Apple to Buy Beats Electronics - Analyst Blog

Reportedly, Apple Inc. AAPL is planning to acquire Beats Electronics for a whopping $3.2 billion. Per Reuters, which quoted Financial Times — if the deal goes through, it will be Apple's largest buyout to date. The acquired service will complement Apple's ad-based music-streaming service iRadio, launched last June.

Beats Electronics, founded by rapper-producer Dr. Dre and music producer Jimmy lovine is popular for its “Beats by Dr. Dre” headphones, priced between $170 to $450. Earlier this year, Beats Electronics launched its $10 a month streaming-service, which gives users unlimited access to its catalogues (more than 20 million songs at the time of launch) through a smartphone, tablet or web-browser.

As revenues from music downloads continue to decline at a rapid pace, subscription-based services are expected to be the next life-line of the music industry. Per ABI Research, streaming music services are expected to generate $5.0 billion revenues this year. The analyst firm forecasts revenues to grow to $46.0 billion by 2018, which presents a significant growth opportunity.

However, the market is already crowded with the presence of Spotify, Pandora P, Rdio, Rhapsody, Google's (GOOGL) All Access, Microsoft's MSFT Xbox Music and Sony's SNE Music Unlimited. YouTube and French company Deezer are also expected to launch their subscription-based service in 2014.

Despite intensifying competition, Beats Music's aggressive marketing and its unique “Right Now” offering has been instrumental in driving market share. Under the “Right Now” offering, users are allowed to create a playlist of their choice based on four variables: a place, an activity, a person and a genre of music.

This user freedom compared to some other services has benefited Beats Music. Moreover, its partnership with AT&T T, Target TGT and promotion by celebrities such as Ellen DeGeneres has also positioned it well over peers. We believe that the deal will expand Apple's footprint in the growing music-streaming market over the long term.

Nevertheless, the acquisition price seems too high for a company, which was valued only at $1.0 billion in its latest round of private funding by the Carlyle Group CG. In Sep 2013, Carlyle invested $500.0 million for almost 50.0% stake at Beats. The reported deal will hand over a net $1.0 billion profit to the group.   

However, it may not be much profitable for Apple, at least in the near term, primarily due to the intensifying competition. Despite all the growth forecasts for subscription-based steaming market, service providers are finding it difficult to grow paid user base. Services like Pandora have yet to report profit, which is a major concern for investors.

Although Apple's loyal customer base is a big advantage in this regard, we believe that the company will take substantial time to gain a strong foothold in the market. Moreover, Beats Music pays a higher loyalty to labels compared to its peers, which can hurt Apple's profitability in the near term.

Further, the lack of a new gadget from Apple will remain a headwind for the rest of 2014. The company is expected to launch iPhone 6 in August, a month earlier than forecasted, which will be a key growth catalyst.

Apple's growing market share in the BRIC and emerging markets is a major positive. We believe that a larger screen iPhone 6 will get good response in these markets, which will further boost top line in the second half of 2014.

Currently, Apple has a Zacks Rank #3 (Hold).