Apple Inc. Faces Antitrust Claims: Should Investors Be Worried?

The U.S. Department of Justice, Federal Trade Commision, and the European Commission are investigating Apple (AAPL 0.05%) over allegations that its upcoming Beats Music streaming service could have an unfair advantage over its competitors, according to a recent Bloomberg report.

Source: Pixabay

Critics claim that Apple can leverage the market dominance of its iTunes Store to boost Beats' market share. They also allege that Apple is securing limited exclusive rights with certain music labels, which could impact their existing partnerships with streaming services like Spotify and Pandora Media (NYSE: P). What do these accusations mean for Apple and should investors be concerned?

Why Apple is expanding into streaming music
Apple's iTunes revenue from digital sales of books, music, movies, and TV shows slipped 5% year over year in the first six months of fiscal 2015. Meanwhile, streaming services like Pandora Media and Spotify have been growing their top lines at double-digit rates.

Since digital music downloads and streaming services were steadily moving in opposite directions, Apple needed a music streaming service. In 2013, it launched iTunes Radio, but the freemium service still has fewer active listeners than Pandora or Spotify. Last year, Apple bought Beats Music and Electronics for $3 billion. Beats had its own paid streaming music network, but its active user base was tiny compared to the market leaders.

Source: Digital Trends, Edison Research, company and industry websites. *Approximate, based on last known estimates.

Why the new Beats is a threat
iTunes Radio's has a unique advantage over Pandora and Spotify -- it lets users purchase the digital versions of streamed songs directly from the iTunes Store.

iTunes Radio. Source: iTunes

For iTunes Radio, Apple offers record labels lucrative payments. Apple offers 0.13 cents every time a song is played plus 15% of the ad revenue during the first year. In the second year, the payout rises to 0.14 cents and 19% of ad revenues. Since Beats is now part of the Apple ecosystem, the same rates will likely be applied to the rebooted service. By comparison, Pandora pays 0.12 cents per play while Spotify pays a whopping 0.35 cents, but neither company offers ad revenues.

The new version of Beats will reportedly be more tightly integrated with iTunes and iOS, although the service will remain separate from iTunes Radio. However, Apple plans to lower Beats' price to $7.99 per month to undercut Spotify.

Is Apple trying to kill Spotify?
Apple's royalties and pricing plan for Beats strongly indicate that it wants to take out Spotify.

Spotify has 15 million paid listeners, making it the largest subscription-based streaming radio station on the Internet, and 91% of its revenue in 2014 (its last known year) came from paid listeners, while the remainder came from advertisements. This is the opposite of Pandora, which generated 77% of its revenue from ads last quarter. Therefore, losing paid listeners would sink Spotify much faster than Pandora.

Spotify for iOS. Source: iTunes

Since Spotify still operates at a loss and pays higher royalties than Apple and Pandora, it could have trouble retaliating against Apple's aggressive royalties and pricing plans. To make matters worse, a recent report from The Verge claims Apple is pressuring music labels to not renew their licensing agreements for Spotify's ad-supported free version. If that happens, Spotify could end up with fewer free users to convert to paid ones.

If those reports are true, it wouldn't be the first time Apple pulled musicians away from Spotify. Coldplay, which pulled its songs off Spotify in 2013, prereleased a new album on iTunes Radio last year.

What does this mean for investors?
For now, the battle over streaming music won't make much of a financial impact on Apple's top line. iTunes revenue accounted for less than 5% of Apple's revenue last quarter.

However, the rising scrutiny of the Beats relaunch could cause other regulatory problems down the road. Last July, Apple was ordered to pay $450 million in a U.S. state lawsuit claiming that it conspired to raise the prices of e-books. Its HealthKit platform, which connects Apple Watch and iPhone users directly to their electronic health records, is still bogged down in regulatory and privacy issues. Last December, Apple dodged a bullet after it was cleared of antitrust violations over allegations that it locked competing music services out of its iPod.

If Apple's clash with Spotify, Pandora, and other streaming services escalates, it could lead to a closer antitrust probe of all its business practices. Therefore, investors should keep a close eye on how this story unfolds.