The Sprint/C. Spire Skirmish: AT&T Loses Ground While DoJ Gets A Roadmap

Any tactician knows that battles can be won or lost by defining the battlefield. Skirmishes like the fight over whether Sprint and C. Spire (formerly Cell South) can go ahead with their private lawsuits against AT&T’s acquisition of T-Mobile help define the terrain for the bigger fights to come (order here). By ruling on what constitutes a recognizable injury under the antitrust rules and making preliminary determinations about the nature of the market, the Order sets the boundaries of what arguments DoJ can make and what it will need to do to prove its case. Where AT&T manages to have certain market definitions locked in and certain potential injuries excluded as not cognizable under antitrust in these early rounds, it gains an advantage. By contrast, where the court rejects AT&T’s efforts to limit the scope of the review by adopting different market definitions or recognizing certain injuries as addressed by the antitrust law, DoJ gains an advantage.

Both Sprint/C. Spire and AT&T claimed victory after Judge Huvelle issued her decision Wed. evening – Sprint/C. Spire for staying in on some claims when AT&T had said they would get thrown out, AT&T on the basis that “most” of Sprint and C. Spire’s claims got dismissed and what remains doesn’t matter. But everyone knows this is just a skirmish in the big battle between AT&T and DoJ. So, setting aside who won or lost this particular round, how does this position AT&T for the real fight?

More below . . . .

Looking at Huvelle’s Order on whether Sprint and/or C. Spire adequately stated a claim, DoJ (which wasn’t even party to the Order) clearly gained the advantage on several key points. Even where Huevelle dismissed claims, the way she did it in a number of cases provided a road map for DoJ going forward and thus created terrain favorable to DoJ that disadvantages AT&T in future rounds. Notably, Huvelle rejected several key arguments by AT&T that would have taken certain DoJ arguments off the table or made them more difficult to prove. (As an aside, this also shows the danger of trying to judge by oral argument. A lot of reporters portrayed Huvelle as aggressive to Sprint and C. Spire and focused on whether she appeared to “like” AT&T and would therefore grant AT&T’s motion. The reality is that she produced a sophisticated and highly nuanced 44-page opinion in 9 days, which is pretty damn impressive.)

My list on what in the Order shapes the ground going forward:

The Number of Equipment Manufacturers Is Irrelevant to the Question of Monopsony Power Over the Equipment Market.

God knows how many times I’ve had this argument with my opposite numbers in industry and at neocon think tanks. “How on Earth can you say AT&T or VZ has/will have market power when we have so many companies making handsets?” They proclaim. When I point out that this argument makes zero economic sense, because the market power is determined by the number of potential buyers rather than the number of potential sellers and that a large seller to buyer ratio actually increases the monopsony power of the buyers because sellers have fewer alternatives, I’m usually told I hate free markets and love regulation for its own sake. Needless to say, AT&T and its supporters have made the “there are so many handset providers we can’t possibly be exercising market power” a cornerstone of its argument that the merger will have no impact on the handset market.

So imagine my delight to see this sentence in the opinion at page 21:

“That there may be and, indeed, by all accounts is, healthy competition among firms that sellmobile wireless devices is irrelevant to understanding whether, by acquiring T-Mobile, AT&T could so increase its buying power as to dictate terms to device manufacturers and otherwise impair plaintiffs’ access to these necessary inputs” (emphasis in original).

The court further noted that AT&T’s past actions in the market to withhold needed handsets from rivals, while not necessarily an antitrust violation in and of itself, is relevant to its likely future actions. Accordingly, if AT&T (and VZ) already have some monpsony power to foreclose rivals like Sprint from getting handsets, it is still a violation of the antitrust laws to let AT&T acquire T-Mo and give it even more monopsony power.  You may think that rates a “duh,” but you have not dealt with FCC staff (or DoJ staff during the Bush years) in “willful disbelief” mode. If staff gave a dollar to the High Cost Fund for every time they gave me a blank look in response to arguments like this, we wouldn’t need to raise the SLCs to make up for lost ICC revenue. Srsrly.

