The financial media is abuzz with excitement over technology giant Apple's (AAPL +1.16%) purchase of Beats Electronics for $3 billion. Indeed, Apple has repeatedly resisted pressure to pursue a high-profile acquisition, instead opting to snatch up several small companies. Apple typically buys several companies every year, but this deal represents its biggest acquisition ever, hence all the hype.
Even though the deal is intriguing, Apple has some explaining to do. It clearly wants to gain an edge in music streaming, but Beats Electronics is a very small streaming service with a tiny number of subscribers. The deal actually signifies a sense of concern on the part of Apple that its iTunes music platform is quickly losing prominence.
If Apple wants to seriously take on its competitors in the streaming space, it needs to stop kidding around and acquire Pandora Media (P +0.00%).
iTunes is in trouble
Apple has a serious music problem on its hands. iTunes collectively generated 15% revenue growth over the first half of the fiscal year, but that's misleading, as most of that growth was due to the App Store. Sales of digital music from iTunes actually declined last quarter.
As a result, Apple must be worried that iTunes is losing favor with music fans. Mounting evidence suggests streaming is where the growth in music is, but Apple is quickly falling behind there as well. Revenue for streaming services soared 50% last year industrywide. But, Apple's streaming service, iTunes Radio, has done virtually nothing so far.
Unfortunately, if Apple wants to be taken seriously in streaming, acquiring Beats really isn't going to do it. Beats' recently launched streaming service holds just 200,000 subscribers. Meanwhile, Pandora is still the leader with more than 75 million active listeners, which increased 8% in the first quarter.
Furthermore, Pandora controls 9% of all U.S. radio listening and generated 69% revenue growth in the first quarter. For its part, Spotify has over 40 million active users and over 10 million paying subscribers.
Why now is the time to buy Pandora
Apple's intentions with buying Beats Electronics are fairly clear. The company wanted to acquire the premium headphone technology, but this actually looks like a talent grab. As part of the deal, Beats co-founders Dr. Dre and Jimmy Iovine will join Apple. By bringing in Dre and Iovine, it's a good bet that Apple Chief Executive Officer Tim Cook is hoping they can develop an in-house Spotify/Pandora killer. Whether that happens is questionable at best.
Buying Pandora now would be even more advantageous for Apple because Pandora is a lot cheaper than it used to be. Shares of Pandora trade near $25, and are down approximately 36% from their peak of nearly $40 per share just a few months ago.
This means Pandora's enterprise value has declined to less than $5 billion. Even assuming a 20% takeover premium, Apple could still buy Pandora and instantly become a leader in music streaming, for only twice what it paid for Beats.
It's official: Apple is losing the streaming wars
It might seem foolish to speak of Apple throwing around billions of dollars, but the reality is that Apple can easily afford to buy Pandora. Apple has more than $150 billion in cash and marketable securities sitting on its balance sheet. Buying Beats, Pandora, or even both would barely make a dent.
Meanwhile, Apple is faced with one of its flagship products quickly falling behind the competition. iTunes is in decline, music downloads are falling, and Apple's iRadio streaming service hasn't gained any traction. If Apple really wants to get ahead in the streaming market, it needs to get serious. Buying Beats won't get the job done. Instead of trying to fight Pandora and Spotify with its own Beats-inspired streaming service, Apple should just buy Pandora and be done with it.
