While almost everyone in the telecom industry has been trying to suss out whether president-elect Donald Trump will try to block AT&T’s $109 billion merger with Time Warner, a more substantial threat to the deal may have arrived the day after the election.
That’s when the Federal Communications Commission’s wireless bureau sent a detailed, four-page letter to AT&T sharply challenging its use of “zero rating,” one of the company’s key strategies for keeping and attracting customers not to mention a core rationale for the merger.
Under AT&T’s zero rating policy, the carrier lets its wireless customers use their phones and tablets to watch streaming video services it owns without counting that usage against the customers’ monthly data allowance. The practice both helps promote usage of the video services and may make customers less likely to defect to another wireless carrier.
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But in the FCC’s letter, dated Nov. 9, the agency warned that the practice “may obstruct competition and harm consumers.” Now AT&T will have to convince the commission otherwise or modify the strategy. It could also go to court to fight the agency, as it has done many times in the past. Yet another option would be stalling, since many in Washington expect Trump and the Republican Congress will repeal the net neutrality rules.
“The FCC will be changing in two months,” observes Walt Piecyk, an analyst at BTIG Research. “So I would question the revelance of any decisions or inquiries made by the current administration.”
If followed through, the FCC’s challenge could also impact Verizon Communications, which uses zero rating in much the same way as AT&T to let customers use video services it owns without counting that usage against data caps. And like AT&T, competitors must pay Verizon for the same treatment. Verizon (vz) declined to comment or disclose whether it had also received such a letter.
T-Mobile (tmus) took a different approach with its Binge On and Music Freedom features, which zero rated any streaming video or music service without charge, provided it could meet certain technical requirements.
If AT&T (t) lost the ability to zero rate its own content, the company would lose the ability to promote streaming Internet versions of Time Warner (twx) content, like its cable channels CNN and TNT or entertainment produced by its Time Warner movie and TV studio. Or, it might be able to zero rate such content only if it also offered the same treatment for free to competitors like streaming services from Dish Network (dish), Sony and Amazon (amzn). Without the zero rating advantage, Time Warner might not be worth $109 billion to AT&T anymore.
Aside from the merger, the regulatory challenge also hits AT&T’s strategy for strengthening its pay-TV business. AT&T has more than 25 million subscribers to its DirecTV satellite TV service and U-Verse standard cable TV service. To fight the threat of cord cutting, AT&T is planning a low cost, cable TV-like service that runs over the Internet. Dubbed DirecTV Now, AT&T says the service will offer access to 100 cable channels for $35 a month.
One aim is to gain more customers for AT&T’s pay-TV business by attracting some of the 20 million households that currently do not subscribe to any cable service. Another piece of the strategy is to reduce defections of AT&T wireless subscribers who like the Internet TV service by zero rating it on AT&T’s network.
The FCC asked AT&T to respond by Nov. 21 as to why its use of zero rating did not violate the agency’s net neutrality rules adopted last year. The agency also made clear in the letter that it was not challenging all uses of zero rating, but only AT&T’s particular strategy.
After receiving the letter, AT&T defended its use of zero rating, pointing out that any other video service could receive the same treatment if it paid AT&T to “sponsor” the data usage. Insurance firms have paid for the streaming of well-care videos, for example, AT&T said.
“While we welcome additional questions, we hope the FCC will consider the enormous value consumers find in obtaining free data or free streaming where someone else is footing the bill for their data,” Bob Quinn, AT&T’s senior executive vice president for external and legislative affairs, said in a statement. “We welcome any video provider that wishes to sponsor its content in the same ‘data free’ way for AT&T Mobility customers and we’ll do so on equal terms at our lowest wholesale rates. Saving consumers money is something we all should support.”
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Jon Wilkins, the head of the FCC’s wireless bureau and author of the letter, appeared to have anticipated and already rejected that defense. Competitors who want the same zero rating treatment must pay themselves to cover all their customers’ data usage, while AT&T has no cash outlay for its sponsorship, he noted. And competitors that don’t pay would be at a disadvantage, since usage of their services would count against customers’ data allowances.
“Under either option for competing with AT&T’s video services, unaffiliated video content providers appear to confront significant disadvantages from the combined impact of AT&T Mobility’s Sponsored Data fees and zero-rating of its own DirectTV offerings,” Wilkins wrote. “We are therefore concerned that this combination appears to present significant anti-competitive effects.”