O.K., I recognize that’s wildly wonky trash talk even for me, so let me clarify my point. Normally, AT&T gets a total free pass on anything it ever did before, and gets to submit all kinds of theoretical stuff to show that it has no incentive to behave in an anticompetitive fashion even if that is what it has actually been doing. For the first time, AT&T is facing the fact that its past anticompetitive behavior (or simply behavior that happens to have an anticompetitive impact but is done for totally legitimate reasons) is part of the evaluation process, which makes it harder to rely on its usual insistence and theoretical handwaving about how of course they have no incentive to behave the way they actually behave. In other words, the fact that AT&T kept Sprint from getting the iPhone for five years is not only  relevant to its possible exercise of market power post-takeover, the fact that Sprint got the iPhone just in time for the hearing doesn’t magically make the issue go away.

As I stressed in my analysis of the H&R Block case, there is a big difference between having the opportunity to win the case and actually winning it. Still, to go back to my military analogy, AT&T lost one of its outer defenses. DoJ (and Sprint and C. Spire) will have the opportunity to prove that a combined AT&T/T-Mo would have market power over handset manufacturers, and the fact that there are lots of handset manufacturers is not an automatic proof for AT&T that the handset market is competitive. As a bonus, I get to be totally obnoxious about this next time I debate one of my opposite numbers. w00t!

FCC Roaming Regs Are Not An Automatic Defense Against Market Power In the Roaming Market.

Another front where AT&T lost territory was on roaming. AT&T had argued that the FCC’s roaming regs adopted last spring took this issue off the table – conveniently ignoring that AT&T has challenged the rules and they are now pending before the D.C. Circuit. Unfortunately for AT&T, the court found that the presence of the FCC regulations did not end its inquiry in the matter. Rather, the court still had a duty to see if the FCC regulations “adequately” protected C. Spire (which has some GSM networks) from market power post-acquisition. Also importantly, AT&T’s history of refusing to negotiate commercial roaming agreements (which AT&T disputes, but is a matter of record in the Data Roaming proceeding and a justification officially relied upon by the FCC when it adopted the rules) are “facts which therefore must be heard to question the adequacy of the FCC’s rules.” (p. 38)

AT&T’s loss here is not as severe as it was with the handset market. The presence of the FCC rules (assuming they remain in effect) will be a factor in the analysis for both C. Spire’s case and DoJ’s case. But the mere presence of potentially ineffective FCC rules does not take the matter off the table. So AT&T loses some ground in this skirmish. Also significantly, it points DoJ to develop the evidence submitted by the other GSM carriers – including the international carriers with regard to international roaming – that AT&T has generally refused to negotiate roaming agreements on commercially reasonable terms and that removal of a potential roaming partner would have significant anti-competitive impact.

The Difference Between GSM and CDMA Matters.

The court recognized that CDMA and GSM are different technologies, and that therefore CDMA carriers like Sprint do not suffer an antitrust injury from the loss of T-Mobile (a GSM carrier) from the market. So AT&T gets those claims dismissed. But the recognition of CDMA and GSM as different markets undermines a number of roaming-related and device-related issues because in many places, if the market is “GSM carriers” rather than “wireless carriers,” the merger goes from being a 4-3 wireless merger to a 2-1 “GSM monopoly” merger – a much easier case for DoJ to win.

AT&T argues that the difference between CDMA and GSM are irrelevant for a variety of reasons, chief among them being (a) the eventual arrival of LTE, and (b) the irrelevancy of CDMA and GSM to consumers. But with the court recognizing both a monopsony claim in devices and a monopolization claim in GSM roaming, AT&T becomes vulnerable to attacks by DoJ (and at the FCC) on the basis of the “GSM monopoly.” The idea that someday LTE will come along and therefore a GSM monopoly does not matter also seems at odds with the court’s statement that there is no “de minimis exception to antitrust injury.” (p.37)

This is an interesting case of AT&T winning the skirmish against Sprint on the grounds that its CDMA network made roaming with T-Mo impossible, but potentially losing the more important point on the importance of the GSM monopoly. While this may not quite prove to be AT&T’s equivalent of Picket’s Charge, it does seem rather reminiscent of Harold Godwinson driving the Norman sortie off his defensive position at the Battle of Hastings, only to get pulled out of position and crushed by William’s subsequent assault.

