Apple’s Cook Pursuing Beats Seen Presaging More Big Takeovers

May 10, 2014 12:01 am ET

May 10 (Bloomberg) -- Tim Cook is making a habit of breaking with Apple Inc.’s past.

The chief executive officer is overseeing talks to purchase Beats Electronics LLC, the headphones and music service company founded by music-industry executive Jimmy Iovine and hip-hop artist Dr. Dre, for $3.2 billion, people with knowledge of the matter have said.

That goes against the playbook of Apple co-founder Steve Jobs, who never paid more than a few hundred million dollars for an acquisition, choosing to buy small companies designed to bring in technology and talent. Buying Beats will also signify Cook’s willingness to use Apple’s $150.6 billion in cash more aggressively, according to Gene Munster, an analyst at Piper Jaffray Cos. in Minneapolis.

“This opens the door to do more mergers and acquisitions, and I think you’ll see more deals around content and products,” Munster said.

Apple’s possible targets include Yelp Inc., payments company Square Inc. and Twitter Inc., Munster said.

Until now, Cook has closely followed Jobs’s mergers strategy. The Cupertino, California-based company has bought 24 companies over the past 18 months, mostly small.

The biggest-ever acquisition was the $400 million Apple paid in 1997 to buy Next Computer Inc. as part of a deal to bring Jobs back to the company. Since then, the largest known purchase was Anobit Technologies Ltd., a flash-memory drive maker, for about $390 million two years ago.

Modus Operandi

A deal to buy Beats would be unlike anything Jobs ever did, and shows that Cook is taking his predecessor’s advice to heart. “Just do what’s right,” Cook recalled Jobs telling him before his death in 2011. Cook said the Apple co-founder told him not to worry about what he would do.

Cook has already been putting his stamp on Apple since taking over, introducing dividends and share buybacks and rolling out a corporate philanthropy program. Apple is also sharing more information about its environmental efforts and labor conditions in its supply chain.

“This appears to be the first time they are acquiring another brand, which hasn’t been their modus operandi,” said Todd Lowenstein, a money manager at Highmark Capital Management Inc. in Montecito, California. “At this deal value, this would mark the largest acquisition in its history and a material divergence from past strategy.”

Tom Neumayr, a spokesman for Apple, and Sarah Joyce, a spokeswoman for Beats, declined to comment. Faryl Ury, a spokeswoman for Square, and Rachel Walker, a spokeswoman for Yelp, declined to comment. A Twitter representative didn’t immediately respond to requests for comment.

Big Targets

Lowenstein and some other investors are questioning why Cook would choose Beats as the company to break the mold. With annual sales of around $1 billion, the Santa Monica, California- based company won’t deliver meaningful top-line growth relative to Apple’s revenue of $170.9 billion in its latest fiscal year, even if Beats were to grow 50 percent a year, according to Charles Wolf, an analyst at Needham & Co.

“I don’t think investors care at all about the $3.2 billion,” Wolf said. “They might care if Apple did a $50 billion acquisition.”

Apple shares barely budged on news of the Beats deal. The stock fell less than 1 percent to $585.54 at the close in New York.

Brand Appeal

With Beats, Apple would also bolster its online music services as the market for downloads, which Apple dominated, slows. Music has long been one of the cornerstones of Apple’s business, with its iTunes store and the iPod player that reignited the company’s growth more than a decade ago. Apple has also rolled out iTunes Radio, an advertising-supported streaming service that competes with Pandora Media Inc. and Spotify Ltd.

While Beats would be too small to jump-start growth, the deal would indicate that Apple is more serious about selling more content and services to its customers to make up for slower sales of mobile devices, according to Colin Gillis, an analyst at BGC Partners LP in New York.

“This would be a step toward building a services layer,” Gillis said. “Why not just buy Spotify? Go for the big boy in the market.”

Maintaining a separate brand might also help Apple appeal to a younger audience that no longer thinks Apple is cool, Gillis said. Still, 67 percent of U.S. teens said their next smartphone would be an iPhone, according to Piper Jaffray.

Another benefit of a deal would be bringing Beats co- founder Iovine closer into Apple’s fold. The 61-year-old music producer was instrumental in helping Jobs hone the strategy that enabled iTunes to dominate the music business.

“Apple seems to want to burnish its brand with a younger demographic and Dr. Dre and Jimmy Iovine have done a great job of branding those headphones,” Mike McGuire, an analyst at Gartner Inc., said. “Tim Cook has been alluding to new products coming soon, maybe they are feeling they need to round their lineup a bit.”

--With assistance from Scott Moritz in New York and Sarah Frier and Adam Satariano in San Francisco.