, and show that their merger is in the public interest. It is not a very hard test for more than 99% of proposed mergers to pass, and most do so routinely. Only mergers from the largest firms face any challenges.
Could AT&T’s merger with T-Mobile easily pass the US antitrust laws? It is less than a night’s homework for any third year law student, and the answer is no, at least on the surface. Any reasonably informed down-to-earth antitrust textbook would lead to a forecast that the deal would face stiff opposition. Many legal precedents point in the same direction. Even the (recently revised and more forgiving!) merger guidelines at the US Department of Justice pointed in that direction.
Theory provides many reasons: Society benefits if firms grow through internal investment instead of merger, because the latter eliminate user choices; more concentration often leads to higher prices in an already concentrated setting; fewer decision-makers gives innovative handset makers fewer channels for diffusing their new designs, so more concentration is particularly bad in innovative markets, such as wireless markets; more concentrated supply makes it more difficult for new entrants to find ways to bring new business models, new pricing models, or new ways to organize a product line. In sum, more concentration in an already concentrated setting leads to a less competitive process and that makes society worse off.
The theory also fits the facts reasonably well, at least on the surface. This is cellular telephony we are talking about, after all. The US has a nicely competitive industry with some good prices, and, in the last few years users have experienced regularly improvements in producer product lines — albeit, the iPhone dominates the growth, with the Android coming in second. But pricing is an issue, and will continue to be. After all, several carriers have recently imposed data limits, which is effectively the same thing as imposing a price increase on heavy users. Surely it is quite reasonable for antitrust to be concerned that society might back away from this admirable pattern by allowing the second largest and fourth largest competitor to combine.
To be sure, theory is theory. Practice can differ, especially because antitrust law is rather forgiving, even for the largest firms. Merging parties have the option to show that there are countervailing gains, gains that outweigh (even obvious and abundant) problems.
Which motivates an initial puzzle: if that was AT&T’s approach, why did the DOJ say no? Let me review a number of reasons why AT&T’s claims about gains just did not past muster.
For the sake of brevity (this post will be quite long), let me focus on only four actions that undercut AT&T’s business case.
First, AT&T took an inconsistent public position on retaining jobs and saving costs. This did not happen immediately. The inconsistency developed over time. At the beginning AT&T announced that the combined firms would save lots of expenses. Every experienced student of mergers knows that means the layoff of thousands of people, since there is no other way to get to the type of savings AT&T was discussing. And everyone assumed T-Mobile’s employees would take most of the hits. Then later AT&T made promises to their unions (and eventually to politicians) that they would save jobs, which, of course, goes in the opposite direction. Did the management think they could just say whatever it was convenient to say in whatever setting they happened to be speaking?
The management at AT&T has a real problem on its hands. Blogs and newspapers hint at the disbelief of the staff at the DOJ and FCC, who had to examine AT&T’s incredulous claims about alleged savings this merger would produce. Staff apparently told the AT&T lawyers their numbers made no sense, and asked for one revision after another. Not only is that a problem for the legal case, but it is disaster for the financial case. If the staff at the DOJ could not find a large enough efficiency gain to justify the merger, then most Wall Street analysts eventually will come to a related conclusion, that AT&T is not getting $39B in value from the merger. In other words, there are not sufficient cost savings to justify the premium AT&T is paying.
Second, AT&T dropped public hints that the concentration at the national level was less of an issue at the local level. This was always a puzzling talking point, because the mathematics of market share made it puzzling. If firm has 25% market share on average across the nation, then in half of its cities it has more than 25% and in half it has less, more or less. And it was only a matter of time before reporters got the actual facts and did the math. Yet, this statement was repeated in many a news story.
