Was Apple's Beats acquisition really a 'no brainer'?

Was Apple's Beats acquisition really a 'no brainer'?

Last night the Apple news we've all been wondering about finally became official: Apple bought Beats The company now run by Tim Cook reached into its wallet and pulled out $2.6 billion big ones (plus another $400 million in stock that vests later on) to acquire Beats Electronics, Beats Audio and of course the incredible talent behind the company. This includes Jimmy Iovine and Dr. Dre, who both become Apple executives.

When a giant company like Apple buys a smaller company like Beats there are important things to consider that are not obvious to those who confine their thinking to a box. Apple has deal-making power that almost no other company has in the technology world. If they see a product, service or team of talent that they like they can accomplish more by owning it than the smaller stand-alone company. This amplifies the potential upside of the target's revenue significantly.

Apple's market capitalization is $542 billion as of this morning. They are paying what amounts to just over half a percent of this market cap to acquire Beats. Put another way, Apple just sped up its entry into a whole new product category for the equivalent of one quarterly dividend payment. If the deal goes poorly it would be about as painful to me as a shareholder as compared to mosquito bite in Canadian cottage country while enjoying a cold beer.

But what if the deal goes well? Could Apple add a few percentage points to its bottom line through this deal? Yes, I think it's entirely possible. And that's probably why Tim Cook told recode the deal is a "no-brainer".

Beats makes premium headphones and speakers. Apple doesn't. This is a perfect complementary product to offer. If I were at Apple I'd be dreaming of ways to incorporate the Beats products into the Apple ecosystem. Could Apple create a Sonos-like speaker product portfolio using AirPlay? Could Apple move into the premium home audio market and serve super high quality streams to audiophiles who are willing to pay a ton of money (read: high margin) for their music experience?

Beats has a subscription music service. Apple doesn't. Again, this a perfect complementary service. Traditional iTunes downloads, iTunes Radio, and Beats Music subscriptions would cover all the bases. Beats only has 200K subscribers and reaches very few countries, but Apple has 800M credit cards on file and the reach of iTunes. If subscription music really is the future, Apple could use Beats to jumpstart their entry into that business model.

Beyond the obvious product synergy, Apple probably has a lot of ideas that it would like to implement if only it had enough talent to execute on them. I can understand why Tim would call this deal a no-brainer. $3 billion sounds like a lot of money. And it is a lot of money to most companies in the world. But to Apple the relative size of this deal is tiny, yet with what appears to be a highly attractive upside to downside ratio.

There's an old expression: "You can't steer a parked car." Ever since Apple's stock price peaked around $700 Wall Street has been complaining that they need to launch new products or new businesses. The investment community was worried that Apple parked its car. As a shareholder I don't think that's true. The Beats acquisition is compelling evidence that Apple still has its foot on the gas and has been planning its course carefully.

Chris Umiastowski

Chris was a sell side financial analyst covering the tech sector for over 10 years. He left the industry to enjoy a change in lifestyle as an entrepreneur, consultant, and technology writer.

More Posts

 

5
loading...
0
loading...
30
loading...
0
loading...

← Previously

Samsonite buys case maker Speck for $85 million

Next up →

iOS 8 wish-list: What we'd love to see at WWDC 2014!

There are 35 comments. Add yours.

Joe McG says:

I have to say, I think this entire acquisition is based on the Beats Audio streaming service. Spotify has the biggest hold on this market and recently announced 10 million paid subscribers. At $100 per year, this is $1 Billion per year, and this is a growing business. It is the future. While this doesn't take into account costs, it also doesn't account for ad revenue for the 40 million total unpaid users.

I am currently a paid Spotify user, but I have no allegiance to Spotify. The Spotify app feels bolted on and doesn't have all of the functionality that Apple could incorporate into an Apple Beats Audio app. I would switch in a heartbeat. With an Apple Beats Audio app, it will grow to, and surpass Spotify levels.

This doesn't even mention the headphone side, which is already a $1 Billion per year business. If you ask me, the $3 Billion dollar price was a steal. They will make the money back in less than 2 years.

Obsidian71 says:

Excellent post.

There's so much upside to this. Chris is right that Beats could be a valuable company to continue to extol the benefits of Airplay.

I'd love to see some Airplay headphones once Wifi antenna and radio get small enough. Bluetooth's range has always been it's primary weakness wrt headphones.

Beats profitability goes up even more now that Apple will be brining the design in-house instead of using Ammunition. Apple's supply chain and bulk buying means better materials and access.

Things are about to get fun in the Apple audio world

BBFunGuy says:

If they paid too much, the relative size of Apple does make that less of a problem. Buying an off-the-shelf solution, rather than developing their own, which would be much more risky. A boring acquisition.

