More and more reports are coming out that Apple's (NASDAQ:AAPL) real interest behind the rumored Beats acquisition is to obtain its subscription streaming service more so than just the accessory business. When compared to market leaders Pandora (NYSE:P) and Spotify, Beats has miniscule paying subscribers (below). Why the interest in BeatsMusic? As Beats co-founder Jimmy Iovine put it in this interview, no one offers an interactive music service through curated lists. The next song is just as important as the one currently playing. According to Iovine, this is the feature that will define future of subscription streaming services.
Timing of deal does not bode well for Pandora
With a diminutive music catalog of about 1 million songs, market leader Pandora utilizes curation to mask the limited selection. Pandora's Music Genome Project database, though, has lost its exclusivity with crowding competition in the music streaming market. Momentum seems to have turned for Pandora who disappointed analysts with Q2 revenue guidance adding to worries of growth deceleration and lack of profits. Pandora's free (and cheaper subscription) business model has helped it become the most popular streaming service. However, this isn't admired by the music industry as it gets short-changed on profits. As with any business, you must keep the supplier happy. Pandora responded to this through a 25% subscription hike.
Apple views Pandora weakness as Beats strength
The music market is moving away from the pay-per-song download model that iTunes uses and towards a streaming model. As a result, popularity of iTunes appears to have reached a peak with sales declining in 2013 for the first time. Pandora & Spotify have benefited greatly from this shift. Beats could be the way Apple stays relevant in this emerging market to challenge the competitive threats.
Beats Music boasts a catalog of 20M songs at a monthly rate of $9.99, making it competitive with established leader Spotify. Beats, however, is distinguishing itself from competition by offering a different music experience for each taste out there through a combination of human curation and computer algorithms. The company has compiled thousands of customized playlists with the help of a small army of freelancers curating. Playlists can be based on the work of an artist, a genre, a year or even an activity, like BBQing or working out. The goal is to provide an interactive music service through curated list that's customized to listener.
The algorithms developed by Beats for music curation would make for a bonus feature on iTunes. With 800 million iTunes users, Apple and Beats will have ample data to curate music tailored towards each music taste. Additionally, with a little marketing, Beats Music could be advertised to 800 million users worldwide. That miniscule 200k subscription figure is expected to grow at a rapid pace once Apple steps into the picture. When taking into consideration that Beats has converted around 70% of their free users to paid accounts, the potential synergies of an Apple/Beats affiliation overshadow the $3.2billion acquisition cost.
Iovine Dr. Dre connections
The rapid growth of Beats Electronics is mainly due to the marketing and human capital behind the company. Iovine is a music industry veteran who co-founded Interscope. Dr.Dre is one of the most recognized names in hip-hop and modern day music. Bringing these two heavyweights into Apple will ensure the monetization potential of streaming music so Apple does not face the same issues as Pandora. The industry relationships that Iovine and Dre hold could distinguish Beats over competitors when negotiating licensing deals and music content
"I've been meeting with Apple about subscriptions since 2004… I think they're an incredible company, and I wanted them to do subscriptions."- Jimmy Iovine
Seems like 10 years later, Iovine got what he was longing for. With Apple in their corner, Beats Music should climb the ranks and become a leader in this subscription based industry. The collaboration of the two brands should have Spotify and Pandora concerned as they possess a distinctive product with the right people supporting it. I won't even mention the financial backing Beats will have. We can see why Apple made Beats the most expensive acquisition in its history.
If Jimmy Iovine is right, curation will define the future of streaming music services. To get ahead of this trend, investors should keep an eye on Apple and CUR Media (OTCPK:CURM), a company developing its own next gen streaming service.
A Pure Play into Streaming
You may have heard of CUR's beta product, Radiatz, back in 2012. The app offered a large music library (14 million tracks) with location-based features to discover new personalized music on the go. Once the company had around 150,000 monthly unique users, it was taken offline in order to focus on launching the finalized product, CUR Music.
The finalized platform, expected to launch by Q4 2014, will have a unique social angle and be positioned in-between personalized radio services like Pandora and on-demand music services like Spotify. This hybrid model will focus on curated genre stations (as indicated by the company name) and sharing content with your network. "Social music" is the phrase being used by the company to describe the impending product.
CURM is utilizing the data collected from Radiatz beta to scale their finalized product. Acting as a proof of concept, the company discovered that the majority of consumers would pay a fee ($2) for CUR and "gift" purchased content to others in their network. The concept of having a relatively cheap "social music" app sounds compelling from a consumer point of view. Does this make it a worthwhile investment though?
Like with any startup, the management team must be top notch to get the company off the ground. Chairman John Lack is best known for being creator of iconic platforms like MTV, Nickelodeon and ESPN2. Lack's specialty is creating global media brands. CUR's content will be in good hands with Bob Jamieson, the former CEO of RCA Records. CEO Tom Brophy is a digital media entrepreneur that helped pioneer the search toolbar business before it became the multibillion dollar industry it is today. Jay Clark, former Sirius XM executive VP of content/programming, will handle programming duties of CUR Music application. Investors of CUR are in good hands as the leaders come from proven backgrounds in media. Similar to how Beats' success could be placed on the human capital behind the brand, I see the same approach with CUR Media's management team.
Earlier this year, CUR Media raised approximately $9 million through a private placement. This offering was oversubscribed by nearly 40% which shows the enthusiasm for a unique music streaming model. In 2013, revenues from streaming music services climbed 51% demonstrating that there is greater room for growth. With this offering, CUR is fully funded through development of the finalized music player.
Valuation & Risk
With valuations north of $4billion, Spotify and Pandora sport P/S ratios ranged from 6x-9x. CUR is projecting $50M in revenue by the first operational year (2015). Applying a 5x sales ratio and discounting back 1.5 years at a lofty 40%, CUR would require a valuation in the $150M range. This is more than double current value.
With product still in development, investors face great execution risk. This speculative nature of a development stage company warrants the discrepancy in company valuation. A proven management lessens this risk, but investors can never dismiss it.
In addition, the competitive pressures from current music streaming market players pose a threat to CUR's success. The field is crowded with companies already public (Pandora & Apple) and private players (Spotify, Rhapsody, Rdio, Songza). Offering an innovative product that will gain mass market appeal will be the challenge what distinguishes the services.
Jimmy Iovine presumed curation would be the future of music streaming, so he produced Beats Music with distinctive features that offer an interactive service. With the rumored acquisition, it seems Apple shares Mr.Iovine's theory on curation's future potential. As an investor, I wanted to see how I could benefit from this prospective trend. The diversified approach would be to invest in Apple and see the Cupertino giant integrate Beats Music with their massive iTunes database. For the high tolerance investors, a pure play into streaming would be the speculative CUR Media. Whatever your preference, I believe we will be seeing a shift in music streaming away from the present leaders and towards the innovators that can offer the best curated playlists.
Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.