AT&T (NYSE:T) has made a lot of news the last few weeks, first with its Time Warner (NYSE:TWX) merger and now with the launch of DirecTV Now, its new digital TV service. Among the many details of the new service was one almost calculated to incite the FCC to anger and action: DirecTV Now will be exempt from all data caps on AT&T's network, a giant competitive advantage over other video services and a blatant and unmistakable violation of the FCC's net neutrality policy.
I am still digesting the implications of DirecTV Now itself, so I won't write on that for a few more days until my thoughts settle a little. But one thing jumped to my mind right away: This second initiative from AT&T may have done serious damage to its first, the Time Warner merger.
Those seeking a strong argument for why the merger will go forward should check out this article from Seeking Alpha contributor Steven Mallas, saying that the merger's prospects were good. I was never quite convinced of that, but held my tongue since the evidence did seem truly mixed. After the announcement of DirecTV Now, however, I see the merger's prospects as less likely than ever.
The White House
A few weeks ago, I was going to write an article about the regulatory prospects of the merger, but CNN had already run an excellent piece summarizing the pertinent points. In short, it doesn't look good. Both of the persons who had a real shot to be the next President of the United States expressed opposition to mergers as a general matter, so even if President-elect Trump hadn't specifically promised to kill the deal, it was always going to be a hard sell to the White House.
The position of the incoming administration on the merger is a somewhat curious, if not schizophrenic one. On the one hand, Donald Trump is on record blasting the merger, and promising voters very loudly and publicly that he would never let it through if he was elected. On the other hand, his appointments to key positions responsible for reviewing the merger have all been traditional, pro-business Republicans with a history of helping private companies ameliorate - or just avoid - federal regulatory intervention.
I don't want to say too much about this particular point. No one really knows what Trump is going to do since he hasn't taken office yet. And my family, like many, has spent enough time arguing about the presidential election. So rather than pour gasoline on that fire, I will simply say that Trump's approval is by no means assured. A public pledge like that might be hard to break. On the other hand, his appointments suggest that maybe that's being considered.
But even if it is, the White House is only one of several hurdles.
Department Of Justice
The biggest selling point of the deal, to gain regulator approval, is that these companies are not direct competitors like AT&T and DirecTV were. And that deal was allowed to go through. But in some ways this deal is actually more anti-competitive. AT&T's U-Verse was a relatively minor player in the Pay-TV space that was losing money on its service and might have just shut down if it wasn't allowed to find a partner.
So the impact on competition was relatively small. This merger, while it is vertical rather than horizontal, involves two of the biggest players on both levels. The best analogy is not DirecTV, but Comcast (NASDAQ:CMCSA) and NBCUniversal.
That deal was allowed to go through too, of course. But DOJ was absolutely roasted for allowing it. Comcast has repeatedly been caught violating some of the conditions it agreed to have imposed on it in exchange for the deal going forward, and many of the fines for such violations are deemed too small to be an effect Many DOJ officials have now expressed regrets for not blocking the deal completely. They may well see this as an opportunity to make amends for the past, and prove they've learned their lesson.
AT&T will of course protest that it is unfair to punish it for something Comcast did, a company with which it has no affiliation. And AT&T has already promised that it does not intend to use Time Warner content as a tool in negotiations or to ward off competition, pledging equal access to content for all distributors.
But those promises are not believed by all, and may not be in the DOJ either. Several Wall Street analysts questioned why AT&T even wanted to acquire Time Warner if it didn't plan to use its content as leverage in negotiations with other providers. It just seems too obvious a tactic not to be used by a profit-maximizing corporation.
But even without any guilt by association, the concerns about the implications to competition would have been all but prohibitive in any event. Even if the new AT&T is prohibited from doing anything as explicit as withholding content or charging discriminatory rates, the sheer size of the combined company will almost certainly give it the controlling vote on the broader direction of the industry. One analyst went so far as to say that the merger could be a "death sentence" for the skinny bundle, just by virtue of the fact that one of the key players opposed to skinny bundling will get so much bigger.
