Yesterday's closing argument in Federal Trade Commission v. Microsoft & Activision Blizzard was lively, and that is primarily so because Judge Jacqueline Scott Corley of the United States District Court for the Northern District of California had interesting and challenging questions for both parties--plus a great sense of humor. However, a litigation is not a talk show. In a talk show, there can be multiple winners, and here the outcome will be binary: the merger won't be blocked (that's what I expect to happen) or it would be. While Judge Corley could hardly have done more to ensure a level playing field in her courtroom, the legal framework is highly unfavorable to the FTC: it has multiple hurdles to overcome, any single one of which can be dispositive (i.e., single-handedly trigger the denial of the motion).
By 5 PM local time (Pacific Time) today, the two sides will have to file the updated versions of their proposed findings of fact and conclusions of law. Throughout the hearing they were probably already keeping track of the extent to which any of the factual allegations were proven. This is about a likelihood assessment and an equitable balancing, and it is about predictions (of what will happen in the future in a world where the merger happens versus one in which it is abandoned). It's not a criminal trial with a "beyond reasonable doubt" standard. But the FTC's problem is that once the court determines that the FTC is not--or at least not realistically--going to prove an essential point in the main proceedings, it's game over--and the same applies if the court has very significant doubts about a couple of indispensable elements of the FTC's case. At that point, too, there is no reasonable likelihood of success, and even if the court went beyond that and balanced the equities, the FTC could still lose at that stage of the analysis.
The parties will make another filing on Monday (about the admission of exhibits). I believe July 5 and 6 are the most likely days for a decision by Judge Corley. She is free to rule at any time of day, any day of the week, but it would make sense for her to enter an order very late by her local time, just to be safely outside trading hours. Her initial order will be sealed (as it will take time to sort out redactions), but the result will show up on the docket, and it's going to be a denial of the merger block that the FTC is seeking.
In a way, the FTC theoretically had multiple bites at the apple: all in all, the FTC proposed five different antitrust markets, and if its theory of harm (vertical foreclosure) succeeded with respect to any one of them, the deal would be blocked. So, practically, there are five theories of harm in the case. But we can simplify that part based on how things went at the hearing:
As I explained in my Twitter commentary, the FTC's console market theory of harm is dead in the water. Those are theoretically two theories of harm, one for a narrow high-performance videogame console market and one for a slightly broader one that includes Nintendo. It would take the inclusion of gaming PCs--and I agree with Judge Corley that in a foreclosure context the fact that many people already have a PC on which to run most of the relevant games cannot be ignored--to defeat those console theories at the market definition stage, but there are plenty of other problems anyway.
The FTC claimed yesterday that it was about protecting consumers, not Sony but that is just lip service to its mission of protecting American consumers. On several occasions, the FTC's incompetence (with respect to how the gaming business works) was on full display. Yesterday, the FTC discredited itself particularly when one of its lawyers talked about a hypothetical scenario of partial foreclosure in which there would be a unqiue game element, such as a character, that would be available only in the Xbox version of Call of Duty post-acquisition. That shows the FTC knows nothing about current market realities. At the moment, there are multiple PlayStation-exclusive goodies in CoD, and the PlayStation is the market leader. So if the FTC was concerned about any of that, it would have to look into Sony's dealings with game makers.
The FTC's view that it's better to have an independent Activision Blizzard negotiate such deals with platform makers is ignorant of basic commercial realities. As I explained a few days ago, the dominant market leader (which is Sony, particularly on a global scale) can strike such exclusive deals more cost-effectively than any challenger, cementing its leadership and avoiding competition on the merits.
The other three markets are services markets: multi-game library subscriptions, cloud-gaming subscriptions, and a market in which one would find services that offer one or both of those types of services.
The closing argument basically had two parts: console and cloud. Or arguably three, but the balance of the equities won't be reached with respect to consoles anyway.
Multi-game library subscription services can hardly be deemed a relevant antitrust market here. A different judge of the same court threw out a class action over Apple Arcade (Pistacchio v. Apple) for that reason, and the plaintiffs did not even appeal the decision. That may be the reason why there wasn't much debate yesterday over whether multi-game library subscriptions are a distinct product or just a price structure. So the discussion was generally about "cloud" during the second part.
