CASE 19 Vertical and Horizontal Ownership in Cable TV: Time Warner-Turner (1996) Stanley M. Besen E. Jane Murdoch Daniel P. O’Brien Steven C. Salop John Woodbury INTRODUCTION After a twelve-month investigation, the Federal Trade Commission in 1996 approved, subject to certain conditions, the merger of Time Warner and Turner Broadcasting, creating, in the words of the merging parties, “a global media organization with the world’s foremost combination of news, enter- tainment, information resources and distribution systems.”1 The FTC al- leged that the merger was potentially anticompetitive because of (a) a hori- zontal overlap between the cable program services of the merging entities, (b) a vertical linkage between the Turner program services and the Time Warner cable television systems, and (c) the participation in the transaction of TCI, the nation’s largest cable television operator, which was a major The authors served as consultants to the attorneys who represented TCI before the FTC in the Time Warner-Turner merger. Because of space limitations, some issues related to the merger have been abbreviated, and some issues have not been addressed at all. The authors would like to thank Jonathan Baker, Christopher Bogart, Kathy Fenton, Robert Joffe, and Joe Sims for their helpful comments on earlier drafts. Of course, the views expressed here are the authors’ own and do not necessarily reflect those of TCI or any of the other participants in the merger. 1“Time Warner Inc. and Turner Broadcasting System, Inc. Agree to Merge, Creating the World’s Foremost Media Company.” Press release of Time Warner, September 22, 1995. 452 Case 19: Time Warner-Turner (1996) owner of Turner and which became an owner of Time Warner, the second largest cable operator, as a result of the merger.2 Time Warner was a large, diversified company with ownership inter- ests in magazine, book, and music publishing; the Warner Brothers motion picture studio; the WB broadcast television network; a large number of cable television systems; and five cable television program services, includ- ing, most prominently, Home Box Office (HBO), the largest and most successful premium cable service. Most of Time Warner’s cable interests were held through Time Warner Entertainment, a partnership with US West in which Time Warner had a 75-percent ownership share. Turner Broadcasting owned a number of cable television program services, including TBS, TNT, CNN, and the Cartoon Network, as well as a television broadcast station (WTBS), the Atlanta Braves baseball team, the Atlanta Hawks basketball team, and some movie studios. Ted Turner owned a major interest in Turner Broadcasting, and the transaction would make him Time Warner’s largest individual shareholder with an ownership stake of about 10 percent. The merger resulted in Time Warner’s adding the stable of Turner services to its ownership of HBO and its other pro- gram services. Moreover, it combined Time Warner’s extensive cable sys- tem ownership with the Turner services. A number of major cable television system operators, including Time Warner, TCI, Comcast, and Cablevision Systems, held ownership interests in Turner3 that would become holdings in Time Warner as a result of the merger. TCI held its interest through its Liberty subsidiary. Although Lib- erty was traded on the stock market separately from TCI, the FTC treated them as a single entity. Thus, TCI’s 23-percent ownership interest in Turner would become an approximately 9-percent ownership interest in Time Warner. TCI would now have a financial interest in Time Warner’s cable systems and program services. Table 19-1 summarizes the major cable in- terests of Time Warner, Turner, and TCI at the time of the transaction. TCI also entered into an agreement with Turner (the Program Service Agreement) that specified the terms under which TCI would carry the various Turner program services. The Agreement committed TCI to carry the services for twenty years in return for a price equal to 85 percent of the average price paid by other cable operators. A BRIEF HISTORY OF THE CABLE TELEVISION INDUSTRY Cable television initially developed as a means to deliver television broad- cast signals via antennas, microwave towers, and cables to consumers. The 2For a statement of the FTC’s views, see Federal Trade Commission, Analysis of Proposed Con- sent Order to Aid Public Comment, September 12, 1996. 3Time Warner had previously owned 23 percent of the Turner shares. 