Wild hypothesis. Amazon started as a book distributor. Now it is fighting to become a publisher. iTunes + iPod started as a music distributor. What if it now has ambitions as a label? How would one build that out of Cupertino?

One would start with a fringe, fragmented genre, to serve as a beachhead. Fragmented by not flat - there should be a node near the top of a hierarchy which can be acquired and leveraged.

$1.3 billion in 2013 headphone sales justifies a $3 billion valuation neatly by itself. But this acquisition certainly comes with interesting optionality.

You'd have to be pretty insane to spend $3b to get into the content industry in 2014. First, it's an industry that's been plummeting for a decade, secondly, the entire recording industry is worth about that much, and thirdly, the entire concept of making money from copyrighted works of art is under threat.

This theory doesn't hold water, sorry.

The meat of this deal is the headphones business [1]. I'm opining on the transaction's optionality for Apple. A lot of attention has been given to the streaming service. I'm pointing out another joker Apple may have considered to hold, if not immediately play.

[1] https://news.ycombinator.com/item?id=7812793

The main evidence you give in support of that claim is that the service doesn't have a lot of customers. But that is true for literally just about every other Apple acquisition. Apple buys technology and talent in the early stages or in component form. Like Tim Cook said there's 70+ other examples of tech & talent acquisitions to look at, and this is just another one of them.

It makes sense financially for Apple, sure, but only in the sense that it doesn't lose them money to purchase the attached headphones business. That business would not even register as a blip in their future growth to be the main goal of the deal.

His other quote was how he was looking forward to Iovine & Dre working on revolutionizing the music industry. That's not about headphones.

How did you arrive at the 15% margin figure?

($3 billion purchase price [1] / 14.9x AAPL P/E ratio [2]) / $1.3 billion 2013 Beats headphone sales [3].

We are asking how much in earnings (E) would Beats need to earn to give a $3 billion price (P) no more than a 14.9x P/E ratio. We then turn those minimum earnings E and turn them into a quick-and-dirty margin by dividing E by sales.

[1] http://www.nytimes.com/2014/05/29/technology/apple-confirms-...

[2] https://www.google.com/finance?q=aapl&ei=_0qGU5C_BabzsgeenYH...

[3] http://nypost.com/2014/05/27/apple-cuts-purchase-price-of-be...

Apple made 170 Billion dollars last year. They are insane not to try to spend chump change on the music industry. The own the delivery of sound from that industry INTO a vast % of the consumers of it.

Apple is going to own the entire experience of media consumption for some % of their customer base.

They will be the label, the distribution, the hardware and the content. A 100% apple audio feed, all wrapped up in a tight little box tied directly to your bank account. Every click costs you something.

Apple has never been one to nickle and dime their customers. While I have little doubt the model will have some component of "you pay for what you use", you can be sure it will be done in such a way that 1) much of the cost is buried in the cost of the hardware and 2) if doesn't feel like every click is costing you something.

In general, perhaps not, but for a specific example, iCloud storage.

At a minimum, there should be enough storage for a full backup of each device.

NZ$125/year for 50GB is, to put it mildly, somewhat subpar.

It's plummeting because it's run by in outdated ways by companies that haven't adapted to new technology. A forward-thinking company that embraces technology would have some advantages.

A company like Pandora or Spotify? Two debt-financed companies that still can't turn a profit from music.

Neither of which also sell music in their own online stores, so it's hard to make a fair comparison.

Also, Apple's iRadio is probably not taking off as well as they'd like and Beats Music already has a better feature set.

Pandora and spotify are structurally unprofitable because of their licensing problems/payments. Apple is %500Bn company-- big enough to become a label--has the marketing expertise (iTunes) and Capital ($X0Bns cash) to be a next-generation 'label'. Or maybe I'm missing something?

If Apple (or Google) had wanted to buy out the record labels and their catalogs, they could have done so years ago. They obviously didn't, probably because it's a dying industry that isn't nearly as profitable as their current products.

The very idea of a 'record label' is a relic of the 20th Century, when all recorded music was distributed on heavy physical artifacts.

Not sure I follow. Who said anything about buying out the record labels? Apple can just <become> a label-replacement. There is still a need for a distribution/production/promotion service layer in music biz.

Or Google Play store, for that matter.

I think the problems run much deeper.

Music is now competing for attention with apps, push notifications, emails, SMS, etc. Listening to recorded music was at one time something to do in and of itself. Today it's something that's done almost exclusively in the background.

Couldn't the same have been said before with the phone industry? The tablet industry?

Didn't they sign an agreement with Apple Records that they would not start a record label?

