Apple Inc and Beats: More Than Headphones

The video-streaming market isn't the only one heating up with new developments. Apple (NASDAQ: AAPL  ) has reportedly gotten quite close to finalizing a $3.2 billion deal with Beats Audio, in hopes of evolving its music streaming service. The trendy accessory of Beats headphones to go with Apple's hardware doesn't hurt either. 

Mixed emotions
According to Forbes.com, the acquisition could bode well for the tech giant because the iTunes Radio service hasn't been performing well compared to competitors Pandora (NYSE: P  ) and Spotify. While iTunes Radio is non-interactive, much like Pandora, Apple wants to stay competitive in the music streaming industry, and the best way to achieve that is to have an interactive streaming service comparable to Spotify. Not only does Beats provide the infrastructure needed to launch an interactive streaming service, but it also brings -- supposedly -- at least 10,000 paying subscribers and a contract with AT&T for families to have access to streaming music and unlimited downloads for only $15. 

However, plenty of analysts were not impressed with the 10-figure-deal. The Financial Times reported this quote from Silicon Valley analyst Ben Bajarin:

If Apple wanted to build some flashy headphones with audio compression and bass boosting, they could have done it themselves for much cheaper." Venture capitalist Om Malik took to Twitter, saying, "Buying BeatsAudio (aka a Baboon'sAss) is a good sign that Apple is pretty much out of ideas & unable to come up w/an anti-Spotify strategy.   

The Financial Times also reported that the Beats brand and its pop-culture-based target market adds value to the acquisition, and while that may be true, let's ask ourselves this: When has Apple ever not been trendy? Although many focus on the acquisition of a brand of headphones, investors, consumers, and analysts need to keep in mind that this transaction is based on keeping Apple relevant in the streaming market, not audio equipment. 

Streaming it all together
Sirius XM
(NASDAQ: SIRI  ) is a dominant player in the music streaming market, but it's more of an extension of traditional radio than a customizable music streaming service that allow access to music downloads. However, Apple started offering its CarPlay automotive platform on some Ferrari, Honda, Hyundai, Mercedes-Benz and Volvo models. While Sirius XM has become standard software in many vehicles, people are still in love with their iPhones and iPods, so Apple adding a Spotify-like app among the others may give Apple the in-car edge it needs.

Pandora has 76 million monthly users, and it offers ad-free subscriptions costing $4.99 a month. However, the company relies on compulsory licensing deals for music, and this has created friction with artists and record companies. Beats has a better licensing setup -- especially with record labels like Universal Music Group being initial investors who stand to do well when the acquisition becomes final. 

Spotify is the world's largest music streaming service, with more than 9 million users worldwide. The company offers a $9.99-a-month ad-free subscription option. Beats service is $9.99 as well. The marriage of Apple and Beats could produce a quality competitor to Spotify. 

Foolish listening
In February of this year, Reuters reported that Spotify recruited a U.S. financial reporting specialist, adding fuel to the fire of speculation that the company was planning to file an IPO. At the time, the company was valued at $8 billion. While there has been no comment from the company, Spotify is the key player to watch for Apple -- even more so if it were to go public. Pandora would seem to come in at a close second, but analysts are speculating that the better move would be for companies like Google or Amazon to acquire streaming services like Pandora and Spotify -- or even Sirius XM.

Apple doesn't need Beats for developing headphone technology or the streaming service. Apple's main revenue driver has always been hardware -- iPods, iPhones, Macbooks, and so on. However, the company has also gained much from the music industry, including market opportunities for hardware and software. So although Beats may not seem like the best investment, Apple still stands to be able to take emerging technology and enhance it so that it outperforms its competitors over the long term. Hold on and see how this plays out.

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Read/Post Comments (3) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 15, 2014, at 12:17 PM, Shades wrote:

    Critics of this arrangement seem darn angry. Seems they wish if they had been smarter and worked for Apple rather than sitting in the bleachers as all fans do. From that seat, I to believe I could do it so much better. I quickly shift back to being a realist, knowing that if I coulda, I woulda.

  • Report this Comment On May 15, 2014, at 8:08 PM, makelvin wrote:

    It seems strange to me that so many critics of this Apple deal with Beats at $3.2 billions as Apple over paying the acquisition and many of these same critics think that Apple should have purchased Pandora instead.

    Let's evaluate the fundamentals of Pandora vs Beats electronics. Pandora generated about $734 million in revenue with a corresponding gross profit of about $136 million. The current market valuation of Pandora is about $4.85 billions with a forward P/E ratio of 48.22

    Beats electronics has an approximate $1.2 billions in revenue with a profit margin similar to Apple. In another word, Beats has both higher revenue and profits than Pandora. If Beats is a publicly traded company like Pandora with just a P/E ratio similar to Apple, it would have been worth a lot more than $3.2 billions already. If Beats is valued with similar P/E ratio to that of Pandora, they would have been closer to what Facebook paid for WhatsApp.

    P/E ratio is typically evaluated based on the potential future growth for the company's earning potential in the future. Beats is a much younger company than Pandora and yet it already surpassed Pandora in both revenue and earnings by a substantial amount. Therefore, it is easy to conclude that Beats has a much better growth rate than Pandora and deserve to have a higher P/E ratio than Pandora.

    The fact is Pandora's business model simply does not generate that much profits for their shareholders. Even if every single person in the US is using Pandora, it is doubtful it will surpass the current profit generated by Apple's iTunes Store and surpass Apple as a whole in both revenue and profit is completely out of the question. With the current market cap of $4.85 billions, Apple will have to pay another 25% more in premium in order to successfully acquire Pandora. This will bring the total acquisition cost of Pandora to a total of around $6 billions for Apple.

    With all of these considerations in mind, does Pandora really still seem like a better acquisition target than Beats Electronics or that Apple really over pay their acquisition for Beats at $3.2 billions? Seriously, do the math.

  • Report this Comment On May 16, 2014, at 12:27 AM, Zendwell wrote:

    I think they stacked enough paper.. that 3.2 billion would be uselessly sitting in a bank account. Hell yeah, Spend it. Spend 5 billion. I'd rather have Beats (and lovine & dre) than money idly standing by in some bank somewhere.. They got 150+ billion more where that came from...

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