AT&T, T-Mobile Merger: A Regulatory Quagmire?

AT&T’s (s t) announcement that it would buy T-Mobile for $39 billion in cash and stock is by no means a forgone conclusion, despite the assurances in the press release that it would close within the next 12 months. In fact, consumer groups are already calling the deal “unthinkable,” referencing a former FCC chairman’s comments from 1997 about a rumored deal by AT&T to acquire SBC, a regional Bell operating company. Ironically, in 2005, SBC acquired AT&T in a deal that was no longer unthinkable.

So is the $39 billion acquisition of the nation’s fourth largest mobile operator by the second largest mobile operator unthinkable? That’s the question industry watchers and regulators are asking themselves in the hours after the deal was announced.

Several sources in Washington D.C. were divided on the idea that the Department of Justice would approve AT&T buying T-Mobile. One source who has held multiple roles in telecommunications politics pointed out that this deal is a vertical horizontal integration that can clearly show a decline in competitiveness, so it should be easy for the DoJ to stop, especially since the FCC last year clearly documented how concentrated wireless ownership was becoming, using an index the Department of Justice actually uses to determine the concentration of mobile wireless service providers: the Herfindahl-Hirschman Index.

Under that index, the FCC found that the average HHI increased in 2008 relative to prior years. The weighted average of the HHIs was 2848 in 2008, an increase from 2674 in 2007. The weighted-average HHI has increased by nearly 700 since the FCC first calculated this metric in 2003. The industry has become more concentrated, leading to lowered capital expenditures and higher profits for the largest two players according to the report.

Chetan Sharma, a wireless analyst, has calculated that this merger would increase the HHI by about 600 to 700 basis points nationally, and notes that DOJ antitrust scrutiny is applied to a merger if it would trigger an increase in the HHI of 100 basis points or greater. However, he said the FCC and DoJ may look at the markets on a regional basis, which could change the equation and result in AT&T giving up some of the T-Mobile assets. That’s in line with those who think the DoJ and FCC will approve the deal.

Some sources think DoJ won’t scuttle the deal, in part because T-Mobile is a fairly weak player in the current wireless industry, and isn’t likely to last without a buyer. That would mean the competitive results would boil down to the conditions set by the Federal Communications Commission and the DoJ as part of their approval of the deal. As Derek Turner, research director at the Free Press, notes in an email, “That’s the key question. Is this industry trending towards natural duopoly and is there a mix of oversight and regulations that can make this devolution not create antitrust problems? Having two companies control three-fourths of the market plainly won’t lead to optimal outcomes for consumers or innovators who use the platform.”

What concessions are we likely to see? My hunch is that the FCC will likely have AT&T disgorge some of the T-Mobile spectrum, might try to enforce some network neutrality provisions on the combined wireless network and could possible try to gain some kind of special access provisions from AT&T that could benefit rural carriers and Sprint (s s). Special access fees are what operators pay to connect their towers back to the main Internet: pipes provided by AT&T and Verizon (s vz) in most markets. A spokesman for the FCC replied to my request for comment with, “We may have something soon potentially.”