At one point they had such an agreement, but according to wikipedia, Apple Inc (the iPhone people) bought the trademark rights to "Apple" outright and relicensed them back to Apple Corps (the record people) as of 2007:

http://en.wikipedia.org/wiki/Apple_Corps_v._Apple_Computer

Which presumably means they are free to do basically whatever they want with regards to using the Apple name on music-related goods and services.

When that all settled, Apple Records gave Apple Computers all rights to the 'Apple' name and Apple Computers will license the name back to Apple Records for their continued use. I'm sure this involved a fairly substantial sum of money, but Apple could almost definitely start a competing record label.

I'm wondering if there is more here than meets the eye. The purchase price seems actually pretty reasonable at least by today's valuation standards. Do we know what the profitability is on the current sales?

Wikipedia on this seems to indicate that the popularity is being drive by product placement and branding deals as opposed to actual product quality (which, while high may not be enough ib its own to even justify the "reasonable" valuation. (Also Nike has been quite successful long term with this practice).

I'm surprised Pandora, Spotify, Rdio and the others have started their own labels.

Follow the Netflix model of owning and distributing the content.

In the long run this would cut down the power of the current labels and in turn increase profits at all these streaming services!

1. The actual design and production isn't done by Beats. It's done by a partner company, that isn't being bought. Beats is a promotional and marketing company. They aren't a particularly amazing one, but they have done ok. Certainly not innovative enough to want Apple to aquihire them.

2. The service has a tiny userbase, and doesn't have any technology apple does not.

Apple will be producing the headphones now and Apple will be building the streaming service. So, IMHO, this is a brand purchase, plain and simple. There's nothing else left. Tim Cook was dissembling because he didn't want to admit he just bought the rights to a name.

"Unique" is one way of putting it. Another is "messy."

If they wanted the headphones or the talent or the streaming service, they could have bought any one individually, or purchased a number of competing services that are better in each of those spaces.

The fact that everyone is so confounded by this acquisition makes me think that Apple purchased something non-public.

I don't believe people are actually confounded by this acquisition. The headphones are wildly profitable and the Beats brand is incredibly strong. This deal is easily justifiable.

Just grabbing some headlines from Google News:

http://www.cnet.com/news/why-does-apple-want-beats-no-one-re...

> analysts are puzzled by the choice

http://www.latimes.com/business/technology/la-fi-tn-reaction...

> We are struggling to see the rationale behind this move

http://business.financialpost.com/2014/05/12/apple-inc-beats...

> It’s a head scratcher

http://www.bbc.com/news/business-27336863

> This is really puzzling... They must have something hidden under the hood

Seems like those days, if they haven't received press release and a press package the only thing analyst can say is that they are puzzled.

Thankfully in a few weeks it will be time for the annual batch of rumour about the next iPhone. That has been almost a year since the last article predicting the 5in iPhone and the iWatch.

The second article says it all: these are initial reactions.

I believe the sentiment has changed drastically since the deal's first announcement (at least it has among sites and blogs I frequent).

If it was company X that was doing the acquisition, no one would care too much. It's the Apple involvement that makes it confounding, since Apple doesn't do acquisitions of this sort. They don't buy brands, they buy tech or people.

I can't think of a single headphone business that is anywhere near Beats. The headphones are crap, they used to be relabeled Monster headphones, for example. It doesn't matter. The brand is successful. Coco-Cola is just sugar water, it's the brand that makes the money. Same here. There aren't other equivalent brands they could purchase.

For those of us not familiar with Beats, what is so special about the music service compared to (for argument sake) Spotify?

Curation and discovery-- they have celebrity and music curator created playlists. They also have an interesting Pandora-like radio where you can essentially select a mood and it'll build a playlist for you.

I think all streaming services have a form of this, heck even iTunes store has celebrity curated and Genius.

> all streaming services have a form of this ... Quality differs.

Most streaming services just use echonest... so quality probably is pretty similar across the board. You may get variations depending on your own personal preferences and the seed artists you provide.

Anyone think Rdio would be a much better fit for streaming?

I'm distinctly underwhelmed by Rdio. I basically started trying it because of the good Chromecast support, but their recommendations are not particularly good (I listen to a bunch of electronica, and one of the (good) choices it presented me with was a Polish artist; shortly afterwards I got a bunch of 70's Polish pop music, and it took me a day of thumbs down and skipping to get it to stop; similarly, I somehow managed to be subjected to a prolonged assault of Irish folk music where the only connection I've managed to spot was that one of the artists have a couple of track that are somewhat similar to a couple of the track of an artist I like a few other tracks of).

