Why the EchoStar/Hughes Merger Can't be Fixed

Why the EchoStar/Hughes Merger Can't be Fixed

by Jonathan Rubin
[Dr. Jonathan Rubin is a lawyer and economist in Washington, D.C. He produced this evaluation of the latest proposed remedy for an EchoStar/DirecTV merger specially for the American Antitrust Institute. Inquiries may be directed to JRubinUS@att.net.]

On October 31, 2002, the Antitrust Division of the Department of Justice (DOJ) filed suit to challenge the proposed combination of EchoStar Communications Corporation-the number two direct broadcast satellite (DBS) operator, with more than 7.5 million subscribers-and Hughes Electronics Corporation-owner of the leading DBS operator, DirecTV, with more than 11 million subscribers. The complaint, which followed on the heels of the Federal Communication Commission's refusal on October 18 to accept the deal, provides an accessible description of the industry and the proposal as well as a compelling explanation of why the DOJ believes it would be anticompetitive. [See http://www.usdoj.gov/atr/public/press_releases/2002/200412.htm.] The American Antitrust Institute (AAI) opposed the combination in a letter to the DOJ in November, 2001, [http://www.antitrustinstitute.org/recent/150.cfm] and is gratified to see the complaint issue. Because there are reports that EchoStar intends to pursue its efforts to persuade DOJ that it has a new proposal for remedying the anticompetitive aspects of the merger, we have prepared this analysis, based on newspaper reports of the alternative proposal. DOJ has already said in the press release that accompanied the complaint that it has concluded that "even if the proposed concept could be realized, it was unlikely to become a sufficient replacement for the vigorous competition that now exists between Hughes and Echostar within a reasonable period of time." The complaint, of course, does not discuss the new proposal. Based on the sketchy information available, I would agree that the latest "fix" is unlikely to do the job.

A Quick Review of the Problem

The most severe problem faced by the merger proposal is that it would provide little or no benefit to consumers to counterbalance the dramatic increase in concentration it would engender in the multichannel video program distribution (MVPD) industry, consisting primarily of cable systems and DBS broadcasters. With only one other fringe operator having about a million subscribers, and a few other companies vying to enter the DBS business sometime in the future, EchoStar and Hughes are presently the only DBS players of any consequence.

Their merger would reduce the number of effective DBS competitors from two to one. In a vein reminiscent of the failed Heinz-Beechnut baby food merger (FTC v. H.J. Heinz Co, 246 F.3d 708, D.C. Cir. 2001), the parties argued that the merger was necessary to ensure the ability of DBS to compete against a fairly well-entrenched cable industry. But the FCC rejected this argument. Neither EchoStar nor Hughes could be considered "weak" or in danger of failing in the absence of an approval of the merger. Indeed, subscriber growth for DBS has been substantially greater than for cable, and competition between them is robust. The proposed merger would have allotted all three continental US (CONUS) satellite positions to a single company, rendering them the exclusive "gatekeeper" for nationwide satellite service. While this certainly may have yielded the merged entity some increased technical efficiency, there is little to suggest that the merger will provide any meaningful improvement in competitive conditions or consumer services over the status quo.

Another justification put forward by the parties is that the merged entity would be able to offer local-into-local service to all 210 U.S. designated market areas (DMA'S) immediately, while the individual firms will have to do some further build-out to do so independently. This is not enough, however, to justify the anticompetitive effects of the merger. Although consumers in some DMA's may have to wait a little longer for local-into-local service absent the merger, a recent report from the GAO [http://www.gao.gov/new.items/d03130.pdf] finds that local-into-local service is a significant factor for consumers choosing between cable service and DBS. Thus, the business rationale certainly exists for the two DBS firms to prioritize the capital investment needed to independently provide local-into-local service in the not-too-distant future.

An Attempt to Fix the Merger

To remedy the monopoly-DBS result, the parties reportedly have proposed to include a divestiture and/or leasing of substantial transponder assets to Cablevision Systems Corporation, owner of R/L DBS Company (known as "Rainbow"), and to joint venture with Cablevision in the provision of set-top boxes and local-into-local programming. It would also provide assistance in establishing retail outlets. Rainbow is the licensee of 11 frequencies at the easternmost U.S. DBS orbital slot. It intends to launch its Rainbow 1 DBS satellite in March, 2003 and to put it into service by December 31, using 13 transponders, including the 11 already licensed to it. But without additional transponder space, some technical experts doubt that Rainbow could compete effectively in the westernmost regions of the U.S. The additional assets and other assistance proposed by EchoStar/Hughes are designed to ensure that Rainbow emerges as a nationwide competitor to the merged entity, thereby providing a structural remedy to the DBS-monopoly that the merger would create.

The Horizontal Merger Guidelines require as a condition for approving an otherwise anticompetitive merger timely replacement of lost competition-usually interpreted as meaning within two years-and that the new competition must be likely and sufficient enough to exert a restraining influence on the prices charged by the merged entity. In all likelihood, the proposed fix failed to sway the Antitrust Division because it's questionable on all three grounds: the timeliness, likelihood, and sufficiency of the competition from the new entity would be far from certain.