Eventually the numbers confirmed that prediction, which puts the AT&T case in a pretty sour place. The merged parties would dominate a high fraction of the markets in which they were present. This did not make the business case better for the merger. Instead, it made it much worse. It implied that a huge number of divestitures would be a minimal condition for carrying through with the merger, which would reduce the business case for the merger in the first place. What part of this did AT&T’s management not understand before it decided to make the merger offer? Did they really think the government staff would not ask for a huge number of divestments as a minimal condition? If they did expect these conditions, why propose the merger in the first place? If they did not expect these conditions, what were they smoking? Once again, this only makes sense as a strategy if the AT&T management did not expect legal staff to be paying attention to the details. But staff at DOJ noticed, called out the obvious points, which means AT&T lost its gamble. (Which puts them in a pickle, like I said.)
Third, AT&T management clearly did not know that discussions were problematic at the DOJ. The executive team at AT&T continued to make positive public remarks about the merger up to the day on which the DOJ announced its lawsuit.
Eeesh, the management should be embarrassed. This is a symptom of a communications breakdown between the DC-based staff and headquarters, at best, or management at headquarters was not dealing with reality, at worse.
Fourth, and finally, AT&T management acted like its own prior investigations would not come out in the laundry. In particular, as the investigation at DOJ grew, it came to light that AT&T’s management investigated the costs of building out their network to support 4G only a couple months earlier, and their own internal estimates put the cost at just under four billion. Yet, when AT&T announced the merger one of their big public talking points involved – you guessed it – merging in order to build 4G.
This makes AT&T’s management look dishonest or inept, and on multiple levels. If a firm can accomplish its goals by spend $39B for a merger or one tenth of that for an investment, which option should the management choose? Did AT&T’s management not believe the internal deliberations and investigations would come to light? This is a gift to the prosecution, who will argue that AT&T did not buy T-Mobile for the investment reasons (which helped it save less than four billion), but, instead, bought them in order to close down a competitor. Relatedly, it is also a gift to any activist stockholder who wants to take the management to task for wasting money on a quixotic merger instead of getting down to business with a large and targeted investment program.
To summarize: The management took an inconsistent position on cost savings, took a public position on concentration that made no sense upon further investigation, showed symptoms that the executive team that was out of touch with actual negotiations, and conducted an internal investigations that directly contradicted the publically stated strategic rationale for the merger.
There have been plenty of other reports of problems in the news, but let’s leave these four out there. It is enough new information to undermine the business case for the merger.
Declare victory and go home
Which leaves the big puzzle: Why hasn’t this proposal collapsed under the weight of its own internal problems?
The newspapers offer one explanation for why we are all still going through with this: AT&T put a three billion escape clause into their contract, as well as some promises about roaming, and the management would rather go to court than pay the escape clause.
I am sorry, but this explanation is not even a homework exercise for MBAs. This question only requires a show of hands in class: how many people think T-Mobile would walk away from this deal for a negotiated amount somewhere less than three billion if they could walk away tomorrow instead of six months or a year from now? How about two billion? How about one and half billion? (It is ok if a few hands go down as the price goes down).
Here is another small homework exercise for MBAs: with an additional several billion dollars how many people think T-Mobile – with its cute branding campaign, and existing infrastructure, and soon-to-be-unveiled iPhone option – has a viable business? (Hint: Any student who did not put up a hand just failed.)
AT&T also has a reason to make a deal. Is there a single AT&T’s stockholder left who actually believes management’s initial claim that this deal contains $39B worth of value? How many stockholders would rather take a three billion dollar loss now through an escape clause with T-Mobile, and save AT&T from a sheer transfer of wealth to T-Mobile’s stockholders?
In light of all that has transpired, taking the $3B loss now looks like a pretty good deal. How about $2B? That looks like a slam dunk.
Maybe, just maybe, it is time for all the parties to be honest with themselves. Management would be better off spending the next year on matters other than preparing for a court case with low odds.
Which brings me back to the big puzzle: Why haven’t all the parties declared victory and gone home? There is time-honored way to do it. The executives should call a news conference, and in angry tones blame the government for inflexibility, and, for good measure, they should call it a travesty for stockholders and users. Such platitudes have always played well in the editorial pages of the Wall Street Journal, never mind that none of those platitudes have any actual relevance to events in this case. It should not stop a first-rate executive from using this face-saving path to accomplish what is best for the business. It is time to move on.