453 THE ANTITRUST REVOLUTION TABLE 19-1 Cable Subscribers and Program Service Ownership Interests (By Company, 1996) Time Warner TCI Turner Cable Subscribers 12,100,000 16,009,000 na National Video Cinemax (100%) BET (17.5%) Cartoon (100%) Program Services Comedy Central (50%) Court TV (33.3%) CNN (100%) (ownership share) Court TV (33.3%) Discovery (49%) Headline News (100%) E! (50%) Encore (90%) TBS (100%) HBO (100%) E! (10%) TCM (100%) Faith & Values (49%) TNT (100%) The Family Channel (20%) Fit TV (20%) HSN (80.4%) International Channel (50%) Intro TV (100%) NewSport (33%) Prime Network (33%) QVC (43%) Q2 (43%) Request TV (47%) Starz! (90%) TLC (49%) Viewer’s Choice (10%) Sources: Paul Kagan Associates, Inc., Economics of Basic Cable Networks, 1997, pp. 48–50; 1996, pp. 39–40; 1993, p. 38. NCTA, Cable Television Developments 21, no. 1 (Spring 1997): 14. relationship between broadcasting and cable was initially symbiotic, with cable systems providing either improved reception of local television sig- nals or service to rural areas without broadcast television stations, thereby increasing station viewership and advertising revenues. Eventually, how- ever, cable systems found that they could sell the reception of “distant” television broadcast signals to urban viewers who wished to augment the broadcast service they could receive over the air. Thus began the trans- formation of cable, from offering an improved antenna to becoming the source of a wide array of programming not available to over-the-air viewers. Because distant signals competed for viewers and advertising reve- nues, television broadcasters complained to the Federal Communications Commission (FCC) that cable threatened their economic viability, or at least their ability to satisfy FCC-imposed public interest obligations. Re- 454 Case 19: Time Warner-Turner (1996) sponding to these complaints, the FCC initially prohibited the importa- tion of distant television signals into larger markets and required cable systems to carry local broadcast signals. Until the early 1970s, the restric- tions on the carriage of distant signals effectively confined the growth of cable television mainly to rural areas with little or no over-the-air televi- sion service. In a further effort to protect television broadcasters from cable com- petition, the FCC imposed limits on the programming that cable systems could provide to their subscribers. In particular, the FCC prohibited the of- fering of series programs of any type, severely constrained the sporting events that could be carried, and permitted movies to be shown only if they were less than two or more than ten years old. These “antisiphoning” restrictions were adopted to prevent the migration of the most popular types of broadcast programming to cable. Notwithstanding these restrictions, HBO, which was then majority- owned by Time and subsequently became a wholly owned subsidiary, began offering uncut, commercial-free movies in 1972 as a “premium” service to cable systems in return for a portion of the fees that these ca- ble systems collected from their subscribers. However, FCC rules, com- bined with the high cost of using ground-based communications systems to deliver the service to individual cable systems, initially limited HBO largely to New York City. This changed when a young Time executive named Gerald Levin identified what would subsequently prove to be an historic opportunity. Noting that new FCC rules permitted a reduction in the size of “receive-only” satellite dishes, Levin convinced Time to use satellites to deliver HBO to cable systems across the country. This de- livery system dramatically reduced the costs of distribution and made it economical for HBO to reach cable systems throughout the United States. Equally important for HBO’s subsequent growth was a 1977 Court of Appeals decision that overturned the FCC’s restrictive “antisiphoning” rules, thus permitting HBO to obtain the rights to a much wider array of movies.4 The consequences were dramatic. In 1979, HBO had only about 2 million subscribers; by 1996, it had more than 18 million subscribers and was the leading pay-per-channel service, with access to virtually all cable households. Although the FCC began to relax its distant-signal restrictions in 1972, widespread carriage was still confined by the high cost and limited availability of the ground-based microwave relay systems that were then in use. Another young entrepreneur, Ted Turner, identified a way out of this difficulty. Turner, then the owner of a small independent UHF broad- cast station in Atlanta (and former America’s Cup winner), arranged to place the signal of his station on a satellite, thus making it available to any 4Home Box Office v. FCC, 567 F.2d 9 (D.C. Cir. 1977), cert. denied, 434 U.S. 829 (1978). 455 THE ANTITRUST REVOLUTION cable system with a receiving dish. Although copyright laws prevented Turner from collecting payments from the cable systems that retransmitted the signal of what became WTBS, Turner could obtain revenues from na- tional advertisers because the reach of his Atlanta station now extended to the entire country. This, in turn, permitted Turner to acquire more expen- sive programming, and the “superstation” concept was born. Turner demonstrated that “basic” services as well as “premium” ser- vices could take advantage of satellite delivery.5 Subsequently, Turner Broadcasting launched the Cable News Network (CNN). CNN offered the first competitive challenge to the news organizations of the three major broadcast networks.