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FTC Enters Metaverse With Meta Merger Lawsuit | Vinson & Elkins LLP

FTC Enters Metaverse With Meta Merger Lawsuit |  Vinson & Elkins LLP

On July 27, 2022, the Federal Trade Commission (“FTC”) voted 3-2 to file a lawsuit in federal district court to block the takeover of Meta Platforms, Inc. (“Meta”) from Within Unlimited, Inc. (“Inside”), a developer of virtual reality (“VR”) applications. In approving the complaint, the commissioners took the unusual step of rejecting the FTC staff’s recommendation to close the agency’s investigation. Furthermore, the two Republican commissioners disagreed but, as is customary in this context, did not issue separate statements explaining their positions. The case has implications for future FTC review of transactions in various industries, but especially for VR, video games and technology mergers.

Customers

Meta is a global technology company best known for its family of apps for Facebook, Instagram and WhatsApp. Meta also develops and sells VR devices and applications, such as the Oculus Quest VR headset and the Meta Quest Store, which distributes applications on VR headsets.

Within is a privately held software company that develops applications for VR devices. Within’s flagship product is Supernatural, a VR subscription fitness service. Supernatural offers over 800 fully immersive VR exercises, each set to music and set in a virtual environment such as the Galapagos Islands or the Great Wall of China.

FTC Claims

The FTC’s complaint suggests that nothing less than the future of the metaverse is at stake in the transaction. According to the complaint, “Meta has in recent years focused its goal on building, and ultimately controlling, a VR ‘metaverse’.” ¶ 2. If the transaction were to proceed, “Target would be one step closer to its ultimate goal of owning the entire Metaverse.” ¶ 13. The FTC’s actual allegations, however, are limited to two types of VR fitness apps.

Eliminating a potential entrant in the VR fitness app market.

Dedicated VR fitness apps are VR apps that are “designed so that users can exercise through structured physical exercise in their own homes,” as opposed to casual fitness apps where physical movement and exertion are part of a larger experience. ¶¶ 38, 40. The FTC asserts that the market does not include “non-VR smart home fitness solutions, such as digitally connected exercise bikes, treadmills, weight machines, mobile phone apps, video games, or exercise videos.” ¶¶ 44-47.

Within offers a dedicated VR fitness app (Supernatural); The target does not. The FTC claims the acquisition will eliminate Meta’s potential entry into the VR-focused fitness app market. As a result of the acquisition, the FTC argued, Meta would use Within’s offerings to compete in the market rather than enter with its own dedicated VR fitness app, thereby reducing competition in the market. Furthermore, the FTC claims that the barriers to entry to developing a fitness app dedicated to VR will prevent any other competitors from entering if Meta acquires Within.

Many of the FTC’s allegations in support of this claim have been redacted so that the details of the FTC’s claims are still unknown. Despite this, the unredacted allegations suggest that Meta was not actually taking steps to enter the market. Rather, the FTC’s claims appear to be based on Meta having the ability and incentive to develop its own VR fitness app due to its sheer size and capabilities. ¶¶ 71, 83.

Horizontal Concentration in the VR Fitness App Market.

VR fitness apps are VR apps that are “recognized and advertised as providing fitness benefits to the user” ¶ 50. This would include both dedicated VR fitness apps (such as Supernatural) and casual fitness apps (such as Meta’s Beat Saber app). The FTC claims that the acquisition would result in horizontal concentration of the broader VR fitness app market since Meta’s Beat Saber and Within’s Supernatural apps are currently close competitors in this market.

Meta’s answer

Meta published a blog post responding to the FTC’s lawsuit. Meta claims that “the FTC’s case has no merit” and that the complaint is “based on ideology and speculation, not evidence.” The target relies on four primary arguments.

  1. The FTC “misunderstands nature [VR fitness] space completely and ignores market realities.” Supernatural and Beat Saber “couldn’t be more different” and are fundamentally different products.
  2. The FTC’s claim that Meta would create a Supernatural-like product “is based on little more than Meta’s size,” and other “well-established brands like Apple and Peloton are far better positioned than Meta” to expand into the VR fitness market. Importantly, Meta “looked into the possibility of building a fitness-specific service” and concluded that it was “not in a position to do so”.
  3. Developers of fitness-specific apps “don’t see [Meta] as their current or future competition and are focused on strong existing players in the space.”
  4. Meta does not attempt to control the VR ecosystem and “supports and develops a viable and sustainable developer ecosystem.”

Meta’s arguments are limited to its core point: “How could Meta’s acquisition of a single fitness app in a dynamic space with many existing and future players hurt competition?”

Implications for future merger audits

The complaint provides insight into the future priorities of the FTC’s current majority for merger review in the virtual reality and gaming spaces, as well as other industries.

First, the FTC appears to have adopted the view that companies with sufficient financial and technical resources should build rather than buy their way into a new market, even if the acquirer has no intention of entering on its own or if the success of its entry is uncertain. In the broader video game industry, for example, a major game developer that has the resources to develop new games but instead buys an existing game studio to fill gaps in its catalog may have to defend itself against FTC charges similar to those brought against Target/Inside. However, to be clear, there is no indication that the FTC’s stance is limited to the metaverse, video games, or even the tech industry. Companies in different industries could face similar issues in future merger reviews.

Second, the FTC’s complaint cites Meta’s history of acquisitions in the VR space as evidence of harmful market consolidation and Meta’s motive to control the relevant markets. While the FTC is not seeking to invalidate these prior acquisitions (as it is seeking Meta’s prior acquisitions of WhatsApp and Instagram in a separate case), it is clear that the FTC views a prior acquisition in the same field in a negative light.

Third, both alleged relevant markets are notoriously limited: both are limited to one genre of VR apps as opposed to all VR or all fitness apps. This may have implications for other mergers in the virtual reality and video game space where the merging parties offer overlapping applications or games in the same genre, such as first-person shooters or role-playing games.

Fourth, the complaint signals the FTC’s focus on protecting competition in the broader “metaverse.” The FTC does not define the metaverse as a relevant market in the complaint. However, VR is seen as one of the primary drivers of the metaverse, and at an October 2021 conference, FTC Chair Lina Khan mentioned VR as an example of a developing platform technology that the FTC will scrutinize. The complaint’s focus on the metaverse also aligns with Khan’s oft-expressed concerns about tech companies allegedly seeking to control emerging platforms as part of an “ecosystem game, where the goal is to capture the ecosystem as a whole.” This move by the FTC to block Meta’s acquisition of Within, combined with the language in the complaint, suggests that other acquisitions with implications for the development of the metaverse will be scrutinized.

Conclusion

The FTC’s latest merger challenge reveals that the newly established Democratic majority of FTC commissioners is protecting competition in emerging industries and preventing “ecosystem games” as central to its enforcement plan, even as the agency lacks a strong case. On a number of issues — including market definition, potential competition and barriers to entry — the FTC’s case is new and could face a skeptical court. Nonetheless, the expansive theories of harm expressed in the lawsuit may have significant implications for future merger reviews in various industries at the FTC.

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