A vertical merger is not, as you might suspect, one with an extra-tall stack of paperwork, but an acquisition in which a company buys a supplier or distributor rather than a competitor. Vertical mergers don’t reduce competition the way “horizontal” mergers between competitors do; indeed, it theoretically benefits consumers by reducing costs and streamlining production. Which is why the government has focused its antitrust enforcement on the horizontal variety, and has left vertical unions alone.
Of course, there are people who think the government should block vertical mergers. These critics don’t look at how much power the combined entity will wield over specific markets for goods and services; they view the size of the new firm as a problem even if it has a relatively small market share for any individual product. The critics especially worry about megadeals — such as a telecom giant buying a cable company.
But opponents of vertical mergers are mostly found on the left. So it was a little odd that the Justice Department moved last year to block the AT&T-Time Warner merger deal, especially given the unpersuasive case mounted by the government.
We can’t prove the Trump administration was trying to punish CNN’s parent company for its less-than-fond coverage of the president. But it sure does look that way. Which is why even mega-merger critics probably should be glad that a judge rebuffed the government.
It is AT&T shareholders who ought to be worried.
The theory behind AT&T-Time Warner sounds suspiciously like the theory behind another mega-merger — the landmark AOL-Time Warner deal that took place in 2000, shortly before the dotcom bubble collapsed. The merger was hailed as a piece of genius, a seamless content pipeline stretching from creative spark to the user’s eyeball. Less than 10 years later, the whole thing unraveled, having caused untold hardship for employees and shareholders.
How could something that seemed so right turn out so wrong? I learned one of the answers in 2001 while studying for an MBA under Austan Goolsbee, who later served as an economic adviser to President Barack Obama. He said: Let’s say you have a company with a valuable asset, such as, I dunno, a vast cable network. They make a lot of money from that asset, and you’d like to get your hands on some of it. What do you think they’ll charge you to buy the asset?
We MBA students dutifully repeated the mantra that we’d been taught: “The net present value of all future cash flows.” It was a fancy way of saying that you determine all the money you expect to earn, and then knock a percentage off the future earnings because a dollar today is worth more to you than getting that same dollar next year.
Then we looked at each other in surprise, having just eviscerated one of the main arguments we ourselves had been making for the splendors of the AOL-Time Warner deal.
Yes, after you buy a company that has a valuable asset, you’ll enjoy the profits that the asset throws off. But you won’t have the money you used to buy it, which you could have invested elsewhere. The deal isn’t obviously a net gain for shareholders. Especially since deals themselves are costly — the fees for lawyers and investment bankers are expensive, as is trying to combine two companies set in their ways of doing things.
Vertical mergers also create potential incentives to use resources inefficiently. It makes superficial sense for an airline to buy an oil refinery to hedge its fuel costs. But if oil prices spike, the airline would likely use the oil to keep flying planes, even if others were willing to pay more for the oil than the airline could make by burning fuel to fly its less-profitable routes. In the end, you’ve destroyed shareholder value and misallocated scarce oil.
In certain circumstances, vertical mergers do make sense. Say you’re an automaker who wants a supplier to locate a plant next to yours, reducing shipping delays. You’re asking the supplier to make a risky investment — what if you decide to stop making those cars? The sensible solution would be to buy the supplier outright. Such mergers also allow companies to share overhead and cut redundant operations, enhancing profits.
But do these gains outweigh the considerable expenses involved? The evidence suggests that most mergers destroy value for their shareholders, and mega-mergers are especially dubious. Which presents us with a certain irony. The AT&T-Time Warner decision is great news for American democracy: the judicial system operated as a strong check against possible presidential interference with the media. For shareholders in the new, combined company, though, this isn’t necessarily so encouraging.
Megan McArdle | The Washington Post
Megan McArdle is a Washington Post columnist and the author of ”The Up Side of Down: Why Failing Well Is the Key to Success.”
