Apple (NASDAQ:AAPL) announced on Wednesday afternoon that it is buying Beats electronics for $3 billion, the largest price tag Apple has ever paid for another company. While the total amount pales in comparison to Apple's $150 billion cash hoard and its $550 billion market capitalization, it still speaks about Apple's strategic plans for the future. Here are the key items investors need to understand about Apple's acquisition of Dr. Dre's Beats.
The best source for the reasons behind Apple's decision to buy Beats is obviously Apple itself. "The addition of Beats will make our music lineup even better," said Apple senior vice president of Internet Software and Services, Eddy Cue, in the press release announcing the deal.
How will Beats add value? By improving Apple's iTunes Radio and the music experience in the iTunes store, and by bringing the Beats Music subscription service to Apple (which essentially gives Apple its first music service on the Android platform), Cue says. Of course, Apple also cites Beats' leading position in the premium headphone market in the press release.
Also key, Apple says, is the Beats team and leadership. "Both Apple and Beats believe that a great music service requires a strong editorial and curation team," said Apple CEO Tim Cook in a letter to Apple employees (via 9to5mac) following the announcement of the deal. Further, Cook told The New York Times that Dre and Iovine would bring talent to Apple. Cook explained:
These guys are really unique. It's like finding the precise grain of sand on the beach. They're rare and very hard to find.
As is typical for the company, Apple doesn't seem to have overpaid. Though $3 billion trumps any amount Apple has spent before on another company, Beats isn't a speculative investment. The company already has a well-known brand and is a leader in its market. Even in streaming music, Beats has shown early success at converting free members to paying members.
With a reported $1.3 billion in revenue in 2013, Beats' high-margin business likely will only require a few hit products and value-adding synergies for Apple to get its money's worth out of the investment.
Beyond beefing up Beats Music, iTunes Radio, and the iTunes music store, Apple says the acquisition will help bring on some "products you haven't thought of yet," Cook promised in the Times. Morgan Stanley analyst Katy Huberty suggests (via MacRumors) that the acquisition will help further monetize iTunes. With 800 million iTunes user accounts, small improvements to its ability to monetize music can have a big impact on the unit's sales and profitability. Huberty says that its iTunes segment "is an underappreciated growth and margin lever for Apple."
However, the iTunes music portion of Apple's iTunes segment, Huberty notes, is suffering. Revenue from song downloads is declining as users turn to streaming services like Pandora. The acquisition of Beats Music, she says, could be part of a plan to reverse the decline in revenue from Apple's music business.
While the acquisition will likely only have a minor impact on Apple's business over the long haul, it strengthens Apple's leadership position in digital music -- a key pillar to the overall Apple ecosystem that makes it enticing for users to stick with Apple products. Best of all, Apple likely didn't overpay -- a common mistake among tech companies recently.