Tired of being an M&A banker? Become a literary agent

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It’s Stephen King to the rescue.

The horror writer testified against Penguin Random House’s acquisition of rival publisher Simon & Schuster last week, saying industry consolidation made it harder for newbie authors to impress. He may be right. But the legal thrust of this case isn’t primarily about unknown writers — it’s about big names like King and the threat to their giant advances.

It is a delicate ground to fight on.

The $2.2 billion deal would reduce the so-called “Big Five” publishing houses to a “Big Four,” cementing Penguin’s leadership position. The question is whether this takeover could lead to a marked reduction in competition compared to the status quo.

In taking the case to court, the US Department of Justice is not claiming that an enlarged penguin would force readers to pay more for the books. His attack hinges on the idea that there will be fewer deep-pocketed publishers vying to buy the rights to potential best-sellers – whether King’s works, political biographies or books by celebrity cooking.

Six-figure advances would plummet and writers would suffer, the DOJ claims. What’s bad for the best writers must be bad for all writers and, therefore, for readers.

Focusing on potential harm to sellers rather than consumers is unusual in antitrust cases. The legal difficulty here is the DOJ’s attempt to define a small market based on price, namely manuscripts that sell for at least $250,000.

As Penguin contradicts in his deposition, it’s ambitious. Top sellers come in many forms and you don’t know a bid will reach that price until the auction begins. Additionally, it says only 1,200 manuscripts commission such reviews each year — 2% of all books published in the United States — with just 85 disputed with Simon & Schuster.

But don’t let the small numbers fool you. These agreements mean a lot. A handful of blockbusters usually determine whether a publisher has a good or bad year.

Assuming the market definition turns out to be legally valid, the challenge is to prove the harm of the agreement.

Obviously, the bargaining power of literary agents who strike deals for authors is determined by the number of options they have. The combination in question would reduce these and create a single publisher eclipsing the competition in terms of financial power. There’s no way Penguin can deliver on its promise that Simon & Schuster would internally compete with other imprints after its acquisition. As King says, it’s like expecting a married couple to bid against each other on a house.

The legal case must cling to something more substantial. To that end, the DOJ used economic modeling to show that if Simon & Schuster tried to cut its advances for bestsellers expected today, between 42% and 59% of the manuscripts it bids on would be lost to Penguin. It’s the fear of losing those bids that keeps the bids high. After the merger, Simon & Schuster could cut its advances by 12-15% and Penguin by 4-6%, the DOJ says.

Calculating numbers is not science fiction, but it is highly theoretical. It assumes that all book transactions are conducted via multi-round auctions and that the two engaged houses end up as the highest bidders based on their current market shares. It also uses assumed profit margins to calculate publishers’ propensity to cut advances.

Things are different in the real world. Penguin doesn’t battle Simon & Schuster as often as the model predicts. And likely bestseller manuscripts are acquired in many ways other than direct auctions. There may be blind bids, invite-only negotiations, or a handful of auctions followed by the final best bids. Contracts could include a right of first refusal on suites.

Still, while not perfect, the calculations are at least a rough guide to the impact of reduced competition. An implied competing buyer underlies any offer to purchase.

Penguin’s defense hinges heavily on the idea that literary agents are so powerful that they can sustain high advances in a more concentrated industry. This suggests that most of these obscure figures frequently avoid auctions for high-value manuscripts. If so, writers should ask their agents why they don’t use the most obvious tool to get leads. Perhaps inactive M&A bankers should change careers – they could do an even better job.

Now that the DOJ has presented its case, Penguin gives its answer and brings in literary agents to testify. Step away from Stephen King and let them tell us how it’s done.

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering the deals. Previously, he worked for Reuters Breakingviews, the Financial Times and the Independent newspaper.

More stories like this are available at bloomberg.com/opinion

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