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Summary

  • It was announced yesterday that Apple is potentially buying Beats for $3.2 billion.
  • This deal should not scare people: yes, it's a little different than Apple's M&A style, but Apple has $3.2 billion under their couch cushions and ROI on Beats comes quickly.
  • This deal is about wearable tech, remaining number one in the music industry for sales and streaming, and bridging socioeconomic customer gaps.
  • In addition, Apple could still have a wild card up its sleeve that investors/shareholders have not considered with regard to this deal (i.e. pairing with iWatch, solar power, etc.).
  • Analysts are too busy being appalled over this deal don't realize it's a minuscule risk for Apple, who can take Beats way over the consumer adoption curve.

There's three types of people in the world…those who don't know what happened, those who wonder what happened, and people like us from the streets that make things happen.

- Dr. Dre, Stranded On Death Row

Admittedly, Beats is a brand that I love. Apple (NASDAQ:AAPL) is a brand I love. The two of them have been working together in my personal ecosystem, as I've listened to my music on my phone through my Beats headphones, for some time now. The music quality is fantastic, the style is great, and all is right with the world when my tunes are on and I'm out and about.

The difference between Apple's standard earbuds, and a product like the Beats Studio or Solo headphones is night and day.

So, naturally, when I heard that a deal was going to be announced potentially sometime soon between Apple and Beats - valued at $3.2 billion, which Apple has under the couch cushions - I was excited. Seeking Alpha reported yesterday:

  • Apple may announce a $3.2B deal to acquire headphone maker (and streaming music hawkers) Beats Electronics as soon as next week, Financial Times reports, though final details might still derail it.
  • An agreement to acquire the Dr. Dre/Jimmy Iovine-founded firm would be Apple's biggest ever, and a departure from Steve Jobs-era reticence on big purchases.
  • Beats was valued at a little over $1B after taking a $500M investment from Carlyle in September.

I personally think Beats is still at the beginning edge of its consumer adoption curve. Apple, in my opinion, can be the company that takes the brand over the apex of the adoption curve, without doubt.

This news is being met with some criticism, but as I thought about it last night, I settled on the fact that I really like this acquisition. Aside from Apple pulling any wild cards with this company (which they may), here are the three obvious reasons that I like the Beats acquisition.

1. It's Yet Another "Wearable" for Your Personal Ecosystem

What about all the people that I know that hate Apple's earbuds?

They either don't like the quality or they don't like the way they slip out of their ears. If these people were given the chance and given a discount on Beats at the time they purchased their iPod or iPhone, they could eventually be part of a growing new stream of revenue for the Beats subsidiary of Apple.

More so, think of this not just as the purchase of a headphone company, but as extending yet another branch into the wearable category. We're all expecting the release of the coming iWatch, and with Apple taking on Beats, the company could literally be all over you, at any point during the day.

As Re/Code put it:

The best way to think about Beats, for now, is as two separate deals. In one, Apple gets an electronics maker that has trained lots of people to spend money on headphones with high price tags, even though some audiophiles don't think highly of them. Industry sources peg Beats' electronics sales at more than $1 billion a year.

Marrying that business with Apple's established design and product operation, overseen by Jonathan Ive, could give Apple a new series of product lines and/or new channels to push out new products like the rumored iWatch.

Walking down the street in the city, you could have an iPhone in your pocket, Beats on your head, and an iWatch on your wrist. In an approach to dominate wearables, Beats could be Apple's shot at getting something started, branded, and set for evolution in the headphones market.

I've seen Beats headphones everywhere. I see them during the week when I'm riding the train through the city and I've seen them at a pot limit Omaha poker table with over $100k in cash out during a game. I see them on basketball courts, I see them on suit wearing young professionals. The Beats brand seems to be breaching into "high end" for all walks of socioeconomic life, from what I can tell. I see the lower end headphones that are more focused on fashion - and I've seen the extremely expensive looking wireless headphones, as well. They're everywhere.

What if you could wirelessly stream music from your watch or iPhone, onto Beats brand headphones - is that something teenagers would be into? I think it would be.

2. Apple Can Monetize Beats Better than Beats Can

Say what you want about the quality of Beats headphones - some people, like myself, love them. Some people, like audio purists, hate them. There's no doubt that when Apple wraps their hands around the company, the quality of the product is eventually going to be beyond reproach.

