FTC Approves AOL Time Warner Merger with Hefty Restrictions

The world’s largest Internet services company Thursday cleared the second-to-last hurdle in its quest to acquire the No. 2 cable company in the U.S., though the restrictions imposed will lead to intense government scrutiny.

The Federal Trade Commission, in an unanimous 5-0 decision, gave its approval to the $109 billion merger of America Online Inc. and Time Warner Inc. The next and final stop is the Federal Communications Commission, whose chairman, William Kennard, has said he expects the merger can be cleared by year’s end.

The FTC had hung up the merger for months over the issue of open access. Time Warner’s cable service, second only to AT&T in size, serves 20 million households in the U.S., and its stable of media properties — the largest in the U.S. — ranges from Fox, CNN, Warner Bros. and HBO to magazines like Sports Illustrated, People, Fortune and Time. Numerous groups, from ISPs to public advocacy groups, have set themselves against the merger — arguing that the merged entity known as AOL Time Warner would harm competing Internet service providers by blocking them from lucrative markets through a monopoly on the Internet’s high-speed infrastructure.

The FTC had argued that the merger would violate Section 7 of the Clayton Act and Section 5 of the Federal Trade Commission Act by lessening competition in the broadband access market, undermining AOL’s incentive to promote DSL service as an emerging alternative to cable broadband, and restraining competition in the market for interactive television.

“There were serious antitrust problems here that needed to be addressed,” said FTC Chairman Robert Pitofsky.

In an effort to counter this argument and gain the FTC’s favor, AOL and Time Warner Wednesday evening signed a pledge that declared AOL Time Warner would work to ensure that competing services would have access to its cable lines. The FTC approved the consent order, saying that it would “remedy the likely anticompetitive effects of the proposed merger.”

“In the broad sense, our concern was that the merger of these two powerful companies would deny to competitors access to this amazing new broadband technology,” Pitofsky said. “This order is intended to ensure that this new medium, characterized by openness, diversity and freedom, will not be closed down as a result of this merger.”

Pitofsky added that the agreement will preserve competition and possibly enhance it.

Terms of the Consent Order

The pact requires that at least one AOL competitor must offer high-speed cable access in cities served by Time Warner before AOL can itself offer high-speed cable service on those lines. The agreement also calls on Time Warner to open its lines to two more competitors within 90 days, and to negotiate with further ISPs in good faith. The agreements must be approved by the FTC, and if AOL Time Warner fails to secure deals with two more competitors within the time frame mandated by the commission, the FTC reserved the right to appoint a trustee with the authority to enter into agreements on Time Warner’s behalf. Additionally, in Time Warner’s smaller cable divisions, the company would be required to enter into agreements with at least three non-affiliated ISPs within 90 days of making its own broadband service available, also subject to the commission’s approval. In that case the commission also reserved the right to appoint a monitor with the authority to enter into deals on the company’s behalf if the deadline is not met.

Also, the commission required that Time Warner include a “most favored nation” clause in all alternative cable broadband ISP service agreements submitted to the FTC for approval. The clause would require that if “AOL executes a cable broadband ISP service agreement with another cable company, AOL Time Warner must provide the Monitor Trustee with a copy of the cable company agreement, give notice of the execution of the cable company agreement t

o each non-affiliated ISP that is a party to an alternative cable broadband ISP service agreement approved by the commission, and give the non-affiliated ISPs an opportunity to opt in to the same rates and terms secured by AOL in the cable company agreement.”

“The FTC pledges to be vigilant on a continuing basis,” Pitofsky said.

The two companies also agreed to impose non-discrimination provisions, barring AOL Time Warner from interfering with content passed along the bandwidth contracted for by non-affiliated ISPs or discriminating on the basis of affiliation in the transmission of content that AOL Time Warner has contracted to deliver to subscribers over their cable system. The consent order also requires AOL to continue marketing and offering DSL service provided by telephone companies in cities where Time Warner controls cable lines — in the same manner and pricing level as they do in areas Time Warner does not offer cable access.

The consent order required AOL to inform the FTC of any complaints from Internet and interactive television competitors that are unable to access Time Warner’s news and entertainment properties on reasonable terms

Time Warner took its first step towards easing open access fears several weeks ago, when it reached an agreement with EarthLink Inc. to run field tests to determine the viability of giving that ISP access to its cable lines.

Reactions

EarthLink, one of the merger’s most vocal critics prior to striking a deal with Time Warner, applauded the FTC’s decision.

