Apple's Beats Deal: 2 Questions Investors Should Ask


U.S. stocks are lower on Friday, with the benchmark S&P 500 and the narrower Dow Jones Industrial Average down 0.13% and 0.03%, respectively, at 10:20 a.m. EDT. In company-specific news this morning, the world's most valuable company, Apple , is (once more) hogging the headlines with reports that it is finalizing a $3.2 billion acquisition of headphones maker Beats Electronics and that it will release the iPhone 6 in August -- one month ahead of schedule.

Source: Wikimedia.

Investors appear to be unimpressed by yesterday afternoon's report of the Beats Electronics buy, as Apple shares were down 0.64%. I think there are legitimate reasons to be skeptical regarding the deal: At first glance, Apple seems ready to pay a very rich price for Beats, which isn't necessarily reassuring considering that it would be the tech giant's largest-ever acquisition. Is Apple eschewing its deal-making discipline to buy some "cool factor"?

Furthermore, much of the value embedded in the acquisition price appears to reside in Beats' brand. But this compatible with Apple's (extraordinarily successful) strategy of building a monolithic brand encompassing its ecosystem of products and services?

On the other hand, Wall Street's reaction today may largely be one of indifference. Yes, the deal would be the largest in Apple's history, but that is mainly a reflection of Apple's approach to acquisitions so far. The $3.2 billion price tag is equivalent to less than a third of Apple's quarterly profit and just six-tenths of a percent of Apple's market capitalization.

Speaking of Apple's ecosystem, ISI Group yesterday had some positive things to say on the topic, even as it downgraded the shares to buy (though it raised its price target from $660 to $675):

While we have always believed AAPL's ecosystem (e.g., iTunes, App Store, iOS, OS X, iCloud, etc.) was highly "sticky" for existing users, we are pleasantly surprised to see AAPL's user base expanding at a healthy pace (e.g., ~60mil new users in ~6mo, ~1/2 of iPhone buyers new to iPhone, ~2/3 of iPad buyers new to iPad, etc.). Importantly, iPhone 5S is also doing very well in emerging markets where per capital income levels are much lower than in AAPL's more established markets. This provides us incremental confidence that next generation iPhones / iPads can help continue growing the ecosystem (vs. simply serving as a refresh for the installed base).

This dovetails with my own opinion that Apple has built a solid moat around its franchise and still has very decent growth prospects. As far as the market recognizing that and closing the gap between the stock price and its fair value, the release of the iPhone 6 could be a catalyst. For long-term shareholders, however, whether the latest iteration of the iPhone hits the market in August instead of September, as Taiwan's Economic Daily News is reporting today, makes no difference whatsoever.

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Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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