Wall Street warming up to $3B Apple-Beats deal, sees potential to offset declining iTunes revenue

Posted:
in AAPL Investors edited May 2014
Apple's newly announced $3 billion acquisition of Beats Music and Beats Electronics has received a generally warm response from prominent analysts on Wall Street, who believe the purchase could help Apple compensate for shrinking digital music sales on the iTunes Store.




Apple made it clear in announcing the purchase on Wednesday that the Beats Music streaming subscription service was key to its interest in the company, while the headphone making side of the business will live on under Apple's direction. But Beats Music is seen as complementing the existing iTunes Store and iTunes Radio, offering a new service that was not previously available from the company's offerings.

Analysts on Wall Street accordingly focused on the acquisition of the Beats Music service in their reactions, and most came away with a positive feeling about the $3 billion deal.

Morgan Stanley

Analyst Katy Huberty sees Apple's purchase of Beats as a "low-risk, potentially high-return deal." She noted that Beats' device business is seeing strong growth of 30 percent per year, and believes the high margins justify Apple's acquisition price.

But it's the subscription music service that could make the Beats deal a home run, Huberty said. She believes every 1 percent penetration of Apple's 800 million active user accounts equates $960 million in revenue.

"Apple believes Beats offers the right strategy for streaming music as it leverages both algorithms and 200 human curators to create playlists, which differentiates it from competitors," Huberty wrote. "Apple plans to monetize the service with aggressive subscriber growth (from 250K today) and become profitable over the long term."

J.P. Morgan

While analyst Rod Hall believes the $3 billion final cost is "pricey," he isn't concerned about how much Apple is willing to pay, as the company is sitting on a massive $133 billion cash pile.

"Rather, it is about what Apple can do to with Beats Music to revitalize their own music business," Hall wrote. "We also see the addition of Dr. Dre and Jimmy Iovine to the musical network and creativity they bring as a positive for Apple."

Hall noted that iTunes content sales declined about 8 percent in calendar 2013, while his estimates suggest sales declined over 25 percent year over year in the second half of 2013 alone. In light of this problem, he sees the "innovative" Beats Music service as a potential solution.

In fact, Hall said he wouldn't be surprised to see Apple sell off Beats Electronics at some point in the future, allowing the headphone making side of the business to stand on its own while Apple would keep the talent and Beats Music service it has acquired.


Photo via Paul Stamatiou.

RBC Capital Markets

Analyst Amit Daryanani also sees the Beats deal as a positive, adding to Apple's recurring revenue streams. Along with the Beats Music service, he's encouraged by the addition of Iovine and Dre to Apple's team, as well as the profitable headphone hardware, which he estimates brings in 70-plus-percent gross margins.
While analysts were skeptical at first, many have begun to see value for Apple in buying Beats, particularly through its subscription music service.
In order for the Beats acquisition to be viewed as a success, Daryanani believes Apple needs to see growth of iTunes sales and increased hardware sales from Beats. He also expects to see innovation in Apple's iTunes product line thanks to input from Iovine and Dre.

He noted that subscription-based music revenues were up 50 percent in 2013 to $1.1 billion. During that same period, sales of digital music fell 2 percent to $3.9 billion, representing the first decline in history.

Piper Jaffray

Gene Munster was originally confused by the Beats deal when rumors first surfaced, but like others, he's begun to warm up to the marriage with Apple. In particular, he believes that adding Iovine and Dre could "help propel Apple into the next level in its content offering, particularly in video."

Munster also noted that because the $3 billion Beats purchase is Apple's largest acquisition in history, it could open the door for other purchases, including potential Internet services outside of content.

As for the Beats headphone lineup, Munster believes Apple will be able to leverage its distribution channels to help the brand rapidly grow over the next few years.


Wells Fargo

Maynard Um views Apple's purchase of Beats as a defensive move, and it's not one that he entirely agrees with. In his view, Apple should be acquiring "more offensive assets to better position itself."

