Will Apple Buy Universal Music? And Does it Make Sense?

By Richard Menta 4/12/03

When you are Apple computer and fighting an uphill battle against the world of Windows, you have to keep continual lookout for opportunities that will allow your company to grow while you still have sizable cash in the bank to invest (Apple has $4 Billion). Prior to its release, the iPod was dismissed by many as foolish, because the naysayers felt that it was a mistake for Apple to divert their focus from their core business, computers.

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The truth is as long as MP3 players need PCs to transfer and collect song files, the iPod fits into the model of an entity whose survival has always come from venturing into prodigious opportunities before anyone else. The iPod became a runaway success, alone capturing 26% of the MP3 market (according to USA Today) and doing it with an average price of $400 a unit to boot. The MP3 market was already saturated at that point too, but Apple was able to capitalize on the "gap" between the limited memory of flash type players and the ample memory, but hefty weight and size, of Jukebox players

To put that price in perspective, HP just announced the will be selling their starter PC sans monitor for $319 - after a $50 rebate! You tell me who is making more profit per unit. (see HP does low-price PC limbo ).

Recently Apple announced they were going to start their own online music delivery service. The title of my commentary on that news was "Apple Paid Digital Music Service. Can it Overcome Record Industry Resistance"? In that article I wrote:

Apple clearly sees the potential to steal this market and create another income stream for a company that needs new income streams. This time around may not be as easy as it was with the iPod. You see Apple still has to deal with a record industry still resisting the changes online music will bring to their industry.

Bottom line is that the record industry is forcing online music services to keep their prices artificially high (almost always more than buying a CD at the store) while handcuffing what users can do with those files (You can't burn most tunes on a CD or load them to an MP3 player) to prevent file trading.

But the music industry is going through turmoil beyond the issues of file trading. Most notably the shakeup at French waste company Vivendi whose CEO several years decided he wanted to get into the entertainment business by purchasing Universal from Seagrams.

Now with Vivendi Universal on the financial ropes, they are looking to unload the music division the now former CEO acquired.

Apple is in position to buy the company for a good price. They are in position to leap over the main obstruction to viable online music services - resistant record companies.

Is this a good move for Apple?

Naysayers will say that to purchase A MUSIC company that a conglomerate is trying to dump is folly. Actually, suicidal is a better word judging by the 8% drop in Apple's stock upon release of the news yesterday.

Here is another argument. I say it is too risky for Apple not to reevaluate its company purpose and direction in a world where PCs are cheaper than iPods.

Analyst Phil Leigh of Raymond James & Associates made an astute comment regarding this.

"We believe that Apple Computer has been slowly evolving into a digital media company anyway. Their computers are focused on digital media applications."

In my commentary on Apple's upcoming digital music service I asked this question. Can Apple overcome these issues? I believe they will transcend some, but the record industry has been self-defeating by handcuffing these services.

Universal music presently controls more than 20% of the music sold worldwide. The music industry as a whole has been floundering the last few years, in my opinion because it has failed to change with the times. Distribution via the Internet and the increased role of TV (American Idol for example) and Film (Oh Brother, Where Art Thou?) is transforming artist discovery. The record industry is doing its best to retain the status quo, most particularly by dismantling Online music mechanisms that don't adhere to the old (obsolete) pricing and delivery standards.

Apple on the other hand sees the great opportunity to use its vision to step into this void that a paralyzed music industry has created by not embracing Online delivery of its artists and the music they make.

I would like to point out that there is still considerable risk here in that while Apple knows the Net, it doesn't know the music industry. Of course, Steve Jobs didn't know the movie industry when he lead Pixar and look how successful that became. Here is another point, one can argue that the big labels themselves may not know the music industry as well as claimed.

The Christian Science Monitor's April 11th article "Independents' Day" describes how the independent record companies are flourishing while the big labels scream that file trading is the blame for a significant drop in overall record sales. From the Monitor article:

While executives at those labels [the Big Five] wail about the industry's imminent collapse, indie labels and artists are singing a much happier tune. Profits are up - in some cases by 50 to 100 percent. That's in contrast to overall album sales, which dropped about 11 percent in 2002.

"We don't do too much crying over here," Cameron Strang, founder of New West Records, admits proudly. The home of artists like Delbert McClinton, the Flatlanders, and John Hiatt has doubled its business for the past three years and is projecting a $10 million income in 2003.

There is compelling evidence that the reason for the overall drop in sales is simply poor business execution and decision making by the five conglomerates that control much of the music. The status quo includes hard ball tactics that reverberate badly with the artists who make the music.

The independent record labels have their songs traded too and they are thriving. Maybe they are the ultimate proof that file trading has the promotional effect of radio (What I feel was the first proof supporting this theory came in our October of 2000 article Did Napster Take Radiohead's New Album to Number 1?)

If Apple can buy the largest holder of music for a song (yeah, OK I had to slip that pun in there) and can both reinvent the sales of music online while simultaneosly applying some of the lessons learned by the indie labels, they have a tremendous opportunity here. That opportunity comes from filling a significant gap between conducting the music business in the old way and adjusting to the new. That's the type of a gap Apple has worked well with in the past, one created when an industry is too slow or myopic to adjust.

Apple has the track record of making the vision come true and I feel they are capable of pulling this off. But I repeat, there is significant risk. The potential selling price for Universal is slightly higher than the reserves Apple possesses in the bank. If profitability - even a modest one - does not come soon, it could sink Apple. Such a venture is so large for the company, missteps could quickly become critical threats to Apple's survival.

Also, there is no guarantee that Apple's vision will actually come through this time. There is no guarantee they have any idea what they are doing beyond a desire to possibly become a new, better Disney. Even when the vision is on the mark, there is no guarentee they will execute upon it correctly as we witnessed with that Apple device that invented the PDA market, the Newton.

This is why a sale may not happen in the end and Universal Music will end up in the hands of some other conglomerate.

But as I said before, with PC prices dropping precipitously, the record industry is not the only one that needs to change with the times to remain healthy.

Apple knows that if they stand still the world will rush right past them. The open source Linux has already passed the Mac OS as the second most used operating system behind Windows (unless you count all the UNIX flavors as one OS). The company needs a new strategy to survive.

Becoming a digital media company offers the most promising growth. Content to leverage that media is needed to achieve that goal. Universal Music has that content. If the terms can be negotiated, Apple will own a big piece of content it needs.



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