Also useful to DoJ, the court clarified what additional evidence Sprint would have needed to state an initial case. For DoJ, this sort of intelligence early in the proceeding with regard to how to expend its resources and what aspects of its case to develop convey a serious advantage. Of course, AT&T also gains intelligence about where it will need to increase its defenses. But since it is DoJ which must prove the case, and DoJ that is much more resource constrained than AT&T, the development of the road map to winning claims about the roaming market in the future favors DoJ far more than it does AT&T.

It Is Possible, But Difficult, to Prove a Claim About Backhaul or Other Indirect Anticompetitive Impacts.

AT&T won its clearest victory this round in getting the complaint about backhaul dismissed. But even here, AT&T took some damage and did not score a clean win. Huvelle did not reject the idea that backhaul could be an element despite the fact that T-Mobile has no backhaul facilities because it would indirectly lead to independent backhaul providers with whom T-Mo currently contracts exiting the market when T-Mo switches its backhaul to AT&T – although she expressed considerable skepticism. Nevertheless, she was careful to note that: “it has been established and as defendants concede (see Reply at 2), such an injury would be of the type that the antitrust laws are designed to prevent.” (p. 41-42).

The advantage gained by DoJ on this front is intelligence on how Huevelle is likely to evaluate harms based on theories of vertical integration and indirect harm as a consequence of the merger without the intent to exploit monopoly or monopsony power, and what evidence would be necessary to sustain such claims. Even if DoJ decides not to pursue a direct argument about the backhaul market, this intelligence fills in the gaps in the roadmap to a winning strategy and demonstrates that while such claims may be difficult, they are possible to win. Mind you, this section of the Order still ranks as an AT&T win, but it is noteworthy that even here DoJ picks up a modest tactical advantage at no cost to itself.

Immediate Impact: Settlement Cost Rises Again, Another Reality Check for DT and AT&T Investors.

In the short term, the order has two significant impacts. First, it directly raises the cost of settlement by keeping in two private parties who now must also be paid off to go away. On top of that, the DoJ understands that it’s position has continued to improve. As I and others noted at the beginning of the week, the more DoJ’s position improves, the greater the concessions AT&T would need to make in any settlement offer. Even if you believe (erroneously in my view) that DoJ filed the complaint as a negotiating tactic, at some point the cost of a settlement exceeds the value of the deal. At that point, AT&T and DT need to give up and figure out how to cut their losses.

In addition, this serves as yet another reality check to investors and analysts who have repeatedly and unconditionally accepted AT&T’s assurances about how this will unfold. AT&T assured everyone the DoJ would not challenge, then DoJ challenged. AT&T then told everyone that they had received inside assurances that this was “really” just a negotiating tactic, a characterization Acting Antitrust Division Chief Sharis Pozen vigorously denied. AT&T insists that DoJ’s case is unwinnable because it depends on “outdated” theories of antitrust. Then DoJ went and won an antitrust case on precisely the theory it has articulated here.

Here, AT&T confidently assured everyone that Judge Huvelle’s initial determination to keep the cases separate showed both that Sprint and C. Spire had no real claims and that Huvelle would be skeptical of the antitrust case against it generally. Turns out, not so much. Even discounting my assessment of the Order above, AT&T’s effort to spin this into a total win because it got a number of the claims dismissed should ring a little hollow after predicting that the court would dismiss the entire complaint.

All in all, between this and the H&R Block decision, the analysts still betting that this deal will still close and the investors who stand to save money by cutting their loses ought to take the events of this past week as a reality check. Things are not working out the way AT&T and DT senior management keep promising they will. AT&T keeps losing ground and being forced into less defensible positions. While it’s still early days, at what point do you stop just accepting the AT&T story and start looking to cut your losses by unwinding the deal.

Stay tuned . . . .