Um doesn't believe investors should be focused on accessory revenue from the Beats purchase, at least in the near term. And while he's intrigued by the music subscription business, the analyst said Beats lacks scale, and he's not sure it justifies the $3 billion valuation.

Um does, however, see value in the addition of Iovine to Apple's lineup, while the Beats design team could help Apple in the wearable devices market.

Evercore

Analyst Rob Cihra admitted the $3 billion price tag on Beats is "steep," but argued that "the cost of Apple not getting the next generation of music right would be much steeper."

He believes Beats headphones will add more than $1 billion in annual revenue for Apple, but like others, he sees the bigger factor in the deal being the addition of Iovine and Dre to Apple's team. In his view, both men bring with them "invaluable industry relationships" that could benefit Apple in content negotiations.

As for Beats Music, Cihra believes Apple was in a position where it needed an answer to subscription streaming service Spotify, and the Beats product fits that bill. While he admitted Beats Music is just getting started, he believes the purchase will provide Apple not only with established content deals, but also an option for split branding if it so chooses.
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Comments

  • Reply 1 of 95
    rogifanrogifan Posts: 10,669member
    And I could find just as many who think this is a dumb idea. http://tinyurl.com/p5ltpy8

    Gotta love spin. ;)
  • Reply 2 of 95
    pazuzupazuzu Posts: 1,728member
    I can see some value in Iovine but what's the value of Dre? And no it's not because he's black.
  • Reply 3 of 95
    I'm starting to warm up to this too as a stockholder. I'm now seeing all the possibilities of Apple's pieces coming together. Subscription based music thru iPhone, Macs, Apple's CarPlay, Satellite connected Headphones, etc. Combine this with an iCloud Subscription and I might actually sign up.
  • Reply 4 of 95
    reason88reason88 Posts: 9member

    Well It's Called "Beats by Dr. Dre"

  • Reply 5 of 95
    gremlingremlin Posts: 45member
    I really can't see why this is such a bad deal. When FB buys whatsapp for $19B or google buys Nest for around the $3B mark, no one seems to comment. The negative Apple press is curious.

    From what I've seen of the Beats subscription service I can see apple turning it into a great thing to complement iTunes song purchase model. Steve was right when iTunes first started saying people want to own their music, but now i think more and more ppl are happy to pay a small monthly fee to have access to a vast collection. Next for Apple should be a huge investment in Netflix! :)
  • Reply 6 of 95
    SpamSandwichSpamSandwich Posts: 30,840member
    Oh, please. "Wall Street is warming up" to the deal... This deal was practically designed by Wall Street. It's the Apple longs who have more of an issue with it. I see it more as appeasement.
  • Reply 7 of 95
    pazuzupazuzu Posts: 1,728member
    It will remain to be see if Cook can to do Beats subscriptions services what Jobs did when Apple purchased SoundJam and turned it into iTunes.
    The bar is high.
    Anyone know what Apple paid for SoundJam? Talk about a return on investment.
  • Reply 8 of 95
    solipsismxsolipsismx Posts: 19,566member
    gremlin wrote: »
    I really can't see why this is such a bad deal. When FB buys whatsapp for $19B or google buys Nest for around the $3B mark, no one seems to comment. The negative Apple press is curious.

    Sure they do, they say Apple should have outbid them. :D It's some weird aberration of the positional good by proxy where they only want Apple to buy it because it's desired by another company. If Samsung had wanted Beats those same people would probably be ecstatic that Apple bought them first.
  • Reply 9 of 95
    asciiascii Posts: 5,941member

    The goal of Apple should be to bring their *own* products and values in to the world. It follows that since the music on the iTunes Store is not written by them, increasing/maintaining sales of it should not be a corporate goal.

     

    The original purpose of iTunes was to help sell more iPods (to sell a digital music player you needed a decent digital music store and there was none). But what about these days? Will adding a subscription service to iTunes help sell more iDevices? No, because these days iDevices can already run the third party app anyway. 

