Is Apple About to Make a $3.2 Billion Mistake?

With a rumored $3.2 billion purchase of Beats Audio, is Apple about to make a gigantic mistake?

May 8, 2014 at 9:44PM

There's a rumor! There's a rumor! Apparently, the latest rumor is that Apple's (NASDAQ:AAPL) acquisition prowl is leading it to consider spending a whopping $3.2 billion on Beats Audio. For those of you unfamiliar with Beats Audio, it's a 300-person outfit that develops audio equipment (think headphones and speakers), as well as software.

Beats Pillsm

A "pill" speaker from Beats Audio. Source: Beats Audio. 

Beats was most recently worth about $1 billion
Right off the bat, it's important to note that handset vendor HTC picked up a 50.1% majority stake in Beats for $309 million back in August 2011. About a year later, HTC sold back half of its stake for $150 million (which would imply that the company took about a $4 million loss on that purchase. Then, a little more than a year later, HTC agreed to sell back the remaining portion of the company for $265 million – this time, actually turning a profit on that initial investment.

Beats Htc

Handset vendor and Apple competitor HTC once owned a majority stake in Beats Audio. Source: Teknobites.com.

This leads to an implied value of about $1.06 billion as of the most recent transaction. Now, one could argue that HTC was in a bit of a bind and needed to cash out as quickly as possible; but if the company was really worth anywhere close to $3.2 billion, then surely HTC would have been able to either negotiate more aggressively with Beats' management, or shop that stake around to others --perhaps even Apple.

Talk about a premium!
When it comes to acquisitions, a premium of anywhere from 50%-100% isn't uncommon, so a purchase for about $1.5 billion-$2 billion would make sense if there were a pressing strategic need for Apple to own Beats; but $3.2 billion would indicate that Beats has something that Apple really wants and can't develop cheaply on its own. That's the iffiest part of this whole alleged "deal."

Now, that being said, while a 200%+ premium seems egregious, there is some strategic merit to picking up Beats. For example, Beats does have a pretty solid reputation in delivering high-quality headphones and other audio products, which Apple could sell as complementary products to its core iPhone/iPad/Mac offerings. Further, Beats recently launched a music streaming service known as Beats Music, which could be the most valuable part of Beats to Apple.

Could Beats Music be worth that premium?
While Apple could certainly buy a headphone vendor for much cheaper -- Apple bought a processor design team for under $300 million -- the value for Apple here seems to be the streaming music service. Apparently, Beats has deals with just about all of the major labels, which gives it access to a broad swath of content.

Ipod Touch

Apple's success today began with the music-focused iPod, which has evolved dramatically during the years. Source: Apple. 

However, do remember that Apple owns and operates iTunes, which is still the world's most popular music download service, even if that growth has hit a snag. It doesn't seem farfetched that Apple could leverage the relationships and infrastructure to develop a streaming service similar to what Beats, and others, offer. If Apple could develop iTunes radio, it should have no problem developing a Beats Music competitor should it choose to.

Foolish bottom line
At the end of the day, $3.2 billion is less than a tenth of Apple's yearly net income, so even if it wanted to absolutely splurge on such a strategic purchase, it wouldn't exactly leave Apple in financial ruin. However, it is important to note that Apple's acquisition strategy has been successful to date precisely because it picks up fairly small companies, each for a reasonable price, and each as an enabler of what ultimately blossoms into a broad/deep internal effort. A $3.2 billion purchase of Beats just doesn't seem to be Apple's style, but only time will tell.

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Ashraf Eassa has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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