Nemesisprimed says:

By purchasing Beats, even though the contracts they once had with the music industry are now void, they can be used as grounds for (fair!) new ones by Apple. This was the biggest hurdle Apple had in launching iTunes Match because of iTune's dominance in the music market. I'm more than sure Apple will happily rewrite the majority of the software and components developed under Beats.

The Reptile says:

Beats has been through this before with HTC. If they didn't add value there, how will they add value to Apple?

Good OL MC says:

The HTC deal basically amounted to being able to use the logo on their phones and name on their equalizer setting. The upside to this deal is actual control over hardware and the executives responsible for the company reporting directly to Apple. An interesting possibility that Chris brought up is a Sonos competitor with the combined Apple/Beats branding.

Sent from the iMore App

ChrisFricke says:

HTC's scope of business was too narrow to take advantage of the full potential of beats' offerings. HTC used beats as a marketing play and a pre-set equalizer to "tune" their mobile devices. Apple probably has a much bigger plan in mind.

Solamar says:

It's more about being able to plug in 800 million CC's or portion there-of into a ready made streaming service. Doesn't matter Beats only has 250k subs.. it's the Subs Apple can get into the service that matters..

And if anyone thinks it will just be the old Beats app.. no.. Apple will tweak and Apple-fy the application.. and it will have more integrated access to iOS than the competition.. Access to iTunes CC, and any subs are 100% Apple's..

If they only get 5% of 800 million in subscribers.. thats still massive..

iSRS says:

+1

Also, remember all the talk of iTunes coming to Android and possibly Windows Phone earlier this year? Well, mission (mostly) accomplished.

I would like to see the following:
* On iOS/OS X - Beats Streaming incorporated into the Music/iTunes apps. Includes iTunes Match @ $100/year. One-click purchase of the song as with iTunes Radio today.
* On other platforms - Current Beats Streaming apps updated to allow one click purchases from iTunes Music Store (assuming platforms allow it)

arbourable says:

800K credit cards? I thought it was more.

Solamar says:

800 million credit cards..

Iphonejackson says:

I can't wait to wear the new headphones around my neck! ;p

Sent from the iMore App

Iphonejackson says:

I can't wait to wear the new headphones around my neck! ;p

Sent from the iMore App

Good OL MC says:

Okay, interesting thought about a Sonos competitor. Never occurred to me as a possible product.

Sent from the iMore App

Nathan Bael says:

I hope it is based strictly on the audio streaming service. Otherwise Apple bought hype and that is about it. There is nothing beats can do that you can't do by adjusting your equalizer. I wish apple would acquire an internet provider instead.

Derrick4Real says:

You can't wear an equalizer. People aren't buying headphones for sound quality or the other headphone makers would be selling like hotcakes.

It's like complaining that there are cars with better acceleration. Yeah but most people don't care enough about acceleration as much as they do gas milage, warranty, cup holders, and the over all look of a vehicle.

Nathan Bael says:

Some people probably aren't Derrick, and you bring up some good points. However, I tend to purchase for purpose and not a label. If I want running shoes, I would buy what I felt were the best shoes for running, not necessarily some Nike shoes, just because they were "cool." The same goes for cars, computers, and tools. I don't buy for the name, I buy what I consider the best for accomplishing a task in the way I want it accomplished.

What I was saying about beats and equalizer wasn't that I think they don't look stylish or that you should wear an equalizer, it was that you could probably take the headphones that come with your iPhone and duplicate the "beats sound" by adjusting the EQ of your favorite music listening app.

Derrick4Real says:

I understand but what's to say the beats consumer isn't buying the best for accomplishing his/her task? There task is different. It's to look stylish while having satisfactory sound. Beats fills that role.

My only point is that most people aren't like you. Most people spend their entire life trying to fit in, to be accepted, and to belong. They also get used to buying brands. Especially for things they wear. They don't buy jeans cause they are the best or or t-shirts cause they are the best made but because they are the best style at the time. People want to do what celebs do, wear what they wear, etc. That's not remotely new. Hell, to make a point, i use $7.99 skull candy earbuds i got on sale at staples because they fit my needs which is "cheap" & "don't care when i break them and they short out." I also have a set of $250 Denon earbuds but i got those as free swag at a Denon party but i'd never pay for them because one, they look goofy, and two, they look goofy, and three they don't sound $200 better than $50 ear buds. Plus I'm never spending that on earbuds.

I get what you're saying about the equalizer. But as for adjusting the equalizer well you can do whatever you want with the equalizer by my $7.99 headphones aren't gonna sound like Beats because they don't have the drivers.

Regardless, i read they had 64% of the domestic headphone market last year. Those other headphones don't sell great. And consider that bass heavy music hip-hop and dance music are the biggest genres in the world right now. And it's not like Latin music and African music don't have heavy drums.