     

    They are spending billions to maintain a position in digital music that is no longer causal in the sales of their devices. I suspect that if the music section of iTunes closed tomorrow, the sales of iDevices would not suffer.

  • Reply 10 of 95
    danielswdanielsw Posts: 905member
    Quote:
    Originally Posted by Rogifan View Post



    And I could find just as many who think this is a dumb idea. http://tinyurl.com/p5ltpy8



    Gotta love spin. image

    Why all this incessant stupid quibbling over what has already happened, and what others think? Apple paid $3B for something. That means it meant quite a bit to more than a few at the company. So move on, people!

     

    I just signed up for my free trial of Beats Music, which I wouldn't have done if not for this acquisition. I figured this is what Apple is interested in. I wanted to see what there was to it.

     

    So far, I like it. It's kinda like the "gap" the iPad filled in Apple's hardware lineup, but this is a "gap" now filled in Apple's music lineup. It's not going to replace music purchases. But it may just boost them. I'm finding that, with Beats, I can now listen to more than just 120-sec clips of a lot of music, and without having to buy. I can re-discover a lot of stuff I used to enjoy listening to in years past. And then I will most likely buy some of what I discover with Beats. I'm sure Apple will do what it can not to stiff the artists out of Beats royalties, either.

     

    I'm sure that's the genius of this acquisition.

  • Reply 11 of 95
    solipsismxsolipsismx Posts: 19,566member
    danielsw wrote: »
    I'm finding that, with Beats, I can now listen to more than just 120-sec clips of a lot of music, and without having to buy. I can re-discover a lot of stuff I used to enjoy listening to in years past. And then I will most likely buy some of what I discover with Beats.

    That only works while you're in the beta. Outside of that it's $100 per year to find new music new buy. For me that's not worth it as music rental isn't how I like to listen to music. Even if they though in $100 worth of new songs per year you can grab from iTunes as a Beats Music credit that probably wouldn't appeal to me as I think I'm at a point where I don't want several dozens new songs per year to own.
  • Reply 12 of 95
    danielswdanielsw Posts: 905member
    Quote:

    Originally Posted by ascii View Post

     

    The goal of Apple should be to bring their *own* products and values in to the world. It follows that since the music on the iTunes Store is not written by them, increasing/maintaining sales of it should not be a corporate goal.

     

    The original purpose of iTunes was to help sell more iPods (to sell a digital music player you needed a decent digital music store and there was none). But what about these days? Will adding a subscription service to iTunes help sell more iDevices? No, because these days iDevices can already run the third party app anyway. 

     

    They are spending billions to maintain a position in digital music that is no longer causal in the sales of their devices. I suspect that if the music section of iTunes closed tomorrow, the sales of iDevices would not suffer.


    Totally disagree.

     

    iTunes will continue to be an important part of the ecosystem, and Beats will only bolster its role. Beats will simply help more people access Apple's entire music library, if only on a subscription basis, but will also "market" that same music to those inclined to buy, all while increasing royalties to artists.

     

    The ecosystem is possibly the biggest reason people buy Apple products and buy into its culture.

  • Reply 13 of 95
    rogifanrogifan Posts: 10,669member
    Oh, please. "Wall Street is warming up" to the deal... This deal was practically designed by Wall Street. It's the Apple longs who have more of an issue with it. I see it more as appeasement.
    I could maybe get behind this deal if Apple decided to use the Beats brand to create cheaper, downmarket products. Everyone is screaming about how Apple needs a cheaper smartphone. Well maybe create something with 5C type styling under the Beats brand. Market it along side new and improved Beats headphones and maybe offer a free trial of Beats music. Use Beats as a cheaper sub-brand of Apple.
  • Reply 14 of 95
    danielswdanielsw Posts: 905member
    Quote:

    Originally Posted by SolipsismX View Post





    That only works while you're in the beta. Outside of that it's $100 per year to find new music new buy. For me that's not worth it as music rental isn't how I like to listen to music. Even if they though in $100 worth of new songs per year you can grab from iTunes as a Beats Music credit that probably wouldn't appeal to me as I think I'm at a point where I don't want several dozens new songs per year to own.