Biting The FCC's Hand That Feeds
Set that aside for a moment as well, however. Assume, despite the bad history and the hard questions, the DOJ signed off on it. If Trump wanted them to he could certainly force the issue, although overriding the career, non-partisan experts at DOJ in that way would certainly carry a lot of bad press. But assume that AT&T's word it won't misbehave on the content front is good enough for the relevant authorities.
It still might not be enough. In trying to dispel one set of worries, AT&T CEO Randall Stephenson may have only lent fuel to another. In comments to the media following the merger announcement, Stephenson said that the reason he didn't see the need to use content as leverage was because he fully intended on using AT&T data on customer Internet history, viewing patterns, and other information gleaned from AT&T's existing operations to help target advertising better during programming and also help the new company figure out which content to run, what customers wanted to watch, a little like Netflix (NASDAQ:NFLX) does. In fact, AT&T recently took a controlling interest in INVIDI, a software provider that can help tailor advertisements to personal tastes and history.
And this is where I see a connection between DirecTV Now and the Time Warner merger. There is nothing wrong with personalized advertising, of course. Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and Facebook (NASDAQ:FB) do it all the time. But there are privacy concerns with such tracking, and a little bit of humility, a willingness to acknowledge and work through concerns, goes a long way. That is not the path AT&T has taken, however.
Instead, by openly challenging the FCC on net neutrality - the same agency that polices privacy - it has sent the message that it doesn't regard FCC rules as all that worthy of deference or respect. And there is no telling if that same attitude extends to the FCC's privacy rules, a fact which will probably make them much more reluctant to even let AT&T have the data in the first place. Or at least to own the content powerhouse that will make it so much easier to get it.
The FCC has already blocked several telecom mergers including AT&T's own deal with T-Mobile (NASDAQ:TMUS). It has proven it is more assertive than in years past. Even if the White House and DOJ both signed off, after a challenge this direct, I just can't see the FCC doing so. And unlike the DOJ, the FCC is a completely independent agency. It cannot be ordered to approve something it doesn't want to, even by the President.
Potentially, AT&T could maneuver around the FCC entirely if it was willing to sell off all of the broadcast stations Time Warner owns, thereby denying the FCC jurisdiction to review the deal at all. But the Department of Justice also has a few blocked deals to its credit lately, including the Baker Hughes (NYSE:BHI)/Halliburton (NYSE:HAL) deal and the Pfizer (NYSE:PFE)/Allergan (NYSE:AGN) merger. And DOJ jurisdiction cannot be evaded on any merger. And I don't see them going along, either, despite the new Attorney General.
The Day After
The good news for AT&T shareholders is that the damage from a blocked merger should be limited. AT&T has at least learned that lesson from its T-Mobile debacle - it will only owe Time Warner a relatively paltry $500 million if the deal is blocked by regulators, compared to the $7 billion it owed T-Mobile following the collapse of that deal. In fact, the fee is only 30% of what Time Warner will owe AT&T if the deal is broken up on their end.
Nor does the deal have to mark the end of AT&T's efforts in the content space. The Time Warner transaction surprised most market observers for its sheer size. Despite the high price tag and questionable returns of its DirecTV investment, the reports were that AT&T was willing to spend another $50 billion on media company acquisitions if the right deal or deals came along.
Of course, the right one did, or at least appeared to. And it was so good AT&T was willing to spend $109 billion, more than twice the ballpark figure that had been speculated on. The demise of the merger would merely send it back to the shopping mall, for something a little more appropriately sized that might pass regulatory muster.
The merger's prospects seem to me even dimmer now than they did last week. But the small break-up fee and potential for other content deals suggest to me that AT&T will bounce back quickly from whatever hit the merger's collapse may produce. The hit to Time Warner, which was being purchased at a substantial premium, is more likely to inflict real pain. I would avoid Time Warner stock right now.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.