And their mobile app is horrible. The amount of skipping is awful; you'd think they could buffer more. Especially when you have synced tracks that it could use to "fill in". Even though I've synced a number of tracks to my mobile, it skips or fails halfway through even those tracks when my network connection is bad, unless I've marked myself as offline. Add on no ability to play my local music, and I find myself almost certain to switch from Rdio to my local player on my phone within 10-15 minutes.

It's nice for when I'm home, using it via Chromecast, and I pick exactly what I want to play, or have the patience to try to beat its recommendations into submission, but I doubt I'll stay a user very long.

I used my trial of Beats Music for awhile -- I will admit, it had the BEST discovery and automatic playlist creation of any service I've ever used (Rdio, Spotify, Pandora, iTunes Radio) -- you really could be confident when you suggested a song it would build a list of songs that you weren't skipping.

It also had a unique UI.

"I used my trial of Beats Music for awhile"

To be fair, Pandora for me was a magical wonderland of new music discovery for even the first 6-12 months of use. Now? Not so much, and I find myself often wishing Pandora was better at several things.

It seems a bit absurd to pay $3 Billion for an acquihire/component deal, but Apple has $145 Billion in the bank and just bought the most popular non-Apple name in music.

They can always sell/spin out the headphones business once the acquisition stabilizes a little. See also: Google/Motorola.

It's not that absurd when you factor in the profitability of the headphones business. It's interesting, not because Apple would overpay for what they wanted (they didn't), but because they looked past the most obvious aspect of Beats from a market valuation perspective to the relatively more startup-y aspects of it.

Isn't this SV bias? Beats is startup-y? With 300 employees and $1.5bn revenue?

Beats drives a successful marketing business (much like RedBull). I think Apple is buying that. Apple doesn't need to acquire expertise on how to build and sell luxury items.

No, in fact Tim Cook mentioned he was looking forward to what Phil Schiller could do to help Beats product marketing, not the other way around.

Cook also said he was looking to the Beats team (Iovine, Dre) to build revolutionary new products for the music industry. So yes, that is in fact why they bought the company, to figure out the next big new technology products & services for music (is iPod still a "luxury"?)

As for the revenue.. that is exactly why I call it a unique deal. Yes, Apple seems more interested in the nascent music service and the team than in the multi-billion dollar accessories business that probably every single other company on the planet would pay more attention to. I mean they're not throwing it away but it definitely got a minor mention relative to the team & music service. For Apple the headphones business doesn't really move the needle much.. they're looking at the next $100B and that's why they're more interested in the "startup-y" aspects of Beats.

Yet they need expertise in marketing?

the deal seems less absurd if placed in the context of apple's overflowing war chest. even if you ignore the hardware and streaming assets, and assume the deal was purely an acquihire, the deal would be comparable to a company like zynga in 2013 [1] buying a startup for $30M. whether the deal represents the optimal allocation of $3B is another matter, but the magnitude of the deal for apple -- unique in its size -- is not crazy.

[1] http://seekingalpha.com/article/1919501-zynga-cash-still-pil...

They could always just spinoff the headphones side of the business at a later date if they choose to. The revenues there were close to $1 billion last year, so it isn't unlikely. After all, Google kinda did that with Motorola Mobility, right?

In other interviews (1) he actually mentions music first, then the talent, than the hardware business. Sounds more like PR story-telling than an actual assessment of why they made this move.

The music angle is touchy-feely, the talent angle makes it seem like Apple got something that's exclusive, and the profitable hardware business is the solid base to calm investors.

1 http://recode.net/2014/05/28/tim-cook-explains-why-apple-is-...

I agree. I think the music industry connections are probably more important than the headphones themselves. It's the brand and the associated people.

This makes it the third fashion (aqui)hire for Apple, after Angela Ahrendts (Burberry) and Paul Deneve (Yves Saint Laurent). But 3 billion for a fashionable headphones company/music service? I don't know, the feeling I get of this deal is like Nike buying Crocs in 2007, when Crocs shoes were at the peak of their popularity.

I hope that you're onto something there -- the headphones are awful!

Are all of their headphone models awful or just the lower end models? I know that most of the reviews I've heard are of the lower end models and they are pretty much universally panned as a fashion accessory. However, the high end Beats headphones seem to be pretty good; well built with a flat response curve.

problem with that is there are a ton of high quality headphones with a flat response curve with more reputable branding.

well beats didnt own the music streaming service entirely, it was a joint venture. So i'm curious how that worked into the deal.

Lack of evidence does not imply lack of existence. We'll just have to wait and see what happens.