Apple In Talks To Acquire Beats For $3.2 Billion, Says FT

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Update: Apple announced the $3 billion deal on May 28th.

This could be Apple’s largest acquisition to date. According to the Financial Times, Apple is close to a deal to acquire Beats Electronics. Beats is the maker of the popular Beats headphones, as well as the music service, Beats Music.

If it closes, the deal should be announced next week, the FT reports. The two companies have yet to agree on some financial details.

The most surprising thing about this acquisition is its size. Apple has had a very shy strategy when it comes to acquisitions. It doesn’t like to spend a large amount of money to acquire a company.

It doesn’t mean that the company is averse to acquisitions. In the last 18 months, Apple has acquired 24 companies. One of the largest recent deals for Apple was the PrimeSense acquisition — for which Apple only had to pay around $350 million.

In the most recent earnings call, Apple CEO Tim Cook said that the company was ready to spend a large amount of money on an acquisition if it made sense. It turns out that it makes sense for Beats. It could be the first company in a series of big acquisitions — in that case, a culture shift is happening at Apple.

It’s a very lucrative market as these headphones are thought to be overpriced

As the Beats brand is very popular, Apple will probably retain the branding to sell audio accessories. Apple could even use it for other devices.

Beats was created by rapper Dr. Dre and chairman of Interscope Geffen A&M Records Jimmy Iovine. The first Beats headphones, branded as “Beats by Dr. Dre”, came out in 2008. At the time, the company’s products were exclusively manufactured by Monster Cable. This deal expired in 2012 — since then, the company has self-manufactured its products.

While Apple’s devices have always come with earbuds, headphones have become more popular over the past few years. Even though audiophiles tend to dislike Beats’ headphones, the company managed to capture a significant market share. It’s a very lucrative market as these headphones are widely considered overpriced. That’s why it makes a lot of sense for Apple to own this segment of the portable music market as well.

And then, there is the music service. In July 2012, Beats acquired music streaming service Mog. Later, the stand-alone Mog service was shut down. It was relaunched as Beats Music in January 2014.

Beats Music is still a newcomer and has very few users. The acquisition price is very high because of the headphones business, not the music service.

It competes with well-established services Spotify or Rdio. There are a few extra features. Overall, the browsing experience is much more visual, with an emphasis on typography and gestures. The service also puts more emphasis on music recommendation.

Apple has a growing problem with music downloads. The music market is definitely shifting toward all you can eat music streaming services.

When you first sign up, you tell Beats what music you like. Then, you receive song recommendations based on your tastes. You can browse music with a Songza-like experience by selecting your mood and activity.

When Apple acquired another music service (Lala) in 2009, the service was shut down and the team was put to work on Apple’s projects. It’s unclear whether Beats Music will live on or be shut down as well.

But there is one thing for sure — Apple has a growing problem with music downloads. The music market is definitely shifting toward all you can eat music streaming services.

In the Recording Industry Association of America’s 2013 report, streaming was by far the fastest growing segment of the music industry, up 39 percent year-over-year. In comparison, downloads only grew by 1.1 percent compared to 2012.

If Apple doesn’t do something, Spotify and other services will eat the company’s lunch. It’s unclear whether the deals with the music labels will be carried over to Apple. In any case, Apple will have to renegotiate with music labels at some point. With the Beats acquisition, it would be acquiring a team that knows how to do a music streaming service.

Apple has already experimented with streaming services on its own — but these experiments weren’t very successful. First, it launched iTunes Match. For $25 per year, you can store up to 25,000 songs in the cloud. The service syncs all your MP3s and your iTunes Store purchases so that you can stream this catalog from your iPhone or iPad. While it’s very practical, it doesn’t really change the model of Apple’s music business. You still have to buy the songs.

In June 2013, Apple unveiled iTunes Radio, a laid-back radio experience. It works a lot like Pandora — you create a radio station based on your music tastes. It’s very different from unlimited streaming services — you still can’t search for a particular song and play it.

Finally, there is one loser in this acquisition — HTC. In 2011, HTC bought 50.1 percent of Beats for $309 million. Later, the company sold back its stake in two chunks. The first stake resulted in a $4.8 million net loss, the second one generated $85 million in profit.

But that 50.1 percent stake would now be worth $1.6 billion. In other words, HTC could have made $1.29 billion in profit from the Apple acquisition. It would have greatly helped the phone maker, which has shrunk precipitously for the past few years.