Apple's Beats Deal: 2 Questions Investors Should Ask


U.S. stocks are lower on Friday, with the benchmark S&P 500 and the narrower Dow Jones Industrial Average (DJINDICES: ^DJI  ) down 0.13% and 0.03%, respectively, at 10:20 a.m. EDT. In company-specific news this morning, the world's most valuable company, Apple (NASDAQ: AAPL  ) , is (once more) hogging the headlines with reports that it is finalizing a $3.2 billion acquisition of headphones maker Beats Electronics and that it will release the iPhone 6 in August -- one month ahead of schedule.

Source: Wikimedia.

Investors appear to be unimpressed by yesterday afternoon's report of the Beats Electronics buy, as Apple shares were down 0.64%. I think there are legitimate reasons to be skeptical regarding the deal: At first glance, Apple seems ready to pay a very rich price for Beats, which isn't necessarily reassuring considering that it would be the tech giant's largest-ever acquisition. Is Apple eschewing its deal-making discipline to buy some "cool factor"?

Furthermore, much of the value embedded in the acquisition price appears to reside in Beats' brand. But this compatible with Apple's (extraordinarily successful) strategy of building a monolithic brand encompassing its ecosystem of products and services?

On the other hand, Wall Street's reaction today may largely be one of indifference. Yes, the deal would be the largest in Apple's history, but that is mainly a reflection of Apple's approach to acquisitions so far. The $3.2 billion price tag is equivalent to less than a third of Apple's quarterly profit and just six-tenths of a percent of Apple's market capitalization.

Speaking of Apple's ecosystem, ISI Group yesterday had some positive things to say on the topic, even as it downgraded the shares to buy (though it raised its price target from $660 to $675):

While we have always believed AAPL's ecosystem (e.g., iTunes, App Store, iOS, OS X, iCloud, etc.) was highly "sticky" for existing users, we are pleasantly surprised to see AAPL's user base expanding at a healthy pace (e.g., ~60mil new users in ~6mo, ~1/2 of iPhone buyers new to iPhone, ~2/3 of iPad buyers new to iPad, etc.). Importantly, iPhone 5S is also doing very well in emerging markets where per capital income levels are much lower than in AAPL's more established markets. This provides us incremental confidence that next generation iPhones / iPads can help continue growing the ecosystem (vs. simply serving as a refresh for the installed base).

This dovetails with my own opinion that Apple has built a solid moat around its franchise and still has very decent growth prospects. As far as the market recognizing that and closing the gap between the stock price and its fair value, the release of the iPhone 6 could be a catalyst. For long-term shareholders, however, whether the latest iteration of the iPhone hits the market in August instead of September, as Taiwan's Economic Daily News is reporting today, makes no difference whatsoever.

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  • Report this Comment On May 09, 2014, at 1:59 PM, walito677 wrote:

    Please don t buy beats,everyone has the headphones and thet are not best. The steaming service is not that good and what else do they do. Please don t buy

  • Report this Comment On May 09, 2014, at 2:48 PM, UgolinoII wrote:

    They wouldn't have been my first choice either. But I am approaching middle age, and perhaps don't have the same view on what's 'cool' anymore.

    They could have picked up the infinitely more refined, Bang & Olufsen (currently only 2.5bn). If B&O are too divers, then I don't know how much SHURE would cost, but I'd go with those over a pair of beats any day.

    Still as I said earlier, I'm past it, and maybe neither of those two companies are that cool :)

  • Report this Comment On May 10, 2014, at 8:23 AM, buddyglee wrote:

    People want good sound without looking like a loser. Beats provides good sound with a nice look. i would never buy them but i understand why my wife wanted a pair.

  • Report this Comment On May 11, 2014, at 11:09 AM, Estrogen wrote:

    talking to my teenage daughters, beats have already hit the high point of their coolness factor and are defending. Don't think a good move for apple as "coolness" is so fickle. But time will tell if Cook is as good as his predecessor in the synergy of acquisitions.

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Alex Dumortier

Alex Dumortier covers daily market activity from a contrarian, value-oriented perspective. He has been writing for the Motley Fool since 2006.

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