At first glance the deal, which values Beats at about three times
more than when it sold a roughly 50 percent stake in itself to the
Carlyle Group in September, appears to be at a very rich valuation.
And yet in analyzing the deal, media and analyst reports lay stress
on how the deal is only about 0.5 percent of Apple’s massive market
cap. Or better yet, that the $2.6 billion cash portion of the deal
is only 1.7 percent of Apple’s $151 billion cash hoard as at the end
Seriously, people, that’s how percentages work: if you take a large
number like, say, $3 billion and compare it to a very large number
like $151 billion you will come up with a small percentage. That
does not imply, however, that because one is small in comparison to
the other it is cheap or even a good deal, only that it is
This kind of thinking is rife in the markets for tech assets which
are bubbly, and may really only demonstrate that things are out of
Following the announcement of Facebook’s $19 billion acquisition of
WhatsApp we saw some similar reasoning.
Benedict Evans, of Andreessen Horowitz, a Facebook investor, said in
a blog post the correct question was not about the $19 billion
sticker price but rather "is this worth 10 percent of Facebook?"
In that instance, because the deal was mostly in Facebook stock,
this logic has a certain perverse truth to it. If you posit that
Facebook stock is overpriced, or should we say has a highly
uncertain relationship to its ability to create profits, you might
conclude that taking a flyer on a new area is worth a tenth of that.
During the gold rush in California in the 19th century miners in the
goldfields often paid 10 to 20 times the Sacramento or San Francisco
price for coffee or meat. That was the cost of remaining on site and
hopefully getting more gold. When the gold ran out, however, the
To be sure, there are huge differences between the Facebook/WhatsApp
and Apple/Beats deals. Though the figures are not public, Apple
appears to be paying something like three times annual revenue for
Profitability at Beats is uncertain, with the headphones portion,
which is more mature, thought to generate high margins but perhaps
also subsidizing losses in the streaming music business. Apple, for
its part, believes the deal can be accretive to profits as early as
2015, though whether it accretes enough to make $3 billion seem
reasonable is another matter.
[to top of second column]
Also at issue here is tax, with some observers suggesting that, as
Beats has tax residency in Ireland, Apple may be able to use cash
held offshore for some or all of the purchase price. That would
effectively reduce the price to Apple as repatriating that money
would incur hefty U.S. taxes.
But what both deals have in common is that the acquirer is paying a
pretty sizable premium to get access to a new area they haven’t been
able to crack. In Facebook’s case it was the 'network' of millions
of users who use WhatsApp to communicate. For Apple it is streaming
music, an area which is eating away at its traditional strength of
music downloads and in which its attempts to compete have produced
Paying up to get that may well make sense. For Facebook every new
network is a potential existential threat (remember Myspace?). For
Apple, its franchise value is about the acquisition and consumption
of content over its devices.
Apple’s far less lofty share price valuation might make you think it
is less vulnerable but only, I think, if you are not familiar with
the story of Blackberry. Some of the vulnerability demonstrated by
Blackberry is already very likely in Apple’s share price.
That, not the fact that Apple can easily afford dozens of Beats, may
be the real reason, and perhaps valid justification, for the deal.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be an
owner indirectly as an investor in a fund. You can email him at
email@example.com and find more columns at http://blogs.reuters.com/james-saft)
(Editing by James Dalgleish)
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