A report by PrivCo, a research firm based in New York, states that it did. According to the report summary, Apple is “substantially overpaying for Beats Electronics with a premium valuation, that no rational comparable valuation multiple can justify.” To back up its claim, the report claims to have access to confidential documents dating back to 2006.
The Beats Story, According To Privco
The documents tell an intriguing story of Beats fortunes.
According to the Privco report, Beats Electronics inflated its revenue numbers for 2012 to increase its valuation. The music company had earlier stated that its 2012 revenues were three times its 2011 numbers. But Privco’s report states that the increase was a result of change in business models from a high margin brand licensing business (which collected royalties for each headphone sold) to a low margin manufacturer of consumer electronics devices.
The Dr. Dre headphones, which have received mixed reviews, were originally made and distributed by Monster Cable. Beats collected a twenty percent royalty from Monster as license fee. Out of this, they paid four percent to Pentagram, a design firm, as royalty for designing the headphones. The licensing model enabled Beats to function as a “virtual company” of a dozen employees, who focused their efforts on branding and PR. Although it was profitable, this model generated less than $50 million in revenue for Beats.
In 2012, the company effected a change in its business plan from licensor to maker of headphones. The change created new accounting heads in its balance sheet. Clever accounting practices (as a result of multiple entities functioning within a common umbrella) increased the company’s revenue figures from 10 cents on the dollar of retail sales in 2011 to over 40 cents on the dollar in 2012. Simultaneously, the company went bankrupt because it lacked manufacturing experience and did not have cash required to sustain supply chain. Carlyle, a private equity group, rescued the company from bankruptcy in October 2013. Dr. Dre and Iovine paid themselves a handsome dividend of $540 million last year, immediately after the cash infusion. And, the rest is history.
So, Is Apple Really Overpaying For Beats?
Possibly.
But it is important to view the deal through a holistic lens and not by numbers alone. According to the report, Beats does not possess much intellectual property nor is its music subscription business, which is fledgling as compared to that of industry leaders such as Spotify and Pandora, a hit. With its resources and technology, Apple can surely correct these metrics. What Beats brings to the tables is a unique perspective to music streaming.
Beats has the resources and connections of Jimmy Iovine, a music industry veteran, and the services of Dr. Dre, a well-known producer and rapper. Besides this, Vivendi music, which part of Universal Music Group, the world’s largest music label, was also a minority stakeholder in the company.
Through most of their evolution, music streaming service companies have touted their technology credentials (or, the superiority of their algorithms) in selecting the best songs for audiences. But the quality and variety of those songs depends on the music industry, where personal connections play an important role and songs are curated by humans instead of algorithms. No wonder then, the relationship between artistes and streaming services has been a fraught one.
Iovine played a key role in convincing hesitant music industry executives to put their songs on iTunes, which started the digital download revolution. My guess is that Cook has just bought himself a music industry insider, who might create a unique partnership and business model that differentiates Apple from other streaming services.
