What antitrust law has to say about the next wave of telecom mergers

The following is a guest post by Hank Levine, a partner with our law firm affiliate, Levine, Blaszak, Block & Boothby, LLP.

It's spring, and a young investment banker's thoughts turn to ... telecom mergers. Since the original 1984 AT&T divestiture, there has been a spate of wireline and/or wireless mergers every few years. The last big wave saw AT&T gobbled up by SBC and the corpse of MCI bought by Verizon. Those were announced in early 2005 and closed about a year later. It's been over four years since those deals were hatched, so it must be time for another round.

Sure enough, reports are now circulating that Qwest has put its long distance network up for sale. And every week brings a fresh round of rumors about Sprint merging with ... someone. Usually AT&T and Verizon are named as likely buyers. But we're looking at a different world than we were in 2005, and for two (related) reasons, I think that neither of the surviving telecom mastodons is a likely buyer of Qwest's LD assets or Sprint.

First, the market is different than it was ten or even five years ago.Wireless services are a much larger factor, and AT&T and Verizon are by far the two largest wireless players, particularly in the enterprise market (where Sprint is weak and T-Mobile is virtually absent). In wireline interexchange services, Sprint has declined from a reasonably strong to a very weak third. Qwest has largely stood pat while working through a huge debt hangover. Although mergers and acquisitions over the past eight years have made the next tier of players (Level 3, XO, Global Crossing and tw telecom) larger, none is capable of being the principal network services provider to large enterprises. The bottom line is that the AT&T-Verizon duopoly really does look like a duopoly -- something AT&T and MCI never achieved.

Second, the Bush Administration's tolerance of market concentration and aversion to antitrust law as a tool for addressing it has given way to what promises to be a much more activist approach on the part of the Obama Administration. From 2001 through 2008 the Justice Department rarely came across a proposed merger it didn't like. No one expects that to be true from 2009 to 2012.

It's fair to ask whether it matters who buys Sprint or Qwest's LD assets. There are two major players, after all, so whatever the shape of the market it's not a near-monopoly and won't be unless AT&T buys Verizon or vice-versa. Should even a vigilant antitrust enforcer care if a major player acquires one of the half dozen or so smaller participants in a market?

To answer that it's worth remembering 1999, when MCI (then flying high under the leadership of the charismatic but felonious Bernie Ebbers) announced that it was acquiring Sprint in a move designed (according to CNET) to "create a telecommunications titan able at last to take on market leader AT&T on relatively equal terms." To snatch the prize, MCI beat out a (then-independent) BellSouth. Eight months later, in July of 2000, the Clinton Justice Department filed a lawsuit to block the deal, and the merger was promptly abandoned.

There were a number of rationales for the Justice Department's opposition to the MCI-Sprint deal. One that received a lot of press at the time was the theory that the combined company would have a monopoly over Internet traffic. But with one exception, all of the objections could have been answered by requiring the new entity to divest itself of certain assets, standard operating procedure in large mergers.

That exception -- and the reason I'm remembering the story -- was the difference between two and three strong competitors in a market. Despite outward appearances of intense rivalry, duopolies are actually quite stable -- each of the two participants in the market is aware of (and able to react quickly to) the pricing and price-related behavior of the other, with the result that robust pricing competition is less common than parallel price increases. The classic example in telecommunications is the cellular market in the 1980s and early 1990s, when, due to government licensing policy, there were two providers in each market and prices were high and stayed that way.

When there are three competitors, by contrast, the weakest often "cheats" on the oligopoly, benefiting customers and competition by offering pricing or other concessions to gain market share. Four is better than three, five is better than four, and so on. But the big break from a competitive standpoint is between two and three providers, which is why the deal rumor of the day has to be judged by whether it preserves the third major carrier option.

As an attorney who has been representing large users in negotiating telecom agreements for 20+ years, I have some experience with this phenomenon. Indeed, I was interviewed and then deposed by the Justice Department when it was investigating the MCI-Sprint merger. I testified that AT&T, MCI and Sprint were the only three carriers capable of serving as the primary provider of interexchange services to enterprise customers, and my deposition was cited a number of times in the papers filed by the Justice Department to block the merger. MCI was well aware of the concern, and sought to counter it by arguing that Qwest was also a substantial provider of telecom services to large enterprise customers. To prove that, it filed a list of (as I recall) 80 deals between large users and Qwest -- of which all but three proved on examination to be with telecom resellers, not end-users.

Ten years later, Sprint is weaker, but it remains the only carrier other than AT&T and Verizon that serves as the primary provider of complex network and wide-area services to large enterprise customers. Qwest is fourth, but a distant fourth, and its enterprise business remains thin and concentrated in commodity services -- voice minutes, not managed MPLS networks.

So at least from a customer perspective, the acquisition of Qwest's LD network or Sprint by anyone but AT&T or Verizon would be a positive development -- it would strengthen competition in the enterprise market by strengthening the market's "Chrysler." Conversely, the acquisition of Sprint or Qwest's LD assets by AT&T or Verizon would disproportionately weaken competition in the enterprise market.

In another nod to automobiles, note that it doesn't matter from a competitive perspective if the buyer is foreign or domestic, or if it is a big supplier in another market (such as IBM, which actually once owned 20% of MCI). In 1999 Deutsche Telecom was widely viewed as a potential purchaser of Sprint, and while that might have dismayed the breast-beating flag-wavers, it would have preserved/enhanced competition. All that matters is that the third provider not be bought by one of the first two.

As the capital markets recover, a play for Sprint is about as likely as clouds in Seattle, heat in Atlanta, and hot air in Washington, D.C. We'll see how it plays out as the season progresses.