FTC:WATCH® No. 570
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July 16, 2001
Albert A. Foer
Some merger proposals are so outlandish that you wonder why they were put forward. Today's case in point is the effort by EchoStar Communications to acquire its much bigger satellite-television rival, Hughes Electronic. Hughes, a subsidiary of General Motors, operates DirecTV. In effect, the number two TV satellite company would join with the number one TV satellite company to create the only TV satellite company. The press plays this up as a battle of egos, with Charlie Ergen, Chairman of EchoStar, trying to out-fox Rupert Murdoch, Chairman of News Corp. Murdoch thought he had his own deal for DirecTV in the coop before Ergen made this counter-move.
Now, some might consider the joinder of EchoStar and DirecTV to be a merger to monopoly. Indeed, there's an antitrust case pending in a federal court in Colorado, styled EchoStar Communications Corp. et al. v. DirecTV Enterprises, Inc., et al., in which EchoStar claims that DirecTV has illegally precluded competition on the merits in the market for high-power direct broadcast satellite ("DBS") television and equipment. Paragraph 76 of the amended complaint defines the relevant market as the "High-Power DBS Market," which subsequent paragraphs describe as dominated by DirecTV and constrained by extremely high barriers to entry.
But a funny thing happened on the way to trial. Defendant's motion for summary judgment, based on the market definition, was postponed and postponed. Meanwhile, EchoStar had entered the battle to acquire DirecTV, its sympathizers arguing in the press that this would not be a merger to monopoly, because the relevant market also includes cable TV. As will be noted in a moment, they are probably right about the relevant market, but wrong in implying that this ends the antitrust inquiry. Had EchoStar been forced to argue the summary judgment motion, this would have highlighted their inconsistent positions. I am told that EchoStar advised DirecTV that if it insisted on forcing the summary judgment motion to be heard while the merger was in play, this would not be good faith, because DirecTV's board had a fiduciary obligation to consider the EchoStar bid and the argument would necessarily place EchoStar in the position of arguing against itself, thereby undermining the merger bid! A stockholders' derivative action against DirectTV was threatened. Preposterous? It worked. The summary judgment proceeding has been put on hold.
So the issue turns to competition between cable TV and satellite TV. According to the FCC's Annual Report in January, 2001, "DBS is the principal competitor to cable television service." Not only does it moderate cable prices, but it is the main source of pressure on cable to expand channel capacity. DBS subscribers now represent over 15% of all multichannel video programming distributor ("MVPD") subscribers. There are currently many different cable companies (the top ten have close to 90 percent of all U.S. cable subscribers, but the recent Comcast bid for AT&T's cable business is predicted to set off a wave of consolidation). But in most geographic markets, one company has a monopoly. ("Overbuild" competition has the ability to serve only18.5 million homes whereas cable passes 97 million.)
DBS is growing much faster than cable. Whereas cable grew by about one percent from 1999 to 2000, DBS expanded at a rate of over 28 percent, spurred on by a change in the law that now allows DBS to present local and network affiliate signals. The FCC Report describes DirecTV as the nation's leading DBS service, with over 8.7 million subscribers, and EchoStar (with a recent growth of 65%) as having 4.3 million subscribers. A third company, Dominion, operates a niche family-oriented service with fewer than 1 million subscribers, using an EchoStar satellite.
For most of the markets in this country, a merger of DirecTV and EchoStar would reduce competition from three companies (one cable, two satellite) to a duopoly. In the approximately 330 communities where there is cable overbuild, the merger might be from four to three, rather than three to two. In rural areas that are not served by cable, the result would be a single provider of TV programming. (Depending on how you measure, this would place between 3.4 percent and 19 percent of the population under monopoly conditions.)
The situation is similar to that of last year's Heinz-Beechnut baby food merger. There, a successful merger would have brought the industry from three competitors to two. Heinz and Beechnut argued that neither was doing very well and that they were rarely competing on the shelf in the same store. Together, they projected, they could compete more effectively against the dominant baby food company, Gerber. But the Court of Appeals of the District of Columbia said there is a very high burden on a three-to-two merger, and the parties had not demonstrated such overwhelming efficiencies as to justify the loss of competition. Here, there is no argument that either EchoStar or DirecTV is a weak competitor, and no argument that they rarely compete against each other. But, they say, only a single satellite company can provide formidable competition to cable monopolists. You'd think it was cable that was growing at the rapid rate.
There may be something to the idea that with limited satellite capacity, one DBS company could be more efficient (by eliminating certain overlaps) than two. Let us assume for the moment that a single DBS has a lower marginal cost of delivering programming than a cable competitor. If there is only one DBS, it can do well by merely setting its price a little below the cable's, protected from the rain of aggressive price competition by the cable's monopoly umbrella. If there are two DBS competitors, not only will they keep each other honest, but their competition against one another is likely to pull down cable's price further than one DBS alone. And, in an industry where future technological improvement seems likely, there is probably an enormous dynamic efficiency in keeping the DBS companies pitted against each other.
Of particular concern is the problem of rural America, where the issue is not duopoly but monopoly. EchoStar's supporters suggest that rural rates could be regulated to reflect the rates charged in competitive markets. It seems, strange, however, to create a regulatory regime, a second-best solution, when a competitive regime already exists.
It is going to take one whale of a good story to convince the public that this merger is pro-competitive.
[Addendum that did not appear in FTC:WATCH: Indeed, the Wall Street Journal on July 16 reported that EchoStar had abandoned its quest, noting (without indicating the nature of the advice) that Ergin had in recent weeks turned to David Boies and Joel Klein for advice.]