Apple is Overpaying for Beats -- But That Isn't the Problem

It's not the price that is problematic in Apple's proposed acquisition of Beats Electronics.

May 28, 2014 at 10:15AM
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The S&P 500 and the narrower Dow Jones Industrial Average (DJINDICES:^DJI) were down 0.19% and 0.33%, respectively, at 10:18 a.m. EDT. In company-specific news, Apple (NASDAQ:AAPL) is reportedly preparing to announce its acquisition of high-end headphones maker and music streamer Beats Electronics -- at a lower price than was originally touted.

When the Financial Times reported nearly three weeks ago that Apple would acquire Beats Electronics for $3.2 billion, I wrote that the target didn't look like an obvious fit and that the price seemed elevated. (I certainly wasn't alone in making that observation -- both the rationale for the deal and its price have proved controversial.)

Whitesolobeatsbydreheadphones

Source: Wikimedia.

It now appears that the deal under consideration may be lower than the figure mentioned by the FT -- but not by much, if we're to believe an article posted yesterday evening by the New York Post. (I don't usually get my financial news from the Post, but this story is making headlines this morning.)

According to the article, Apple is preparing to announce the acquisition of Beats Electronics this week at a price of $3 billion. Let me remind you of the few elements we have to assess the acquisition price (as a private company, Beats has neither a publicly traded stock nor an obligation to publicly disclose its financials):

 

Beats Electronics revenue*

$3 billion reported acquisition price as a multiple of revenue

2013

$1.3 billion

~ 2.3 times

2012

$1.0 billion

~ 3.0 times

*Estimated. Source: Fast Company, Mergers & Acquisitions.

At 2.3 times last year's estimated revenue, the deal doesn't look outrageous, particularly as Beats appears to be growing at a healthy rate. However, we have some other valuation benchmarks. Taiwanese mobile devices manufacturer HTC invested in Beats Electronics in 2011 at a valuation of roughly $600 million, then sold its remaining 24.8% stake at a valuation of $1.07 billion last year.

Did Beats' intrinsic value nearly triple since last year after having only doubled over the previous two years? The two previous valuations don't look consistent with today's $3 billion figure. Either HTC got bamboozled last year -- despite earning a very decent return on its investment -- or Apple is getting ready to overpay for Beats (or some combination of the two).

My concern with the Beats deal is not so much that it suggests a lack of financial discipline -- overpaying a bit on a deal this size is financially inconsequential for a company of Apple's size -- but rather a lack of strategic vision. The fact that the original $3.2 billion reported price is the same amount that Apple rival Google is paying for smart appliances maker Nest (at what is likely an inflated valuation, too, incidentally) highlights a huge missed opportunity for Apple.

Nest was a much better fit for Apple (it was even founded by Apple alumni), as well as a wedge into an enormous nascent market -- the Internet of Things -- especially if Apple is getting ready to announce a smart home software platform at next week's Worldwide Developers Conference.

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Alex Dumortier, CFA 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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