The FTC would have us believe that it just has to raise an interesting question so it gets to kill a merger. Not so:
All that makes a question interesting in this context is a reasonable likelihood of success. The fact that "cloud" is a buzzword doesn't count. The fact that companies including Microsoft invest in cloud services doesn't suffice either.
For a given theory of harm--here, foreclosure of cloud-gaming services--the FTC must satisfy multiple requirements to prevail. So on the bottom line an FTC theory is only interesting enough to warrant an injunction if the court sees a reasonably strong indication of the FTC being able to satisfy all of the requirements.
The short version is that "cloud" is interesting, but by far not interesting enough (in the above sense) to order an injunction.
Market definition
I don't see that the FTC's cloud-gaming services market (or any derivative thereof) is supported by the facts. But if the closing argument is any indication, Judge Corley--no matter what her conclusion regarding that proposed market may be--is not going to stop there even though she could if she wanted to.
Google's testimony that cloud-gaming services compete with console games and PC games could be held against the FTC's market definition. In the hypothetical (though unimaginable) scenario in which Judge Corley were to block the merger, Google's testimony and other reasons for which cloud-gaming services are not a relevant antitrust market would likely be emphasized in an emergency motion asking the appeals court to lift such an injunction.
It would appear erroneous to me if the FTC was deemed to have established a relevant antitrust market for cloud gaming. The same pragmatic approach that Judge Corley has to the console market definition (where she focuses on what consumers would do if prices went up or content became unavailable on a given platform) is antithetical to the assumption of there being a relevant antitrust market for cloud gaming. The President of the UK Competition Appeal Tribunal, Mr Justice Marcus Smith, explained at the initial case management conference that after reading the decision more than once he couldn't see a technical reason for which gamers could not simply install some games locally. It would not at all surprise me, however, if Judge Corley left that question open (such as by expressing some and possibly even serious doubt without disposing of the cloud theory at that point), as there is no shortage of other issues.
Essential input
It strikes me as crystal clear that the FTC has failed to make a credible showing that Activision's content is a critical ("must have") input. As Judge Corley rightly noted yesterday, it is very much about CoD (even though the FTC would now also like to place some more emphasis on the Diablo franchise).
Let's get real:
The games market is highly fragmented and will be even after this transaction. I'm not deying that if Microsoft wanted to buy Tencent after acquiring Activision Blizzard, the question of market concentration would become interesting to say the least. But not now.
The FTC's expert totally failed to show that CoD is an essential input for the console business. Microsoft's economic expert Dr. Elizabeth Bailey clearly impressed Judge Corley with her data-driven analysis, particularly focusing also on how committed gamers actually are to CoD. Most gamers don't really spend a huge numer of hours playing that game over the course of a year.
All that the FTC's expert Professor Robin Lee attempted to show was that complete foreclosure with respect to CoD would have competitive implications (in my view, even his own results are actually procompetitive) for the console business. He did not analyze partial foreclosure, and in particular he did not analyze (whether for full or partial foreclosure) potential switching rates with respect to cloud-gaming services.
So the FTC really has nothing of substance to offer in support of its claim that Activision content (basically meaning CoD) is a critical input for cloud-gaming services, while services like Nvidia's GeForce Now and Microsoft's xCloud don't have and apparently don't need CoD (or any other Activision games).
Let that sink in: the FTC wants the court to kill the merger without any credible indication (I'm not even talking about hard evidence) that CoD has the potential to tip the cloud-gaming market.
This, too, is the kind of reason for which I believe the appeals court would likely lift an injunction (which, again, I don't see happening) in no time.
Incentive to foreclose
The FTC can't even show an incentive to foreclose with respect to consoles. There is no specific argument concerning cloud services. No verifiable numbers. Nothing.
