What Does the Stock Market Tell Us in the Aftermath of the Failed AT&T / T-Mobile Merger?

Josh Wright —  20 December 2011

In the wake of the announcement that AT&T and T-Mobile are walking away from their proposed merger, there will be ample time to discuss whether the deal would have passed muster in federal court, and to review the various strategic maneuvers by the parties, the DOJ, and the FCC.  But now is a good time to take a look at what the market is predicting — and what that has to say about the various theories offered concerning the merger.  In prior blog posts, we’ve examined the stock market reaction to various events surrounding the merger — and in particular, the announcement that the DOJ would challenge it in federal court.

For a brief review, there are two primary theories that the merger would reduce competition and harm consumers.  Horizontal theories predict that the post-merger firm would gain market power, raise market prices and reduce output.  On these theories, Sprint and other rivals’ stock prices should increase in response to the merger; thus, if the DOJ announcement to challenge the merger reduces the probability of the post-merger acquisition of market power, Sprint stock should fall in response.  We know that it didn’t.  It surged.   That is consistent with a procompetitive merger because the challenge increases the probability that the rival will not face more intense competition post-merger.  Thus, Sprint’s surge in reaction to the DOJ announcement is consistent with the simple explanation that the merger was procompetitive and the market anticipated more intense competition post-merger.

Of course, as AAI and others have pointed out, Sprint’s stock price surge in response to the merger challenge was also consistent with “exclusionary” theories of the merger that posit that the post-merger firm would be able to foreclose Sprint from access to critical inputs (in particular, handsets) required to compete.  Richard Brunell (AAI) made this point in the comments to our earlier blog post, relying upon the fact that Verizon’s stock fell 1.2% (compared to market drop of .7%) to emphasize the applicability of the exclusion theory.   The importance of Verizon’s stock price reaction, the argument goes, is that while Sprint has to fear exclusion by a combined ATT/TMo, Verizon does not.  Thus, proponents of the exclusion theories assert, the combined surge in Sprint stock with Verizon’s relative non-movement is consistent with that anticompetitive theory.

Not so fast.  As I’ve pointed out, this conclusion relies upon an incomplete exposition of the economics of exclusion and one that should be difficult to square with your intuition.  If Verizon has nothing to fear from the post-merger firm excluding Sprint, it should greatly benefit from the merger!   Consider that if the exclusion theories are correct, Verizon gets the benefit of free-riding upon AT&T’s $39 billion investment in eliminating or weakening one of its rivals.   Surely, the $39 billion investment to exclude Sprint and other smaller rivals — as the exclusion proponents argue is the motive for merger here — provides considerable benefits to Verizon who doesn’t pay a dime.  Thus, rather than holding constant, Verizon’s stock price should fall significantly in response to the lost opportunity to appropriate these exclusionary gains for free.  Verizon’s stock non-reaction to the announcement that DOJ would challenge the merger was, in my view, inconsistent with the exclusion theories.   In sum, the market did not appear to anticipate the acquisition of market power as a result of the merger.

We now have a new event to use to evaluate the market’s reaction: AT&T and T-Mobile abandoning the merger.   It appears that, once again, Sprint’s stock price surged in reaction to the news (and now up about 8% in the last 24 hours).  Again, Verizon doesn’t move much at all.

Stock market reactions and event studies — and I’m not claiming I’ve done a full blown event study here,  just a simple comparison of stock price reactions to the market trends — produce valuable information.  They are obviously not dispositive.  The market can be wrong.  But so can regulators.  And as my colleague Bruce Kobayashi said in an interview (which I cannot find online) in Fortune Magazine evaluating the market reaction to the Staples-Office Depot merger in light of the FTC’s challenge: “It boils down to whether you trust the agencies or the stock market. I’ll take the stock market any day.”

Markets provide information.  The information provided here gives no reason to celebrate the withdraw on the behalf of consumers, or even the ever-present “public interest.”  Celebratory announcements to the contrary should be read with at least a healthy dose of skepticism in light of information above (and see also Hal’s excellent post) that the market did not anticipate the merger to facilitate the acquisition of market power via the combination of AT&T and T-Mobile or through the exclusion of Sprint.   Media reports that the merger was a “slam-dunk” in terms of the economics or that this is a tale of dispassionate economic analysis defeating the monopolist lobbying machine are misleading at best.   More importantly for the future, abandoning this merger does not repeal the spectrum capacity constraints facing the wireless industry, the ever-increasing demand for data, or the dearth of alternative options (despite the FCC’s claims that non-merger alternatives abound) for acquiring spectrum efficiently.

This will be a very interesting space to watch as the agencies deal with what will undoubtedly be other attempts to consolidate spectrum assets — especially in light of the FCC Report and the framework it lays down for evaluating future mergers.

5 responses to What Does the Stock Market Tell Us in the Aftermath of the Failed AT&T / T-Mobile Merger?

  1. 