Further, Beats headphones are as much about style as they are about quality. The younger generation has been groomed now to spend $200-$300 on headphones - both for the quality and for the style. Apple is one of the original companies that mixed technology with style.

Current users of Beats could find themselves gravitating towards Apple for future purchases, and the middle aged white businessman in the suit could be the next guy you see on the train wearing a set of hot pink Beats headphones. By plugging the Beats brand into the Apple mothership, they extend the market for both sets of products (Beats and Apple) - this will likely help to drive sales.

Beats is already estimated to do $1 billion in sales per year. With a boost from Apple's brand name and marketing, this acquisition could pay for itself in as little as a couple of years.

By leveraging the brand, the company is going to be essentially opening up an entirely new revenue stream.

3. This Helps Apple's Continued Domination of Music

The numbers are astonishing. According to a recent piece in the Wall Street Journal, Beats revenues increased fivefold between 2010 and 2012 alone, hitting the $1 billion mark. As of this summer, some 59 percent of high-end headphones sold in the U.S. bear the Beats logo. All this despite the fact that the audiophile press has often viewed Beats as underwhelming-or worse-and overpriced. Dre and his co-founder Jimmy Iovine, who together control 75 percent of the company, intend to get Beats not just onto our heads but into our homes and automobiles by expanding into "speakers, audio systems in cars and consumer electronics, and a soon-to-be-launched online streaming music service," as the WSJ reported.

-Slate.com

Music and media are two of Apple's biggest assets.

Every quarter their iTunes revenue continues to grow, and buying music off of iTunes is synonymous with how many people purchase their music nowadays. Apple wants to remain the front runner and industry standard when it comes to people purchasing their tunes. Buying Beats does well to both expand into music accessories, but also to capture the company's subscription streaming service.

There's certainly a large chance that a lot of this acquisition has to do with Beats' subscription streaming service. Said to only have 200,000 subscribers, it can still be an asset for Apple, who is certainly going to look to protect iTunes. iTunes is under a small threat from companies like Spotify, who offer streaming subscription music. They could be trying to nip this threat in the bud here.

The Beats music app has a 3 and a half star rating on Apple's app store. With Apple's help, that's likely to get a big boost in the future. The reviews, as a commenter yesterday pointed out, have been fantastic.

"Beats Music comes closer than other services at transporting you to a beloved record store that's flush with musical finds - and savvy experts to direct you." - Mike Snider, USA TODAY

"At the heart of every winning aspect of Beats is a commitment to what should be obvious in 2014 - that music is not a product, but a process grounded in the human impulse to connect." - Ann Powers, NPR

"I'm turning to Beats for its lively app and fun approach to music discovery." - Joanna Stern, WSJ

When you start to think outside of the hardware for a second, $3.2 billion may not seem like such a hefty price tag after all.

Conclusion

Further, what if there's something that Apple has in mind that we haven't explored? There's always an outside chance that Apple, "thinking differently" has an entirely different set of plans for Beats that we don't know about. What if there's a patent that Apple needs for something else? This scenario is not to be ruled out.

Some analysts, clearly not in touch with the benefits of this deal, are doubting it right off of the bat:

"We are struggling to see the rationale behind this move," Piper Jaffray analyst Gene Munster said in a report late Thursday. "We view a better use of capital for acquisitions to be in the internet services space given that is, in our view, Apple's biggest weakness."

Additionally, people may be starting to see this deal as a backhanded admission from Apple that they need to look outside of their corporate realm to come up with innovation. I don't necessarily know if this is true, and if this deal isn't going to simply complement what Apple has coming down the innovation pipeline, instead.

Beats isn't a brand that's going to go away overnight, like some people suggest. Even if it did - in the absolute worst possible scenario, Apple would be out $3.2 billion - which could essentially go unnoticed.

But, this won't happen of course. Apple will monetize Beats and poach what they want from the company to generate new revenue for itself. I'm bullish on this acquisition, and think Apple is smart for buying Beats now, instead of waiting for the company to continue to grow at the rate which it has been.

Best of luck to all investors.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: 3 Reasons Apple Buying Beats Is Smart