“EarthLink is pleased that America Online and Time Warner have agreed to a settlement and that the Federal Trade Commission has voted unanimously to approve their merger,” said Dave Baker, vice president for law and public policy, EarthLink Inc. “The guiding principle of the Internet has always been choice — in access, in content and in applications. Today’s FTC decision helps ensure that Time Warner Cable customers will have real choices in broadband Internet providers and content. We applaud the FTC for its diligence in making sure that this merger truly benefits consumers.”

The Walt Disney Company, whose high-profile dispute with Time Warner culminated in Time Warner briefly blocking the broadcast of Disney’s ABC network last year, also hopped on the congratulatory bandwagon. “The unprecedented open access and non-discrimination conditions imposed by the FTC today represent a huge victory for consumers and for competition,” said Preston Padden, executive vice president of government relations, Disney. “With these safeguards in place, we congratulate AOL and Time Warner on their merger and wish them well. We look forward to working with the newly combined company in all areas, including the development of new media.”

Not everyone is ready to trust restrictions to keep the new biggest boy on the block in check, however. Herb Hauser, president and chief executive officer of Barnes Wentworth Inc., and professor of Telecommunications and Information Management at Polytechnic University in Manhattan, had grave reservations. Hauser, who says information is becoming the “fourth” utility in the U.S., spoke to InternetNews prior to the FTC’s ruling. He described the soon-to-be AOL Time Warner as a huge monopolistic entity and predicted the current open access promises will last as long as the promises made by the regional Bells when they expanded into long distance markets.

“They played nicely with the children in the sandbox,” Hauser said of the regional Bells, “and as soon as they got the ball they kicked all the children out of the sandbox. Essentially they’re back to protecting their sandbox, which is their infrastructure.”

He continued, “The bottom line is that all of these mega-companies have business agendas. Open access was never a part of the AOL Time Warner business consideration.

It was forced on them. Every single large company will do what it has to to protect its monopolies.”

He argued that merging content and infrastructure companies is a mistake, likening it to having a local energy utility — in his case Con Edison — produce electrical appliances knowing that the utility has no incentive to make them energy efficient.

“Where are you going to go to buy an electric mixer? Do you go to Con Edison? No, you go to Sears,” he said. “You cannot serve two masters. You’re either in the infrastructure business to move the product or you’re in the content business to manufacture the product. With the merger of AOL and Time Warner we now have a very interesting situation where, like the telephone company, they own the infrastructure and they sell the applications.”

Jeff Chester, executive director of the Center for Media Education (CME), one of the four consumer groups that led the charge against the merger, lauded the FTC’s conditions as a “first step.”

“These were difficult negotiations, with a lot of high-stakes lobbying on all sides, and Chairman Pitofsky and the FTC are to be commended for striking a balance between corporate concerns and the public interest,” he said. “The danger all along is that the advent of intelligent cable set-top boxes and the migration of Internet services to a proprietary interactive television platform would signal the closing of the digital frontier. The FTC’s ruling today prevents that, at least as far as AOL Time Warner is concerned. But now these principles of interconnectivity and non-discriminatory transport must be applied across the board in the emerging broadband market.”

Rob Lancaster, an analyst in The Yankee Group’s Internet Market Strategies Planning Services group, said this decision is good for the FTC, good for the industry and good for AOL and Time Warner, albeit not to the extent they had in mind when setting up the merger.

“This is about as close to open access as we can see from the FTC,” he said. “Open access isn’t ultimately their decision, but it looks like they’ve put clauses in here that will allow them to enforce these restrictions to some point.”

He added, “Overall it’s going to be good for the industry. Giving consumers a choice of service is a good thing…What may be the most significant thing is that this is a good showing for the FTC as an organization. It really showed that it can’t be pushed around and it showed that it really is a tech-savvy organization. They stood their ground against one of the biggest companies on the Internet and one of the biggest media companies in the country and they were ready to take it to court.”

Lancaster didn’t predict a dramatic effect on the industry as a whole, though he did say the merger could increase the speed of broadband’s growth. “If you are able to offer a variety of ISP services over a cable modem, it can only help the growth of broadband,” he said. He added that competing providers are already aggressively moving to strike deals of their own with multimedia content providers.

Lancaster said EarthLink will probably be the first non-affiliated ISP using Time Warner’s infrastructure.

“It looks like EarthLink is going to be the first ISP to be up and running,” he said. “Probably a matter of minutes after EarthLink launches we’re going to see AOL launch.” He added that Juno is another likely prospect for a deal with AOL Time Warner.

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