Apple (NASDAQ:AAPL) has done everything right so far in the last 5 years, with blockbuster products like the iPhone and the iPad. What Apple has done thus far is to create a revenue stream through selling products, a second revenue stream through selling content through a conduit (iTunes), a third revenue stream through product refresh, which in the case of its best selling product (iPhone) is heavily subsidized at the hands of carriers. A fantastic business model is one where you not only sell a product but also supply the content consumed by the product, for a price. When the product is obsolete, sell the consumer another.
Apple has not had any other meaningful new revenue stream in the last 2 years other than the three I have highlighted, and it is a lack of invention and imagination that can come to bite them at a later date. I honestly don't know what the strategic wing of Apple is up to, but if I were them, I would pursue some - if not all - of the following strategic initiatives to acquire content.
Content is the King
It is difficult to be critical of Apple for the kind of shareholder value they have created. The only thing lacking in the Apple factory is content. Think about it this way: they own the device, they own the conduit - but they do not own the content. Apple has big ideas for Apple TV ,and the biggest piece missing in Apple TV's puzzle is content.
A major chunk of Disney (NYSE:DIS) would be a fantastic buy for Apple. Disney's business lines include movie studios, TV channels, radio stations, theme parks, merchandise, broadway shows and cruises. Disney currently has a market capitalization of about $45 billion and margins of about 15% against Apple's margins of about 30%. I am confident that the margins can be drastically improved by selling low-margin business lines which do not align with those of Apple.
I think Disney's media and movie studio business would giv Apple a treasure chest of content for a reasonable cost. Margin pressures would be worked around with asset sales that do not align with Apple's. Even if this addition provides some margin compression, Apple should bite the bullet, as this will give large-scale benefits when it comes to content for Apple TV.
The second content owner Apple should actively pursue should be the now bankrupt MGM Entertainment. MGM is no longer a big film studio but a shadow of its past. MGM has more than 4,000 movie titles which have been licensed to Sony (NYSE:SNE) for distribution. Apple can buy the entire bankrupt entity and then cut Sony out when the deal comes up for renewal.
MGM went through a bankruptcy recently, and struck a deal with their debtors to convert $5 bn in debt to 73,202,553 shares. Certain assets of Spyglass Entertainment were contributed for additional equity issuance of 397,440 shares. The current outstanding debt for the non-listed entity is about $385.7 mn, and the company has a revolving credit facility of $500 mn with $320 mn already used up. The company is not listed and, in my view, the entire entity can be bought out for about $2 bn.
Reliance Entertainment and other parties had expressed interest in the pre-bankruptcy entity at the $1.5-2 bn range, with the entire debt dissolved for pennies on athe dollar, but the deal did not go through. So assuming Apple pays a billion for the equity and settles with debtors for another $350 mn, they could get their hands on a war chest of content for $2.5 bn, maybe less.
The third content owner Apple should go after should be Lionsgate Entertainment (NYSE:LGF). Lionsgate's market cap at this point is a low $1.5 bn, and their library has about 13,000 films. Video properties currently owned by Lionsgate Home Entertainment include those from Family Home Entertainment, Vestron Video, Lightning Video (a former Vestron company), and Magnum Entertainment. Lionsgate is the best among small studios, as they have the best pipeline (Hunger Games and Twilight series) and the best library. Apple, in my view, should buy Lionsgate for about $1.7 bn in cash and assume debt load of about $700 mn, and make the internal accruals from Lionsgate movies in the next 3 years pay for the debt and the acquisition.
Apple can get their hands on 2 large studios (LGF and MGM) with huge film repository for $5 bn, and Disney for a neat sum, provided they divest assets which do not naturally fit with the business. I am sure AAPL's management would figure out a way to make the content EPS accretive in year 1 while building reserves for Apple TV.
Disclosure: I am long AAPL.