EUROPEAN BLUES

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Washington-European regulators reviewing America Online Inc.'s merger with Time Warner Inc. have concluded that the new company would be the dominant provider in five different market categories, claiming, "Effective competition would be significantly impeded."

In a 27-page "statement of objection," the European Commission did not say that the merger should be blocked, but spelled out in great detail anti-competitive harms that would likely result from the deal, according to a copy of the report obtained from a source.

Still, the tough stand in Europe is the first sign the merger could be in trouble with a regulatory body.

Barry Schuler, AOL's president of interactive services, and Time Warner president Richard Parsons will be sent to meet with regulators in Brussels, Belgium, in a closed-door session, AOL spokeswoman Tricia Primrose said.

Primrose said reports were inaccurate that AOL chairman Steve Case and Time Warner chairman Gerald Levin had accepted invitations to appear in Brussels. "That is not true," she added.

The EC has been cracking down on telecommunications, Internet and media mergers. In July, it was preparing to block WorldCom Inc.'s $129 billion merger with Sprint Corp., but the companies withdrew the deal when the U.S. Department of Justice filed suit to block the union of the second- and third-largest long-distance companies, both with vast Internet-backbone holdings.

Also in July, the EC forced Microsoft Corp. to settle for a minority stake in Telewest Communications plc, Britain's largest cable company, which is in the process of upgrading its lines for broadband. Under the original plan, Microsoft would have shared control of Telewest with Liberty Media Group.

In the United States, the Federal Communications Commission and Federal Trade Commission are sharing review of the $123 billion merger. While the FCC has peppered the companies with requests for information, the agency is not expected to impose draconian conditions when it wraps up its review, probably sometime in late October.

The FTC is conducting what it calls "a nonpublic investigation." An FTC spokesman would only say that the agency would complete its review "sometime this fall."

According to sources outside of the FTC, staff there is taking a much harder look at the deal than the FCC in terms of imposing conditions.

In its report, the EC staff said AOL-Time Warner would be dominant in the delivery of online music, music software, Internet dial-up access, broadband Internet access and integrated broadband content, with negative consequences for competitors and consumers.

In a separate paper also obtained from a source, EC staff raised similar concerns about Time Warner's proposed joint venture with EMI Group plc. The EC staff said that deal would create the dominant force in the recorded-music and music-publishing markets.

The EC said AOL-Time Warner would have enormous power over rivals and customers through proprietary controls and services. This could make it next to impossible for competitors to sign up subscribers that had been locked into the AOL-Time Warner distribution chain via "sticky applications" such as e-mail and software music players, regardless of access speed.

"AOL may be compared to an essential distribution facility or an unavoidable trading partner," the EC said. "The combination of Time Warner's content with AOL's distribution network gives rise to a snowball/network effect: More content attracts more subscribers, more subscribers attract more content, and so on."

Employing a term used by merger critic The Walt Disney Co., the EC said AOL-Time Warner is seeking to create a "walled garden" of compelling content that would attract subscribers and "deprive a subscriber of any incentive to abandon AOL."

The EC reasoned that AOL-Time Warner would have a content- and applications-driven gravitational grip on consumers to such a degree that changing providers would become so inconvenient as to be next to impossible.

"AOL could raise these switching costs by refusing to forward [e-mail] sent to the old address, which, for example, would be bounced back to the sender," the EC said.

Probably after Parsons and Schuler return from Brussels, Case and Levin are expected to testify on the merger before the House Telecommunications Subcommittee, which is headed by Rep. Billy Tauzin (R-La.).

Case and Levin have already testified before two Senate panels in February and March and before the FCC in a public hearing in July.

"I can tell you that Mr. Levin and Mr. Case have agreed to testify, but there are still a lot of things that need to be worked out," Tauzin spokesman Ken Johnson said, adding that the focus of the hearing would be interactive television.

No hearing date has been set, he said.

As part of its ongoing response to FCC inquiries, AOL and Time Warner said last week that key talks with AT & T Corp. were at a standstill. Time Warner said talks with AT & T on offering local phone service over Time Warner Cable systems have gone no further than the letter of intent the two companies signed last year.

Also last week, AOL told the FCC that it is continuing "to seek an agreement with AT & T," and preliminary talks on terms and conditions were ongoing. AOL said it was "reviewing and analyzing documentation" in connection with AT & T's multiple-Internet-service-provider trial in Boulder, Colo. AT & T plans to conduct the six-month trial starting in November.

The AOL-Time Warner merger has come under attack from Disney, NBC and various instant-messaging competitors-rivals that fear that the merger would create large anti-competitive incentives.

AOL-Time Warner executives have repeatedly said those concerns were unfounded, and they have committed to provide open Internet access and to swap IMs with competitors when privacy and junk-IM concerns are cleared up.

As part of its review, the FCC has ordered AOL and Time Warner to furnish reams of documents related to their plans to offer interactive-TV services, IM policies and high-speed Internet access for competing ISPs. Many of the documents were turned over under a confidentiality agreement.

Two weeks ago, AOL publicly disclosed that "AOLTV"-a dial-up service that complements video programming on TV with e-mail, chat and Internet access-would eagerly pursue deals with numerous video-programming providers to enhance the interactive-television-content business.

In an Aug. 22 letter to the FCC, AOL official Steven Teplitz said AOL would offer an open platform for

content providers that decided not to affiliate with AOLTV.

"A video programmer can offer both its video programming and associated interactive content over the AOLTV platform even if it chooses not to partner or enter into any agreement with AOL," Teplitz said.

But he added that AOLTV content agreements "would prohibit content providers from promoting AOL competitors within the content partners' customized AOLTV interactive content."

Teplitz said such a condition was standard business practice, noting that ABC Inc. does not use its television network to promote NBC's hit series, Friends and Frasier.

Disney has complained that AOL-Time Warner would abuse its control over interactive-television technology to favor its own content and advertisers, and it has urged the FCC to require AOL and Time Warner to divest either content or cable-system holdings.

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