That may not be Judge Corley's style, but some other judges would probably tell the FTC in this context that it is now paying the price for the fact that cloud gaming was only an afterthought in its original complaint. The CMA altered course and refocused on cloud after dropping its console theory in late March. The FTC is, for procedural reasons, stuck with its December complaint, but also with the decisions it made in its in-house adjudicative proceeding. So the FTC is basically standing on the wrong foot: most of what it has relates to the laughable console theory, and while I don't consider the cloud theory strong, it is now the one that appears at least a little more interesting and the FTC has almost nothing to show to support it.
It does not reflect favorably on the judgment of the decision makers involved that the FTC placed its primary bet on the proposterous console market theory (protecting a market leader). But the FTC made its bed and must now lie in it.
I don't think the court would even have to reach this question here, but if it does (as it very well may), I can't see how evidence that is anecdotal at best could serve to justify a finding that Microsoft has an incentive to foreclose cloud-gaming services (and I'm not even referring to Microsoft's agreement with cloud-gaming providers yet, but to the fact that during the hearing no calculation was discussed that the court could rely on).
Impact of foreclosure on competition
As the FTC can't show that CoD is a critical input for cloud gaming, it's impossible to argue that the competitive process would be seriously jeopardized by hypothetical foreclosure. But that is what Judge Corley told the FTC yesterday it had to show: she wanted to know how consumers would be harmed.
Competitive response
The FTC can't deny that other cloud-gaming providers have various ways of responding and adjusting to this merger (even more so since they've known for almost 1.5 years about the possibility of this merger closing). Just like in the console market, where Sony can improve its product and/or lower prices and/or offer other attractive content, there are plenty of options in the cloud-gaming business. The assumption that without CoD they will all be unable to compete is, frankly, absurd.
Remedies already in place
The FTC has from the beginning--this even goes back to the pre-hearing status conference--urged Judge Corley to ignore Microsoft's 10-year agreements with the likes of Nvidia. But the amount of time spent discussing the subject yesterday suggests strongly that those contracts will be considered. Maybe Judge Corley will decline to resolve the legal question of whether such remedial contracts and commitments should be considered when the FTC is seeking a preliminary injunction under Sec. 13(b) of the FTC Act. But she appeared inclined to take such market realities into consideration.
At least the effect of existing agreements and other enforceable commitments cannot be reasonably ignored. If Nvidia and some others can stream CoD, then exclusivity is no longer achievable by withholding it from others.
The pragmatic perspective is that there is no evidence of a merger having survived such a preliminary injunction, and that anything that determines the likelihood of success on the merits should be considered. At the very least those remedial agreements, the commitments to the European Commission, the offer to Sony etc. should be factored in at the final stage, which is the equitable analysis. If the FTC wants to block a merger, it has to convince the court that remedies would not be acceptable.
If Judge Corley finds against the FTC on multiple grounds (as I believe she could, though I don't know what she plans to do), the FTC may realize that an appeal is futile. If the decision was or appeared narrow, the FTC would probably raise this legal argument again.
The policy problem that I have with the FTC's anti-remedy attitude is that the regulatory process is actually meant to bring about such solutions. Judge Corley also told the FTC yesterday that the regulators have arguably already won if there are remedies in place as a result of their review processes.
What the FTC and also the CMA in the parallel proceedings in the UK are trying to do is a radical departure from long-standing practice, which is that regulators normally welcome an amicable resolution (such as a consent decree in the U.S.). While the current FTC and the current CMA may have a strong preference (first choice) for blocking major deals, that is the last resort under the law--and that is one major reason for which both those agencies are not on the winning track in court.
Balance of the equities
Toward the end of yesterday's closing argument, Judge Corley also indicated to the FTC that apart from all other considerations there could be a problem with the balance of the equities. Judge Corley explained that harm to the merging parties (private equities) cannot be dispositive, but when a deal has procompetitive effects, blocking the deal does raise questions with a view to the public equities.