    I don’t think simple helps you here Paolo. First, the simple economics are that if the merger is anticompetiitve a la the DOJ complaint we expect to see a decrease in S’s stock in response to a merger challenge or failure, not a surge. You are contending that the probability that this merger failing indicates S is a viable target for T-Mobile — certainly a possibility, even if remote (at the time, Verizon, Google and Comcast were among the most frequently rumored possible buyers) — is enough to drown out any possible anticompetitive effects. Your argument cuts against those anticompetitive theories, not for them. Second, your explanation also has other testable implications. The failure of the merger should signal an opportunity for all sorts of other carriers with spectrum assets and thus their stock should also surge in recognition of the new opportunity. Again, this isn’t borne out in the data. Third, just as a practical matter, and there has been quite a bit of commentary on this point, Verizon was the most likely desired buyer for Sprint. Whatever opening the merger rejection created for T-Mo, it likely closed for Verizon based on the shares you describe above. Fourth, the loaded FCC Report closes that opening further even with the most charitable reading.

    Feel free to take the market reaction with a grain of salt or two if you like — but the information has proven to be valuable. And while the possibility that the merger rejection explains the Sprint stock increase is interesting, I don’t think it squares with the evidence generally, and most importantly, simply doesn’t provide a defense of the view that the merger is anticompetitive.

    Feel free to have the last word.

    • 
      Paolo Siciliani 22 December 2011 at 2:02 am

      Josh, I am sure you are quite familiar with Popper’s teachings. I wasn’t trying to provide a defence of the view that the merger is anticompetitive, I was simply trying to confute your attack of that view, providing a perfectly reasonable alternative explanation for the observed stock price movement, so please, don’t twist my words.

      I used the words simple and reasonable because it seems to me more plausible that the aggregate response of market traders/investors/analysts reflects the view that there is a window of opportunity for Sprint, rather than their aggregated view regarding which anticompetitive theory of harm should prevail, if any.

      You mentioned the fact that Verizon was the most likely desired buyer for Sprint. Two comments: a) this strenghten the argument that “the most likely” buyer of a mobile operator like T-Mo is another mobile operator like Sprint (rather than “all sorts of other carriers”) – btw, the view that Verizon could have bought Sprint was surely conditional on the merger between AT&T and T-Mo being cleared, so to re-establish conditions of symmetry with two large duopolist from what would have been an asymmetric triopoly; b) accordingly, I agree that Verizon doesn’t stand a chance now to buy either Sprint or T-Mo, but this is in favour of Sprint buying T-Mo since the other major potential contender has been ruled out. Hence, Sprint’s price stock moved, whereas Verizon’s didn’t .

      You could argue this is tantamount to regulatory meddling. Maybe, but again, what counts is that your inferences from stock price movements of Sprint are only one of the possible interpretations and in my view not surely the most plausible one. Anyway, I am sure you will turn this into an opportunity to add to the any of the four literature strands you mentioned above.

  2. 
    Paolo Siciliani 21 December 2011 at 2:31 am

    Apart from the laughable assertion that the market is generally better at predicting the effects of a merger than regulators (I guess the same wisdom should apply also to IPOs….), couldn’t the price movement simply signal that there is now an opportunity for Sprint to be a target for the next proposed merger maybe with T-Mobile itself?

    • 

      Paolo: there is a sizeable literature both on event studies in antitrust as well as, more broadly, the performance of prediction markets relative to “experts.” There is also all of public choice in incentives facing regulators that can distort such decisions. None of these individually or in the aggregate suggest (nor did I suggest) that regulators always get it wrong. But they do provide both theory and evidence to support the “laughable” assertion; indeed, I suspect the only way to render the claim laughable is to completely ignore all three literatures (and possibly a fourth literature on the performance of antitrust regulators historically).

      Further, note that the claim in the post was that the stock market effects were not consistent with the DOJ theory. You posit an alternative explanation for the price movements — also inconsistent with the DOJ / FCC theory (even if one assumes that DOJ challenging this merger on the grounds articulated by the DOJ’s “4-3 in a national market” complaint somehow increases the probability Sprint can be acquired by another major player rather than decreases it).

      • 
        Paolo Siciliani 21 December 2011 at 9:52 am

        Josh, let’s keep it simple. I gather that national market shares in July 11 were: AT&T at 32%; Verizon at 31%; Sprint at 17% and T-Mobile at 11% (http://web.yankeegroup.com/rs/yankeegroup/images/2011AT%26T-T-Mobile-Merger-Report.pdf). So, if I am a market analyst who thinks that the market will have to consolidate in the future and I see that regulators have challenged the largest operator from taking over the smallest, my best guess would be that regulators wouldn’t challenge a merger between Sprint and T-Mobile to the extent that the merged entity would be better placed to challenge the two largest players.

        Accordingly, Sprint’s stock prices should surge in recognition of the fact that the failed merger opens an opportunity for the third largest operator to take over T-Mobile.