Apple Confirms It Will Buy Beats for $3 Billion — Is It Worth It?

Source: twitter.com/tim_cook

Source: twitter.com/tim_cook

Apple (NASDAQ:AAPL) confirmed its long-rumored acquisition of Beats Electronics in a press release on Wednesday that revealed that the Cupertino-based company will purchase Beats for a total of $3 billion, including approximately $400 million that will vest over time. The acquisition includes Beats Music, the company’s nascent subscription music streaming service, as well as its premium headphone and speaker business. Apple also confirmed that Beats co-founders Jimmy Iovine and Dr. Dre will join Apple, although it is not yet clear what their new roles will be. According to Apple, the deal will be finalized in the fourth quarter of fiscal 2014, pending regulatory approvals.

The acquisition of Beats has been rumored to be in the works since it was first reported by the Financial Times on May 8. Although the final purchase price was slightly lower than the $3.2 billion figure that was initially reported, the acquisition of Beats is still the most expensive company purchase that Apple has ever made. The most that Apple had previously paid for a company was in 1997 when it acquired NeXT for $400 million in a deal that also returned Steve Jobs to the company he helped found.

While the $3 billion price tag is still a relatively small amount considering Apple’s $150 billion-plus cash pile, some analysts have questioned the wisdom of spending this amount of money on a company that doesn’t appear to have any valuable patents or other intellectual property that Apple can use to enhance its existing products and services. However, in an exclusive interview with The New York Times, Apple CEO Tim Cook appeared to hint that the iPhone maker was primarily interested in the innovative abilities of Iovine and Dr. Dre — two music industry icons. Along with a photo that Cook shared via Twitter that can be seen above, the Apple CEO appeared to reiterate the importance of Iovine and Dr. Dre by tweeting, “It’s all about the music.”

Source: Thinkstock

Source: Thinkstock

“These guys are really unique,” Cook told The New York Times. “It’s like finding the precise grain of sand on the beach. They’re rare and very hard to find.”

Cook also noted the importance of Beats Music to the overall deal. “Could Eddy’s [Eddy Cue, SVP of Internet Software and Services] team have built a subscription service?” asked Cook rhetorically. “Of course. We could’ve built those 27 other things ourselves, too. You don’t build everything yourself. It’s not one thing that excites us here. It’s the people. It’s the service.”

Cue similarly emphasized the importance of Beats Music in Apple’s official press release about the deal. “Music is such an important part of Apple’s DNA and always will be,” said Cue. “The addition of Beats will make our music lineup even better, from free streaming with iTunes Radio to a world-class subscription service in Beats, and of course buying music from the iTunes Store as customers have loved to do for years.”

Although Apple’s press release and additional comments made by Cook and Cue appear to suggest that this deal was a straightforward move to bolster the company’s struggling music services, some analysts criticized Apple for overpaying for Beats. In a note to investors released after the deal was confirmed, Wells Fargo analyst Maynard Um described the acquisition as a “defensive” move.

“[W]e believe Apple should be acquiring more offensive assets to better position itself,” wrote Um. On the other hand, Um admitted that “Apple should get some benefit of the doubt because of its historical success.”

However, Um argued that the addition of human talent like Iovine and the Beats Music subscription service still does not justify the $3 billion price tag for Beats. “Iovine would bring music industry contacts and the design team could help with Internet of Things,” wrote Um. “But we believe the valuation for this reason is high.” As noted by Um, it is unclear if Beats has any valuable IP that is unknown to the public. However, he pointed out that Apple paid less for the essential wireless patents that it acquired from telecom giant Nortel in 2012.

The Wells Fargo analyst also noted that Beats Music “lacks scale.” According to comments made by Iovine at the Code Conference on Wednesday, Beats Music currently has 250,000 subscribers after being available for approximately four months, reports Re/Code. In contrast, Spotify has about 10 million paying subscribers out of a total user base of 40 million. On the other hand, Spotify has been around for almost ten years. While Um believes that Apple could be developing a cross-platform ad business through Beats Music, he still cited the service’s lack of scale as a downside.

Finally, besides critiquing the two primary reasons behind Apple’s acquisition of Beats, Um also examined Beats’s premium headphone business. According to IDC data cited by Bloomberg, Beats Music holds about a 65 percent share of the headphone market. Although Beats’s premium headphone business fits well with Apple’s similar premium computer hardware business, Um noted that acquiring a company for accessory revenue is a short-term move, as opposed to a long-term strategic move that the company should be making.

Um maintained a “Market Perform” rating and a valuation range of $515 to $585 on Apple shares. Apple has already set a new one-year high of $630.61 in early Thursday morning trading following Apple’s confirmation of the Beats acquisition deal.

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