AT&T Kills T-Mobile Deal as Regulation Turns into Industrial Policy

How the Federal Communications Commission Essentially Pulled the Plug on the Potential AT&T/T-Mobile Merger

AT&T this week pulled the plug on its proposed $39-billion purchase of T-Mobile, conceding defeat in the face of the Federal Communications Commission’s and the Department of Justice’s combined opposition to the deal.

Opponents of the merger may be celebrating today, believing they’ve struck a blow to wireless competition and consumer choice.

In the FCC’s effort to quash the deal, it turned to dubious tactics. Fearing that the AT&T-T-Mobile merger might get a more favorable hearing in court, the FCC, in a procedurally questionable move, released a staff report on the merger without any vote by commissioners.

An even-handed assessment of the proposed deal shows the document fails spectacularly by relying on cherry-picked data to support dubious observations and conclusions. It ignores critical facts including T-Mobile’s tenuous financial position and the critical need for available spectrum as millions of eager consumers snap up smartphones.

The 157-page redacted staff report is largely built on the FCC’s dismay of the “horizontal” union between AT&T and T-Mobile-that is, where one facilities-based wireless service provider buys another, reducing the field of national wireless companies from four to three.

But in insisting that the harm to consumers from of the potential consolidation outweighs the arguments in the merger’s favor, the report pays little attention to two enormous elephants in the room.

The first is T-Mobile’s failing financial health. The FCC casually disregards the fact that T-Mobile’s parent, Germany’s Deutsche Telekom, cannot afford the funds to keep T-Mobile competitive. And it’s even stopped investing in the T-Mobile’s U.S. fourth generation network upgrade. Nor does the FCC acknowledge the numerous forecasts from a cross-section of financial analysts that say, without this deal, T-Mobile’s value will plummet.

This sidestep is significant because the report takes great pains to argue that it is in the public interest that T-Mobile remain in the market as its own entity, particularly because it is “innovative” and “disruptive.”

As one of T-Mobile’s disruptive innovations, the FCC report cites the company’s introduction of wireless rate plans and discounts that are more varied and diverse than AT&T’s, Verizon’s, or Sprint’s (even if some of these pricing “innovations” are derived from the wireline and cable TV market). This is just one example of how the report veers into industrial policy. As a regulatory agency the FCC should not be basing policy decisions because it is impressed with the strategy of a specific market tactic. This is like a football referee unfairly penalizing a teams’ aggressive defense because he likes other team’s innovative passing game.

The FCC’s job is to ensure a level playing field and enforce laws and rulemaking. In the FCC’s view, T-Mobile isn’t just a competitor, but it’s a competitor in ways the FCC approves. And so, in the FCC’s eyes, it should be preserved as its own entity.

This isn’t an argument; it’s a judgment call. While praising T-Mobile’s competitive innovations, which are mostly in pricing, the report overlooks innovations competitors have made in other areas.

AT&T took the risk on partnering with Apple on the iPhone, which turned out to be a game-changer for mobile services. Verizon answered with Android, which is now the leading operating system for smartphones. Conversely, there have been areas where T-Mobile has lagged. For example, AT&T, Verizon and Sprint all have early termination fees that decrease over the life of the service contract. T-Mobile does not.

But even if the characterization of T-Mobile as the wireless industry’s sole disruptive innovator were indisputable, by commenting on the way T-Mobile positions itself in the marketplace, the FCC begs the question as to whether these tactics will be sustainable over the long run. What works for T-Mobile today might not tomorrow, especially when we go back the company’s financial problems.

Deutsche Telekom has made it clear that it will sell T-Mobile, if not to AT&T, then to another company such as América Móvil or even Google or Apple. After that, there is no guarantee that T-Mobile will continue to fill the role of “disruptive player.” Rather, there is every reason to expect the new ownership will adapt a business strategy suited to its own corporate objectives. That’s what kills the FCC’s assertion that blocking the merger would have preserved a disruptive competitor.

The report’s second major oversight is the spectrum shortage. Here the analysis is directly at odds with other FCC opinions. It’s also at odds with the National Broadband Plan, which deems the spectrum challenge important enough to warrant its own chapter.

“The growth of wireless broadband will be constrained if government does not make spectrum available to enable network expansion and technology upgrades. In the absence of sufficient spectrum, network providers must turn to costly alternatives, such as cell splitting, often with diminishing returns,” the report states.

