Analyst: Apple's Beats Purchase may be Defensive

With Apple's confirmation that it is buying Beats Music, the question shifts from "if" to "why," and Wells Fargo analyst Maynard Um thinks that's still something of a mystery. Based on what we do know, Mr. Um thinks Apple's US$3 billion deal could be a defensive move, which would mark a change in company strategy.

Beats purchase has analysts wondering about Apple's game planBeats purchase has analysts wondering about Apple's game plan

Mr. Um told investors,

Apple is future focused and it's not what the two companies are doing today, but what they'll be doing in the future. While we believe Apple should get some benefit of the doubt because of its historical success, a music-related acquisition still seems, to us, more defensive.

Apple announced on Wednesday that it is buying Beats Music for $2.6 billion plus $400 million vested over time, and that company founders Jimmy Iovine and Dr. Dre will be employees reporting to Eddy Cue, Senior Vice President of Internet Software and Services. Beats is a two-pronged company with a streaming music service as well as a headphone and speaker business.

There isn't any word from Apple yet as to how it plans to meld Beats into its own offerings, leaving analysts to speculate as to what may be in store.

Mr. Um thinks if Apple made the purchase to get into the accessory market, the company is focusing too much on near term goals. Apple could also be looking at Beats as a new source for its ad revenue stream, although that isn't a perfect fit with the company's style.

"This would be more in line with our view of the future," Mr. Um said. "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."

That leaves Beats' music subscription service, which could fit with Apple's needs. That said, Mr. Um doesn't think Beats lacks the scale Apple needs, and doesn't justify the hefty price the company is paying.

If the focus isn't on Beats accessories or streaming music, it's possible Apple sees value in the company's intellectual property and talent.

"Iovine would bring music industry contacts and the design team could help with Internet of Things. But we believe the valuation for this reason is high," he said. "While unclear if Beats has IP, note Apple paid less for the Nortel patents, which we believe included essential wireless technology IP."

With Apple's Worldwide Developer Conference coming next week, there's a chance we'll get more insight into the Beats purchase. The company will host a two-hour keynote event on June 2 where it is expected to show off new features for iOS 8 and OS X 10.10, and possibly introduce home automation and fitness tracking platforms, too.

Regardless of what Apple's motivations were, it seems investors have been pleased with the announcement because the company's stock rose over $6 Thursday morning. Now it's up to Apple to show how Beats was worth $3 billion.

Mr. Um is maintaining his $388 to $626 target price range and "Market Perform" rating for Apple's Stock. Apple is currently trading at $630.20, up 6.19 (0.99%).

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