Given the myriad issues that the FTC's push for an injunction has, I don't know if the part about balancing the equities will be very elaborate. If she wanted, Judge Corley could definitely address some interesting points in that context. Here, the FTC wants to block a vertical merger, which in and of itself is a long shot to say the least, and it wants to do so on the basic of a speculative theory involving a nascent market (if it even is a market). It would take years for that "market" to become really large, and Microsoft will hold Activision Blizzard separate, so a future divestiture is a possibility. I frankly can't see a clearer case for telling a regulator that there is no reason not to let the parties close the deal at this point.
It could also be held against the FTC that it has been unreceptive to access remedies that could solve the problem. Like the CMA, the FTC just argues that a merger means one independent economic operator less, but that can't be the standard. The question is how much less competition there is if the merger goes through.
Given all the agreements and commitments that are in place here, this really is an interesting case also from an equitable point of view. The alleged harm would not materialize, and the "market" would not reach a tipping point, anytime soon. While it's obviously not the law that the government has to show immediate irreparable harm (a substantial lessening of competition is enough), a preliminary injunction that effectively kills a merger (and deprives consumers of the procompetitive benefits that it would bring) does not appear equitable where there is no urgency not only in a traditional preliminary injunction sense (meaning that something bad would have to happen in the weeks or at least months ahead) but even for years to come.
The FTC is asking the court for too much given how speculative its theory is.
No smoking gun
It's safe to say after five hearing days that the FTC has not found a smoking gun among millions of documents. An email in which a mid-level manager talks about a mere possibility ("spend Sony out of business") is not impressive. It is actually way less meaningful than Sony's internal reaction, which initially was that they'd be just fine.
The absence of internal calculations for the profitability of those 10-year access agreements with the likes of Nvidia doesn't mean much either. Especially in the case of companies like Nvidia and Nintendo, which are large and sophisticated, I believe there must be a strong presumption of those commercial agreements being meaningful just based on who entered into them.
Recent developments in UK and Canada
During the hearing yesterday, I tweeted about a decision by the Competition Appeal Tribunal of the UK to deny a stalling motion by the CMA as well as about a letter by the Canadian Competition Bureau to Microsoft's counsel in the FTC case, requesting that the letter be (as it indeed was) filed with the district court.
The UK decision shows that the CATribunal is doing its best to keep the UK open for business, while the CMA is seeking to avoid a decision on the merits and apparently realized that the FTC was going to lose the U.S. case (the timing of the CMA's motion is hardly a coincidence). Time is not on the side of the UK. Activision's announcement that the center of gravity of its European operations is going to be in Barcelona is an example of how the CMA's regulatory excess harms UK interests in the post-Brexit situation. I always believed and still believe that Brexit also creates opportunities for the UK, but the fact that the CMA can make crazy decisions like the one of April 26 is definitely part of the downside of Brexit.
I personally--and I have no idea whether any of the decision makers share that view in the slightest--believe that the CMA's renewed attempt to stall, which is contrary to clear directions ("strategic steer") from the UK Prime Minister that regulatory processes should not hold up business, weighs in favor of "closing over" the UK regulator after the FTC has been defeated in court. But as I also said in a Twitter Space today, the great work that the CATribunal is doing would weigh in favor of a short extension of the deal in order to let the UK appellate hearing go forward (it starts on July 28) and await the decision, which the court said would come before October.
As for the Canadian letter, it is just an expression of solidarity by one regulator with another, especially between regulators of neighbor countries and also probably in light of the historic ties between Canada and the UK. The letter says there is "likely" a competition issue in the eyes of the CCB, but they did not block the merger while the window of opportunity was open. The letter is not going to make an impact, not even psychologically.
Now let's wait for Judge Corley's decision. The FTC has failed to surmount any of the relevant hurdles. The cloud-gaming part of the decision will not be as damning for the FTC as the console part may be (given how absurd that one is), but I just can't see how it would entitle the FTC to a preliminary injunction. In the private lawsuit over this deal, Judge Corley did not just ask questions for the purpose of enabling a party's counsel to make the strongest arguments. She tends to be very transparent, and given that she indicated problems with several parts of the FTC's theory of harm while a single failure would doom the motion, I'm convinced that the FTC has failed to make a showing of a reasonable likelihood of success on the merits.
