Net Neutrality Review Could Give Comcast an Out in the Time Warner Cable Deal

Comcast’s acquisition of Time Warner Cable has already drawn many heated detractors to urge the Federal Communications Commission to reject the deal. Now, it has been hit been hit yet again by President Obama’s endorsement of net neutrality. Comcast may have buyer’s remorse, but it may find that ironically, the only way out is to have the F.C.C. block this deal. M.&A. makes strange bedfellows indeed.

In February, the parties announced a strategic combination of the two companies, with Comcast buying Time Warner Cable for $45.2 billion. Comcast was a white knight, outbidding Charter Communications, which had made a hostile bid for Time Warner Cable.

The F.C.C. has to approve the transaction. To do so, the agency must find that the merger is in the public interest. The F.C.C. can also reject the deal, or it can impose conditions like requiring asset sales or requiring Comcast to share its broadband.

For many consumers and other interest groups, including competitors, this F.C.C. approval requirement is the waterloo of cable and broadband access. They are out to stop the deal on the grounds that it will make the combined company “a veritable gatekeeper over vast swaths of the nation’s telecommunications industry” as Senator Al Franken, Democrat of Minnesota, wrote in a letter to the F.C.C. opposing the deal.

The basis of Mr. Franken’s argument is that the combined entity would control about 35 percent of the wired broadband market, based on Comcast’s figures. Already, the F.C.C. has received more than four million comments (more than the average number of people who watch the Kardashians these days).

Time Warner Cable and Comcast dispute these arguments by relying on a point made by David L. Cohen, executive vice president and chief diversity officer for Comcast. He said that the two companies “do not compete for customers in any market and no customer will lose any choice.” Instead, the combined company would be in a better position to square off against the real big competitors like Google, Facebook and their ilk.

This F.C.C. battle all comes down to whether bigger in and of itself is a problem, and President Obama’s statements only add to the troubles for this deal. Potentially, the F.C.C. could require that the two companies agree to a form of net neutrality as part of the needed regulatory clearance.

There are two moving parts. The first is whether Comcast wants to complete the deal at all in light of the net neutrality issue. If not, can Comcast get out of the transaction if the F.C.C. approves the deal but then separately adopts a net neutrality rule in a way that would hurt cable and other broadband companies?

If the F.C.C. adopts Mr. Obama’s view, then Comcast (and other broadband and Internet service providers) could not charge content providers like Netflix an extra fee for fast-lane access to consumers, meaning billions in lost profits for the industry.

Comcast said in its acquisition agreement that it would do several things to show the F.C.C. that the deal was in the “best interest” of the public. First, Comcast agreed it would divest up to 3 million subscribers to avoid antitrust issues.

More important, Time Warner Cable got Comcast to agree to do anything that the F.C.C. has ordered in the last 12 years in connection with the approval of other cable systems. The parties estimate that there have been 25 comparable transactions in the past 12 years, and so that gives Time Warner some room to push Comcast based on prior F.C.C. actions.

The 12-year mark is also important in light of the fact that a group of 30 law professors and economists submitted their own letter, arguing that this combination is similar to the AT&T/MediaOne transaction in 2000. In that case, the Justice Department prevented the merging parties from combining broadband assets that, like the current transaction, would have given them a dominant position in the national market for broadband distribution of content. But that was 14 years ago, allowing it to escape the merger clause.

The problem is that there is pressure on the F.C.C. to simply halt this transaction. The F.C.C. could demand that Comcast agree to net neutrality as a condition for its approval, but the F.C.C. has never asked for this in any previous cable mergers.

It means that if the F.C.C. blocks the deal or requires merged Comcast-Time Warner Cable to agree to a net neutrality rule in exchange for approval, Comcast might be able to walk. The parties also deliberately did not include a termination fee in the deal, meaning not only could Comcast walk away, it could do so without paying a dime.

If the F.C.C. does not act to reject the deal outright or require net neutrality as condition to this deal, then Comcast’s options are limited in terms of fighting any net neutrality rules that would be imposed on all companies.

This seems like a small difference – having the F.C.C. impose something on the deal itself rather than on all companies – but in this case, Comcast would not have a clear out. Instead, Comcast’s best option in this circumstance would be to try to argue that the net neutrality plan was a “material adverse change” that did not require it to complete the Time Warner Cable acquisition.

The material adverse change, or MAC clause, in the agreement states that Comcast is not required to close the merger if something changes to negatively affect Time Warner Cable’s business or results. In this case, having the F.C.C. adopt a net neutrality rule could qualify.

But just because President Obama says he wants net neutrality doesn’t mean it will happen. The F.C.C. is an independent agency, and it could certainly do something different or refuse to adopt the rule. There needs to be an actual event here, not just the threat of it, to justify a MAC claim.

Even if the net neutrality plan were a certainty, the acquisition agreement exempts from the MAC any changes in law. However, there is an exception to this exception, and if the change in law had “a materially disproportionate effect” on Time Warner Cable in relation to other companies in the industry, then the clause would be triggered. In plain English, this means that Comcast can only invoke the MAC clause if there is harm to Time Warner Cable that is over and above what other companies generally experience and that harm has an adverse effect.

Proving the adverse effect in court is hard. A MAC claim has to be long term and significantly impact the company.

There is no hard and fast rule, but you would need to see Time Warner Cable have a 5 to 10 percent hit to its earnings to begin the analysis and find an adverse effect. Then, you would subtract the general earnings drop for the rest of the industry. And there may not be disproportionate impact if the stock prices of the cable and Internet companies fell largely in tandem.

Thus, if Comcast does want to get out of the deal based on a MAC claim, it will have a tough time doing so, though the potential of a claim like this may give Comcast leverage to renegotiate the price if the F.C.C. adopts a net neutrality rule.

If it has buyer’s remorse, Comcast’s best strategy is to wait and see what the F.C.C. imposes on the deal as a condition for approval or whether it tries to outright block the transaction. This means that, despite President Obama’s talk, we are back where we were before – waiting for the F.C.C. to act.