Yet, instead of allowing natural market mechanisms, i.e., the AT&T and T-Mobile merger, to create greater efficiency through pooling spectrum, “costly alternatives” are exactly what the FCC staff suggests AT&T and T-Mobile should carry out instead. Specifically, the technocrats at the FCC suggest each company turn to costly but less-than-optimal technological fixes-like adding more spectrally efficient radio equipment to its networks and selling dual-mode devices that can work across a number of frequencies (as if most wireless phones don’t already have this capability).

There are other areas as well where the analysis falls short or simply goes off the tracks. Here are a few.

Market concentration

The FCC report relies on the Herfindahl-Hirschman Index (HHI), an economic formula that measures the size of companies in relation to the size of the industry as a whole. By this measure, the merger would create a wireless market that is so concentrated that it is detrimental to consumers. But most economists say that, by itself, HHI offers a dubious assessment. And in wireless, there are other measures, many of which come from the FCC itself, that suggest HHI is a poor metric for judging market power in wireless.

For example, in its current annual report on competition, the FCC reports that, as of 2010, 89.6 percent of the population can choose from as many as five service providers in their local market.

The FCC competition report also spotlights the declining cost of mobile broadband data service. “AT&T’s estimated price per megabyte (MB) for data traffic – calculated by dividing AT&T’s reported annual wireless data revenue by its reported mobile broadband traffic – has declined from $1.21 in 2008 to $0.35 in 2009 to $0.17 in 2010,” the FCC states.

True, HHI in the wireless industry has been increasing since 2007, but it stands in stark contrast as the only metric that runs counter to the wealth of data accumulated over the same period that indicates wireless is a highly competitive market. What damages the merger report’s credibility is that it makes HHI the foundation for its market consolidation argument, when clearly the metric is an outlier and likely to be specious.

AT&T and Verizon are treated as monolithic

A large number of paragraphs in the report begin with or contain words to the affect of “Without T-Mobile, AT&T and Verizon will…” as if the two companies, without check of another competitor beside Sprint, will execute identical strategies in lockstep.

While the merger would have resulted in 77 percent of the market being in hands of two companies, the operative words are two companies. Both companies aggressively compete. Even post-merger, AT&T and Verizon would have split that 77 percent roughly 43-34, respectively.

Year to year, the wireless industry is consistently near the top of the list in terms of advertising spending-a factor hardly indicative of a passive duopoly satisfied with maintaining the status quo. Plus there is Sprint and, despite the FCC’s efforts to downplay them, regional carriers such as Metro PCS, U.S. Cellular and C Spire Wireless, all of which take enough revenues away from AT&T and Verizon to be viable in local markets.

And if, as the FCC asserts, there is a portion of consumers that do not want to use AT&T, there’s no saying how they will affect the market shares of the remaining players. If the FCC is correct, anyone of these regional companies could emerge as a fourth national player by winning T-Mobile customers who eschew AT&T. In the airline industry, Southwest Airlines is a textbook example of a regional discount competitor that went national as its larger competitors consolidated and alienated one-time loyal fliers.

Failure to appreciate the pace of change:

Finally, the report fails to account for how fast business can change. The most glaring example is in the report’s detailed analysis as to how the merger would have hurt the wholesale market for spectrum-groups of frequencies that companies like Virgin Mobile and some cable TV companies buy in bulk and use to market their own branded service.

Since T-Mobile is particularly active in the wholesale market, the report argues that if merged, resellers will lose an important source of wholesale spectrum. AT&T and Verizon (assumed again to be monolithic bad guys) would not be interested in wholesaling causing reseller alternatives to disappear, the report says without much support.

Well, before the office printers on K Street had a chance to cool from running off hard copies of the 157-page report, Verizon agreed to purchase spectrum held by a consortium of cable companies as part of a broader agreement to wholesale it back-precisely the arrangement that the FCC argued would vanish if AT&T and T-Mobile were allowed to merge.

The Verizon deal represents more than a missed call on the FCC’s part; it was downright embarrassing, illustrating how tenuous government observations, opinions and conclusions about markets can be.

It was not so surprising to see the FCC oppose the merger. What is surprising is how bad its reasoning is. Premises are chosen based on the weight they give conclusions, while market realities are ignored. As a result, Americans will have to deal with slower broadband wireless while the FCC continues to wring its hands over the spectrum crunch preventing the private sector from taking action to solve it.

I’m not sure who wins here. All we gain from the FCC staff report on the now failed AT&T/T-Mobile merger is an illustration of the mess that can be made when regulators try to make themselves central planners.

Steven Titch is a telecommunications policy analyst at Reason Foundation.