2 Reasons Apple Shouldn't Buy Beats

Making the case that Apple would be better off without spending the reported $3.2 billion it’s offered to buy Beats

May 13, 2014 at 7:30PM

Headphones, hip-hop moguls, and history... this deal has it all.

By now, hopefully every tech investor has gotten wind of the rumor that tech giant Apple (NASDAQ:AAPL) has entered advanced negotiations to purchase the uber-cool headphone and streaming music company Beats Audio for a whopping $3.2 billion.

This deal has gotten plenty of deserved notoriety as it contains a number of juicy storylines at both Beats and Apple. However, in circling this deal, which appears to have yet to close as of today, it's difficult to determine whether this is a good deal for Apple and its investors.

So, as this storyline evolves, let look at two possible arguments that Apple should scrap its deal for Beats altogether.

1. Apple could be overpaying
Tech companies have a long and storied history of massively overpaying for acquisitions, but not Apple. Even as Facebook and Google happily shell out billions for emerging technologies, Apple has historically maintained its discipline on the M&A front.

Apple has always favored small, highly targeted acquisitions of key technologies as its way to control whatever technology it covets, so the rumored $3.2 billion price tag that Beats reportedly costs represents a huge shift in tactics for Apple. However as investors, we know determining a good value goes beyond simply the price paid. Beats clearly has two great products in its high-end headphones and its budding streaming service.

Beats Music Logo

Source: Beats Audio.

Although it's hard to nail down specifics, most analysts seem to agree that Beats' headphones are probably quite profitable. However, even if the financial profile from Beats' headphones marries well with Apple's, it doesn't necessarily mean Apple needs to own that revenue stream. They could just as easily strike a distribution deal to sell Beats headphones through its retail channels, a far less expansive business arrangement.

This supports the notion that Apple is really interested in Beats' streaming music service. And although Beats Music product is apparently a membership conversion monster, its user base remains a drop in the bucket, at just north of 110,000 paying subscribers, especially compared to the likes of Pandora's 76 million subscribers. So, all told, between an attractive, but hardly necessary, line of headphones and a start-up music service, it's fair to question whether Apple is making the right decision in shelling out $3.2 billion for Beats rather than developing a comparable service internally.

2. Apple and Beats: Brand competition
One of the possible rationales supporting Apple's buying Beats has also been Beats' indisputably strong brand.

However, Apple is consistently ranked as the most valuable brand in the world. And while Apple has shrewdly borrowed cool points from other brands in the past (partnering with Bono and U2 for instance), it's hard to see how a marriage between the Apple and Beats brands would work from in a practical sense.

Beats Music On Ios

Source: Beats Audio

Apple's iTunes music brand is arguably the most universally recognized brand in digital media, which makes the notion of some kind of co-branding between Apple and Beats all the more implausible. What would this new on-demand music app be called? iTunes Music by Beats? Beats by iTunes? There just doesn't seem to be a lot of possible room for both brands to co-exist in a stand-alone product. So, why acquire the brand?

It could be possible that the Beats Audio team is more than willing to let the brand behind their music service die given the dollar figures involved. But as far as the arguments touting the combination of two great brands go, I'm certainly not convinced.

In Cook we trust
Generally speaking, I'm a big believer in CEO Tim Cook and the rest of Apple's management team.

Especially given Apple's "black box" approach to product development, there's clearly a lot of information the investing public isn't privy to that's driving management's behavior. Apple could be encountering issues with developing a parallel service for some reason or another that might make Beats Music a must-have product as digital music increasingly shifts in favor of on-demand models. Beats Music could be a perfect fit for some unnamed product as well. It's unlikely, but certainly possible.

We just don't know, and that's the point.

So, although there are still a few issues I'd like to have addressed, I'm willing to trust that Apple's management team knows what it's doing. All told, the Apple-Beats merger is still an ongoing storyline, so the deal could still unravel as well. However, as this deal represents one of the more noticeable shifts in thinking we've seen at Apple in some time, so make sure to check back for all our coverage of this key storyline as it evolves.

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Andrew Tonner owns shares of Apple. The Motley Fool recommends Apple and Pandora Media. The Motley Fool owns shares of Apple and Pandora Media. 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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