Analysts mixed about Apple's prospects for Beats

Some see potential benefit for Apple's iTunes Radio offering, while others said it was a defensive move at a time when Apple should be looking for offensive assets.

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The acquisition of Jimmy Iovine (left) and Dr. Dre (second from right) is considered key to Apple's deal for Beats. Apple

Even after Apple confirmed long-standing rumors that it planned to acquire Beats on Wednesday, industry analysts lacked any harmony in their impressions of the deal, with some singing its praises and some cracking sour notes.

Morgan Stanley came out in favor of the $3 billion deal, saying a possible acquisition of the popular headphones business and subscription streaming music service was justified because of its low risk but potential for high return. Taking in to account Beats' 30 percent revenue growth and gross margin that is likely to best Apple's, Morgan Stanley said it viewed the acquisition's valuation as fair, especially given the potential for further revenue growth from pairing Beats with Apple's global distribution network.

"Subscription music service could make the deal a home run, with every 1% penetration of Apple's 800M account base equating to $960M of revenue," Morgan Stanley wrote. "Apple believes Beats offers the right strategy for streaming music as it leverages both algorithms and 200 human curators to create playlists, which differentiates it from competitors."

RBC Capital Markets was also positive on the proposed deal, noting that Apple will acquire access to a leading music subscription service and the company's high-margin hardware business, which the analyst firm estimates to be sustaining more than 70 percent gross margins. But another key will be the acquisition of creative management talent in the form of Beats co-founders Jimmy Iovine and Dr. Dre.

"In our view, the iTunes/music strategy, which has been challenged recently, could benefit from the new hires," RBC Capital wrote. "Notably, Iovine was one of the first industry executives to anticipate the download business's decline and advocate for subscription and streaming services as music's future."

While Wells Fargo Securities said it was willing to give Apple "some benefit of the doubt" based on its historical success, the analyst firm took a more bearish position. The analysts viewed the music-related acquisition as defensive and posited that "Apple should be focusing on more offensive assets to better position itself."

Noting that Beats' premium headphones business likely enjoys high margins, Wells Fargo Securities worried that the acquisition was a shortsighted effort to drive accessory revenue. The analyst said it saw more benefit in the opportunity the deal presented for growth in an ad business.

"However, we believe Beats lacks the scale Apple would need and, frankly, driving apps for plain old in-app banner ads is not the differentiation and innovation we expect Apple to bring to this model," Wells Fargo Securities wrote.

Pointing out that the offer for Beats was by far Apple's acquisition, International Strategy & Investment Group also noted that the purchase price represented a little more than 2 percent of Apple's cash on hand. The analysts said they viewed the deal as a "head scratcher" but said there was potential for Beats' nascent music subscription service to give a boost to Apple's iTunes Radio offering.

But in one of the odder concerns voiced Wednesday by analysts, ISIG suggested that Apple's new "spaceship" campus currently under construction would have to undergo a major architectural redesign to ensure talent retention.

"Since 1996 and enacted through Proposition 215, medical marijuana has been legal in the state of California," the analyst firm wrote. "However, based on our knowledge, there are no plans to house a medical marijuana dispensary in AAPL's new 'spaceship' campus... Considering Dr. Dre's debut solo album in 1992 was called The Chronic (slang for powerful marijuana), AAPL may want to reconsider the construction plans."

 

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