Apple and Universal?

The LA Times’s scoop on Apple’s reported negotiations to buy Universal Music Group had me shaking my head this morning as I drove in. What the heck is Jobs thinking, I wondered. So I ran down what I knew about Apple’s strategic situation:

  • Item. Apple has “miniscule” market share, in the words of the LA Times (greater than the share of BMW in the auto industry, but who’s counting?).
  • Item. Apple is betting that the future of the personal computer, its main product, is as the “digital hub,” the connected center for a set of digital media products including MP3 players, digital cameras (still and movie), and DVD burners.
  • Item. All of the things that plug into the digital hub rely on content to make them useful. For digital cameras and DVD burners, the user creates his own content. For MP3 players, someone else creates the content.
  • Item. The music industry is scared to death of what piracy will do to their bottom line and looks at MP3s as the instruments of their doom. They’re desperately trying to legislate digital media and space-shifting out of existence.
  • Inference. Apple is as desperate as everyone else in the hardware business about finding a recurring revenue stream. .Mac, its online subscription service for email, web page space, online backup, and related services, has apparently done pretty well, but overall its segment, which also includes boxed sales of Mac OS X, QuickTime licenses, and other software and Internet services products, is still a small portion of Apple’s revenue streams. Everything else is in hardware.
  • Scurrilous rumors. Apple has been rumored for months now to be in talks with the labels to start an online music service. Such a service would provide recurring revenue, assuming that people would actually pay for the content, and would theoretically drive demand for iPods and Mac hardware.
  • Item. The music industry has been seen as unlikely to let Apple have access to its catalog (though the LA Times article thinks otherwise). The CEO of Disney has accused Apple of encouraging piracy with its “rip, mix, burn” slogan.

That’s the situation. So why might Apple buy Universal?

  • Diversify away from hardware? If this is their only reason, it’s not a good one — not for shareholders with a basic understanding of portfolio theory and the poor history of conglomerates, anyway.
  • Content for its hypothetical music service? Possibly. But why does it need to do an acquisition to get that? Wouldn’t a JV be a reasonable alternative? Maybe not. After all, the music labels would have all the holdup and might be able to learn enough from Apple in the partnership to start their own service. Look what’s happening with Travelocity and Orbitz.
  • Leverage in the content creation space? Yeah, having a more direct relationship with artists and music producers would be a Good Thing. Why? Restoring credibility as the producer of the best hardware and software for audio creation. The Mac isn’t the only player in that game anymore, and I’m betting that getting XServes and Mac OS X into the music industry is potentially an important long term strategic move to keep one of the company’s historic core segments.
  • Opportunism? Definitely. Vivendi paid $34 billion for Seagram, the parent company of Universal and Polygram, a while back, but is now cash poor. It’s conceivable that the reported $6 billion price discussed in the LA Times article is a bargain.

Which brings us to the reality check. Wouldn’t acquiring one of the big five music groups make it that much harder to do business with the other four??? And the price…. $6 billion??? Come on. Look at Apple’s balance sheet, for crying out loud. All of Apple’s assets together are only worth (accounting value) $6.26 billion, of which only $4.4 billion is in ready cash or cash equivalents. Apple doesn’t have a lot of long term debt, but I can’t see it levering up to a minimum 33% debt for an acquisition in this economic climate. Not even for a make or break strategic move, which acquiring Universal isn’t.