    Wrong. I'd consider subscribing if only on a month-to-month basis in order to get this "enhanced access." Not everyone shares your skepticism.

  • Reply 15 of 95

    I think this will be a good long term acquisition because I don't just see this as an acquisition of a music streaming service, a couple of faces with credibility and contacts in the industry, or a ploy to build an image among the black community, but rather I think that the production potential is enormous.  Apple has already launched A-list performers' albums exclusively on iTunes and iTunes has given a tremendous amount of smaller, independent performers a venue to market their music.  Why not take it to the next logical level; groom and produce this new talent and sign them to an iTunes or Beats label?  This would allow Apple to cut out the middle man (the record company) and offer more royalties to the performer and at the same time pocket their 30% plus a bit more.

  • Reply 16 of 95
    mjtomlinmjtomlin Posts: 1,820member
    Quote:

    Originally Posted by gremlin View Post



    I really can't see why this is such a bad deal. When FB buys whatsapp for $19B or google buys Nest for around the $3B mark, no one seems to comment. The negative Apple press is curious.



    From what I've seen of the Beats subscription service I can see apple turning it into a great thing to complement iTunes song purchase model. Steve was right when iTunes first started saying people want to own their music, but now i think more and more ppl are happy to pay a small monthly fee to have access to a vast collection. Next for Apple should be a huge investment in Netflix! image

     

    Eh, the downfall of radio was the "Top 40" crap that was constantly played.

    The downfall of subscription based music libraries were all the limitations. Plus, having to browse through huge libraries to find a song or artist you want to listen to is just freaken tiresome and overwhelming.

     

    The reason iTunes took off is because it allowed people to purchase what they liked with very little hassle.

    The reason Pandora took off is because it allowed people to customize "radio" to their tastes.

     

    It wasn't until iTunes Radio, that I got the best of the latter two... By creating a Black Keys station, it would play songs by Arctic Monkeys and Cold War Kids... I ended buying albums from both bands - and I haven't bought music in a long time.

     

    iTunes Radio isn't perfect, far from it (really, Katie Perry as part of my station!?) and this is where Beats could help make the experience much better. I just hope Apple keeps iTunes Radio free w/ads (and without ads for iTunes Match subscribers).

  • Reply 17 of 95
    SpamSandwichSpamSandwich Posts: 30,840member
    There's another aspect to the Beats purchase and the increased focus on the youth demographic at Apple (the hire of Ahrendts, former CEO of youth clothing brand, is another dimension of this). It all feels like chasing marketshare, while the largest segment of the population, the aging Boomers, are less of a focus. Will they only be served with the imagined Apple health and fitness band, iPad and iPhone? Surely they will be completely uninterested in Beats headphones.
  • Reply 18 of 95
    solipsismxsolipsismx Posts: 19,566member
    danielsw wrote: »
    Wrong. I'd consider subscribing if only on a month-to-month basis in order to get this "enhanced access." Not everyone shares your skepticism.

    If I'm wrong then explain how I can use Beats to listen to entire songs without paying for or being on a trial subscription.
  • Reply 19 of 95
    anantksundaramanantksundaram Posts: 19,051member

    This is actually surprisingly good analysis by the analysts. I too have come to the conclusion that this acquisition is basically a "worst case, not much to lose; best case, a lot to gain" type of deal. Between them, these analysts have articulated the logic well.

     

    The naysayers here can stuff it. Or stew in it. But the nays are really getting old. Enough already.

  • Reply 20 of 95
    anantksundaramanantksundaram Posts: 19,051member
    Quote:

    Originally Posted by SpamSandwich View Post



    Oh, please. "Wall Street is warming up" to the deal... This deal was practically designed by Wall Street. It's the Apple longs who have more of an issue with it. I see it more as appeasement.

    That's a weird assertion. What evidence do you have for it?!

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