People should buy what they want. I don't begrudge them but i do find the Anti-beats aspect of the tech crowd funny and irrational. I don't like Sony headphones. I just don't buy them. I don't go on forums when they are announce to vent my anger that other people like them and my anger at people that like their bass heavy music and buy brands. And i'm talking people in general and on other tech blogs not you or your comments. But like i think Chipotle is shit and fake mexican food that's as authentic as a Chalupa. But if people want to eat it i not crusading against it at every turn. That's weird to me.

Nathan Bael says:

I agree with you about the skull candy and buying for the fact that they will break. As for the crusade against beats, it isn't so much that we are going on a beats forum and trashing beats, this is an Apple website. As for the personal vendetta against beats, I have felt that they were overhyped from day one and never cared for them. I don't fault other people for buying them if that is the sound or look that they like, I do take umbrage with calling them high quality.

Eric Blank says:

I think these Apple execs are in a much better position to know if this deal was a "no-brainer" than any of us are. I personally will defer to their judgement on this matter.

Sent from the iMore App

Nathan Bael says:

I agree that Apple execs are in a way better position than the rest of us to make these judgement calls. What I hate is the term "no-brainer." I have always felt that you should think about any decision before making it, even the simple or "no-brainer" decisions.

Eric Blank says:

I understand your point Nathan. Though I don't know if in this case "no-brainer" means that no thought was put into it as much as it's a hyperbolic way of describing the decision to purchase.

emjayess says:

Looks like Beats just came out with improved headphones. iMore's slow news reporting is disappointing.

Dark_Huntress says:

This is one of the best articles I have read on the Beats acquisition! I totally agree with you. As for this leading to an Apple music subscription service, I would be the first one to sign up!

Sent from the iMore App

Chris Umiastowski says:

Thank you! Very kind. It sure does seem like subscription music has legs.

digitaldeath187 says:

“Beats makes premium headphones and speaker" are you smoking crack LMFAO!!!! The only thing premium about beats is the price of there cheap ass headphones! I don't Thank you have a clue! what a premium headphone sounds like.

Sent from the iMore App

Chris Umiastowski says:

Yeah. You're right. I am clueless. The clarity and logic in your argument is undeniable. Consider me corrected.

Tricorius says:

In the Apple world "premium" generally means "costs more than the competition". It also *usually* means "better" as well, but not always. Regardless, most people don't know the difference between a set of Beats headphones and anything else out there other than the brand name and the price.

Nathan Bael says:

Chris, while I don't agree with snarky way digi responded, I do agree with his assessment that beats headphones feel cheaply made and lack in sound quality. I know they sell well, and they have brilliant marketing, but that doesn't necessarily make them worth the price charged. I don't think Apple made a mistake with this purchase, I just hope it is more for the streaming potential instead of the hardware.

Either way, Apple will make money in the long run from this purchase.

Derrick4Real says:

Pretty much any headset over $100 is considered premium.

protominet says:

If beat music was in canada I will subscribe to it !

Sent from the iMore App

Derrick4Real says:

"Could Apple move into the premium home audio market and serve super high quality streams to audiophiles who are willing to pay a ton of money (read: high margin) for their music experience?"

personally i think trying to appeal to "audiophiles" is the least profitable avenue. I think you're spot on with the Sonos sort of whole house audio but i think anything Apple makes should be aimed squarely at the average person with money to spend. That doesn't make it not a premium product. Starbucks isn't the best coffee but it's still overpriced and ridiculously successful. Yeah you can get better but people don't want better. They want that price point and level of coffee: Petes, Coffee Bean, Starbucks level. They sell Sonos at Target and Best Buy. My dad's an audiophile and there isn't a single piece of equipment save an airplay plugin in that he got at a Best Buy level store and he only bought that cause i convinced him he could set up some songs for a party on his computer and airplay them through the house rather than relying on his old school 5 cd changer he bought specifically for use during a party. Regardless, I think worry about audiophiles is worrying about a tiny meaningless subset of the potential market. Audiophiles can hate it and if it's easy to use, convenient and cool tons of people will use it. Netflix isn't the highest quality picture image but streaming is steadily eroding Blu-ray sales because the quality is "good enough" for most consumers.

randian says:

Beats headphones aren't premium in the sense that, say, a set of electrostatic headphones are. They certainly don't have audiophile quality sound. Great if you like "boom boom" bass, but are otherwise low to middling fidelity.

krikaoli says:

Very nice article, but many assumptions and conjecture, there are many variables on the table. I think this deal was a gamble. On the other hand, more solid business did not work, as the purchase of Motorola by Google, so nothing is certain, right?