Exclusion Still Doesn’t Explain Verizon’s Stock Price Non-Reaction to the DOJ Challenge Announcement (Correcting AAI’s Letter to the WSJ Editor)
Yale’s George Priest authored an op-ed in the WSJ on September 6th in which he raised a few of the arguments discussed here at TOTM over the past several weeks regarding the proposed AT&T / T-Mobile merger. For example, we’ve focused upon the tension between the DOJ complaint’s theories of competitive harm (coordinated and unilateral effects) and the reaction of Sprint’s stock price. Along these lines, Priest writes:
If the acquisition would lead to increased prices and lower quality products as the Justice Department has claimed, Sprint would be better off after the acquisition. Sprint would be able to add subscribers, not lose them, because of AT&T’s higher prices and lower quality. Sprint would oppose the acquisition—as it has—only if it thought that the merger would put it in a worse position by increasing the competitive pressures that it already faces.
The market—though not the Obama administration—understands this point. On the day that the Justice Department announced its opposition to the acquisition, Sprint’s share price rose 5.9%, reflecting investors’ belief that Sprint will be in a better competitive position without the acquisition.
As we’ve pointed out, Sprint’s stock price reaction is simply not consistent with the DOJ theories. To find a theory of harm more consistent with the market reaction, critics of the merger have abandoned the DOJ’s theories in favor for a new one — that the merger will facilitate future exclusion of rivals from access to critical inputs like backhaul or handsets.
The AAI’s Rick Brunell makes this point in our comments. The basic point is that under an exclusion theory Sprint benefits from the challenge to the merger because it prevents its future exclusion. Brunell also argued in that comment that Verizon’s stock price movement supported exclusion theories of the merger, pointing out that its stock price fell 1.2% (with a .7% drop in the S&P 500) upon announcement of the challenge.
We challenged the economic logic of Brunell’s claim that Verizon’s non-reaction was consistent with exclusionary theories in a follow up post. Put simply, assuming the merger will result in successful exclusion of rivals in the future, Verizon would be a gigantic winner from its successful completion:
The relevant economics here are not limited to the possibility that post-merger AT&T would successfully exclude Verizon. Think about it: both Verizon and the post-merger firm would benefit from the exclusionary efforts and reduced competition. However, Verizon would stand to gain even more! After all, it isn’t paying the $39 billion purchase price for the acquisition (or any of the other costs of implementing an expensive exclusion campaign). Thus, an announcement to block the would-be exclusionary merger — the one that would allow Verizon to outsource the exclusion of its rivals to AT&T on the cheap — wouldn’t happen. Verizon stock should fall relative to the market in response to this lost opportunity. The unilateral and coordinated effects theories in the DOJ complaint are at significant tension with the stock market reactions of firms like Sprint (and its affiliated venture, Clearwire). The exclusion theory predicts a large decrease in stock price for Verizon with the announcement. None of these comfortably fit the facts. Verizon more or less tracks the S&P with a slight drop. What about the smaller carriers? Take a look at the chart. MetroPCS barely moved relative to the market (in fact, may have increased relative to the market over the relevant time period); Leap is down a bit more than the market. Here, with the smaller carriers there is not a lot of movement in any direction. But, contra NB’s comment (“Verizon, a larger and far more significant competitor, had its stock drop sharply in that same period you show Sprint “surging”. MetroPCS’s stock also dropped.”), Verizon’s small fall relative to the market is nowhere near the magnitude of the positive effect on Sprint and Clearwire.
In other words, contra Brunell and other proponents of the exclusion theory, its not just that Verizon has “nothing to fear” from exclusion but that it has much to gain from it. If the merger is likely to exclude Verizon’s rivals at a price tag of at least $39 billion paid with its chief competitor’s dollars, the announcement of a challenge should have resulted in a substantial loss for Verizon not one barely detectable beyond market trends. Excluding rivals and gaining market power with other people’s money is good work if you can get it. If proponents of the exclusionary theory believe exclusion is worth $39 billion for AT&T and is the purpose of the merger, surely they also believe it is worth something quite significant to Verizon who would reap the benefits of exclusion and get it for free.
Unfortunately, AAI (through Brunell) ignores this point in a Letter to the Editor to the WSJ filed in response to Priest’s op-ed:
Mr. Priest ignores the fact that Sprint would be harmed if the merger enhanced AT&T’s (and Verizon’s) ability to exclude Sprint from the market (or raise its costs) through increased control over the best handsets, roaming and backhaul services that Sprint needs to compete effectively in the market, as Sprint alleges in its own lawsuit challenging the merger. Sprint also benefits, from the merger’s demise, as a potential acquirer of T-Mobile.
Mr. Priest also ignores the stock-price movement of Verizon, AT&T’s chief rival, which has no reason to fear exclusion from the market, and would be harmed the most if the merger made AT&T a more efficient competitor. In the two days following the merger announcement in March, Verizon’s stock price jumped 3.1% (compared to the S&P 500’s increase of only 1.1%), while in the two days after the Justice Department’s suit was announced, Verizon’s stock fell by 1.2% (compared to a .7% drop in the S&P 500). Verizon has not opposed the merger.
Event studies of stock-price movements are notoriously inconclusive. However, the data here are entirely consistent with investors’ expectation that the merger will result in less price and quality competition in the industry and higher costs for AT&T’s smaller rivals, all to the detriment of consumers.
If you are keeping score at home: Priest 1 – AAI 0. Once again, the exclusion theories don’t seem to hold up to these data. On the other hand, the DOJ theories are embarrassingly confronted by the response of the rival’ stock price surging upon the announcement of a challenge. For what its worth, I agree with Brunell that event studies are not dispositive of a merger’s likely effects — though query what data available to predict merger outcomes are? But event studies and stock-price movements produce valuable information. In this case, financial market responses cut against the the exclusionary theory favored by AAI and Sprint and the conventional DOJ theories.
Filed under: antitrust, doj, economics, exclusionary conduct, merger guidelines, mergers & acquisitions, telecommunications, wireless