Apple’s (AAPL) 2014 decision to purchase Beats Electronics for roughly $3 billion sparked much debate as to whether the tech magnate had overpaid for Dr. Dre’s headphone conglomerate. The Beats acquisition was by far the largest in Apple’s recent history and signaled the emergence of a new era under CEO Tim Cook (after the 2011 passing of founder and CEO Steve Jobs). Many critics, and shareholders alike, argued that Apple overpaid for Beats Electronics, which is arguably true when solely reviewing public information. However when the firm’s future earnings and production costs are analyzed, it is quite obvious that Apple’s purchase of Beats By Dre will generate tremendously lucrative returns.
The main argument against Apple’s purchase of Beats Electronics highlighted the fact that Beats was a one-dimensional company; one which lacked an abundance of products, services, and intellectual property rights. Beats primarily relied on its popular headphones for the capital required to support its fledgling music streaming service. However, Apple did not buy Beats for its past accomplishments. No, instead Apple purchased Beats for its future ambitions.
To the surprise of many, it was recently revealed that the cost of manufacturing Beats headphones stands at $14 per unit. Anyone with an Internet or cable connection probably interprets Beats celebrity-branded headphones as those of a “premium” collection (that range in price from $199.99 to $699.99). While these profit margins are incredible, it makes one question why a company like Apple, which prides itself on creating high quality consumer electronics, would buy a company accused of developing low quality goods?
Call it free market capitalism, but the first reason for Apple’s acquisition of Beats, despite the company’s “cheap” perception, is that consumers love Beats By Dre earpieces and, more importantly, continue to purchase them at premium prices. The Beats marketing machine, headed by co-founders Dr. Dre and Jimmy Iovine, has transformed the company into one of the most demanded “luxurious” headphone distributors in America. Beats’ marketing and popularity made it incredibly profitable and represents the first ever Apple acquisition of a cash flow positive company. Prior to this, all other Apple acquisitions had been of profitless startups. Nevertheless, one cannot argue with success, and Apple has gambled that Beats headphones are here to stay. Last year the consumer headphone market generated $8.4 billion in sales; this year it is expected to command $9.9 billion, whereas 2016 expectations sit at $11.3 billion.
The second, and arguably more important, justification of Apple’s $3 billion acquisition of Beats Electronics is that the takeover merged the Beats engineering team with Apple software/hardware developers. Beats co-founder Jimmy Iovine is arguably the most influential person in the music industry. He was one of, if not, the first advocates of downloading music from the Internet, and actually convinced many noteworthy artists to upload their music to iTunes. Tim Cook even mentioned that “Jimmy has been on the cutting edge of innovation in the music industry for decades, including as a key partner for Apple in the launch of the iTunes music store more than ten years ago.” There’s no doubt that “buying” talent, like Lovine, will allow Apple to expand Beats’ music streaming service.
While at first many criticized Apple for an egregious accounting error, it has since become evident that Apple, as always, makes extremely calculated decisions. While the Beats acquisition was expensive, the company’s proven products, brand value, and marketing potential prove $3 billion was a fair, if not low, offer; not to mention that $3 billion is a drop in the bucket considering Apple maintains roughly $180 billion in cash reserves.