The entry of a new DBS service faces substantial barriers and represents a huge undertaking. As to timing, the FCC's Order expressed doubts that even the more modest proposed Rainbow service (i.e., without the additional EchoStar assets) could be fully operational within two years. There is even greater doubt that the more ambitious goal of providing nationwide competition could meet such a timetable. Unless the new competitor emerges within the two year period, the Guidelines ignore consideration of the potential entrant in the structural analysis.

Moreover, even assuming the adequacy of the two-year time frame, the successful entry of a start-up DBS operator with zero initial subscribers will require substantial resources and make extreme financial demands on the new entrant. While the parties' estimates put start-up costs for a new nationwide DBS service at $2 billion, others have estimated that the requirements are closer to $5 billion. If the necessary financial resources do not materialize on terms palatable to Cablevision, the firm may decide to cut its losses by closing up shop or severely scaling back its plans, thereby vitiating the envisaged structural fix.

Finally, even if timely entry on the scale contemplated were possible, it is not clear that the Rainbow service would provide sufficient competitive pressure to constrain prices. Were the merger to be approved, the new entrant would find itself operating in the shadow of a dominant entity with upwards of 18 million subscribers and gross revenues in the neighborhood of $864,000,000.00 per month. In order to provide a structural fix, the new competitor not only has to survive, but thrive. This represents a substantial risk for the antitrust authorities. To attenuate that risk, the authorities would need to establish a fairly pervasive regulatory regime-contrary to the clear and longstanding intent of Congress and the regulators-to assure that the newcomer was treated fairly by the merged entity. Dependent for its very survival on its much larger rival, Rainbow would have to rely on such regulatory oversight to ensure that the merged entity not only lived up to its expressed undertakings, but did not so vigorously compete that it crushed the new entrant before it could achieve enough critical mass to operate as a profitable DBS provider.

In light of these risks, it seems clear that the "fixed" merger proposal would result in a much more fragile and vulnerable market structure than the fairly well-balanced DBS competition that presently exists under the status quo.

Relief for Rural Consumers?

Another reason the divestiture/assistance proposal will not remedy the anticompetitive effect of the merger is that it fails to address one of the most serious drawbacks-the specter that rural customers in markets not passed by cable would have only one MVDS service to choose from. It would be natural for Cablevision to concentrate building its name recognition and retail distribution in the relatively more profitable urban areas instead of in sparsely populated rural areas. In the absence of regulatory oversight, there is little reason to believe that the new Rainbow service will be readily available in rural areas, where DBS competition is needed most. Even if rural areas not served by cable are inside of Rainbow's footprint, customers in those areas would need receiver equipment and customer service. With existing subscribers and well-established retail outlets in many such areas, the merged entity would have a substantial leg-up on the new entrant. It should not be assumed that just because the new entrant would illuminate the non-cable rural areas, it would provide such consumers-nearly 40 million of them-with an effective competitive alternative to the New EchoStar.

The Broadband Product Market

Another important failure of the proposed fix is that it would do nothing to ameliorate the resulting monopoly in satellite-delivered broadband services. Rainbow has not proposed to offer broadband services. The merger would thus eliminate competition in the satellite broadband product market, and in rural areas where no digital subscriber line (DSL) or cable services are available, it would eliminate competition in the delivery of broadband services altogether. This contrasts with the status quo, with both EchoStar and Hughes capable of providing delivery of broadband services independently. At present, this may be a fairly minor aspect of the merger, but new technology which will soon be available to satellite operators will greatly enhance the quality and attractiveness of their broadband services. Thus, even with the proposed fix, the merger can easily have deleterious consequences for broadband competition over the longer term.

A Fix-Specific Antitrust Problem

The proposed fix also raises the problems associated with the common ownership by Cablevision of a new DBS system as well as its cable system, with its substantial penetration in the New York-New England region. As things stand, consumers in markets served by Cablevision have the choice between at least three competing MVPD operators: DBS from EchoStar or from DirecTV, and cable services from Cablevision. In areas served only by Cablevision, the fixed merger would reduce consumer choice from three firms to two. Competition between Rainbow and Cablevision's cable service would be an illusion-it cannot be assumed that the firm will effectively compete against itself. The most populous markets in the country are in the northeast, and the loss of a competitor there would not be insubstantial. The proposed remedy does little or nothing to attenuate the anticompetitive impact of the merger on consumers in Cablevision's exclusive service areas.

Conclusion

The EchoStar/Hughes merger was ill-conceived from the start, but it also cannot be fixed. The parties need to prove that in spite of the resulting increased concentration in the MVPD market, the merger would result in substantial countervailing benefits to consumers. The attempt to do so by arguing the merits of stronger competition against cable is belied by the fact that healthy competition between DBS and cable-and between the merger partners themselves-already exists. In rural areas not passed by cable and in the northeast, the proposed structural remedy does not remedy anything at all. In other markets, there is substantial risk that the new entrant will not develop into an effective and robust competitor, absent pervasive and objectionable regulatory oversight. It is also worth noting that the spectrum allocation efficiency argument put forward by the applicant before the FCC is severely undercut by a remedial proposal that would require a new competitor to send duplicate transmissions to reach both East- and West-coast markets. The merger proposal illustrates an old adage, "If it ain't broke, don't fix it." The proposed merger fix illustrates a new one, "If it ain't broke, but you try to fix it anyway, you can't fix the fix."