I don't know the etiquette of posting here, but I just wrote quite a long response to a comment by JumpCrisscross who says that the meat of the deal is the headphones business rather than the streaming business. I don't know if that comment best lost in a tree of other comments, so I thought I'd repost it here. But I disagree absolutely with that point of view.

The meat of this deal is absolutely the streaming service. Apple NEEDS streaming. I buy an iPhone: I pay $100 to have ALL THE MUSIC ALL THE TIME with that phone, for the lifetime of the device. Awesome! It's like Amazon Prime but better.

And Apple NEEDS that; for them to negotiate their own streaming service with the majors + merlin it would have cost them dear - probably some sort of huge advance or equity stake (because that is the basis that streaming deals are done on these day). Apple is too rich to do that, so it's probably cheaper for them to spend $3bn on a pre pack streaming service than it is to negotiate their own deals. They are sitting on $170bn in cash. The majors don't budge on streaming - they want big fat advances, and they want equity. There is NO WAY that Apple can pay a percentage advance that will satisfy the majors ("we can't do this for 0.1% of your cash on hand, because that means that next time someone comes to us, they will want the same terms but they will only have $100m on hand") and they can't give them equity - because they value their equity too highly. It's no surprise that this deal is 90% cash and 10% stock, or thereabouts. The Spotify/Echonest deal was absolutely the reverse - 90% stock, 10% cash, because the value to Spotify of that defensive acquisition was worth way more to the Echonest investors in an upside dictated on a future Spotify IPO. $90m of Spotify stock today turns into a whole lot more in a year when they float.

Oops.

Anyway.

For the headphones, Beats did $1.5bn in revenue last year. Let's assume that the average revenue per unit is somewhere in the mid to late hundreds - $150 - $180 per unit. At $150 - $180 per unit that means they sold somewhere around 8,500,000 pairs of headphones. Gosh. Check my maths there, because I thought it was insane too.

In 2010 Billboard reckoned the global headphones market was worth about $670m on 70.8m units sold - so that's about $9.50 per unit. Beats have massively outperformed this expectation. And thhis means Beats owns 10% of the headphones market, give or take.

There have been various tears-down/BOM costings of Beats which have brought them in at about $20 - $30 per pair - or less. A huge part of the cost of Beats is in the marketing - the endorsements, the adverts (hello, Super Bowl spot at a supposed $8m) the billboard campaigns, the product placements. None of this comes cheap. So let's assume that of their 8,500,000 pairs of headphones they spent maybe $200m - $225m or thereabouts to actually buy the pieces, and manufacture the cans. Let's also assume that - yes - they made 15% margin. On revenue of $1.5bn that means they are making $225m profit. So the manufacturing costs and the profit are about the same - which is fair enough; a 100% markup is pretty decent. But that means that a HUGE element of the value of Beats (and a huge element of that $225m profit on $1.5bn sales) is created in the aspirational value created through marketing - and the marketing costs LOTS money. Remove that marketing spend, and you have a business that doesn't look so shiny. If 90% of the value of the headphones is created by the marketing, then suddenly headphones that can retail at $180 or so per unit, on a per unit cost of $25 need to drop down and retail at $40 or so - which, coincidentally, is about the price point for SkullCandy and other fashion/aspirational headphone brands. So I think the headphones business is worth about 10% - 15% of what Apple is paying in that $3bn transaction. At most. Let's call it $450m, to be generous.

So yeah. I really don't think the headphones business is a thing.

I imagine for a while they may either incorporate Beats into a "premium" Apple headphones range - or they will drop the Beats brand almost entirely and sell the consumer headphones business off to someone else. Whatever happens, I'd doubt Apple will be using "Beats by Dre" as a brand. It'll be entirely integrated into the Apple brand - "iTunes On Demand" or something else.

Whatever they bought, it was not the headphones business. It probably wasn't the streaming business either - if we assume that maybe the Beats Super Bowl commercial netted them some more subscribers for the Beats streaming service and we call it a very generous 200k subscribers, that means that Apple has paid (once we deduct the $450m for the headphones business) something like $12750 per streaming user.

Spotify is worth something like $4.5bn at the moment (or, at least, it was until tonight, before Apple potentially decimated that market) and they have 10m paying subscribers. So that's a cost per user of $450 to buy that business. Spotify pays out 70% of every dollar of revenue to rights holders, giving them 30% of their revenue to cover their costs and make a profit. They say that they will pay out $1bn to rights holders this year. Which means that they are expecting to bring in about $1.4bn in revenue. So they have $400 to run their business and make a profit - only, of course, they don't make a profit. So the 10m subscribers + ad-supported users bring them $1.4bn.

If you want to buy Spotify today, it's going to cost you $450 per subscribing user.

Let's assume that there comes a point that Spotify has maybe 40m subscribers and they bring in $5bn in revenue a year. That gives them $1.5bn to run their business, and maybe at that point they turn a profit. If they return 15% also, then they're making $225m a year profit. That's $5.63 profit per subscriber per year. It's going to take a long time to make back the $450 you spent per user.

The value to the Spotify in buying the Echonest was that nobody else could have it.

The value to Beats in being bought by Apple is that nobody else wanted it.

The value to Spotify in all of this is that it makes it a three (or maybe four) horse race: them, Apple and whichever of the remaining players Amazon buys and bundles into Amazon Prime Instant Music. And then we'll see what Google does with YouTube Streaming.

For everyone else, it's a race to the bottom: so long as Apple can offer "iTunes On Demand" for a dollar less than anyone else, they win: they have a one click route to market, and they have a product that becomes more appealing to more people by the addition of a streaming service.

Basically, as far as streaming music goes, we're all fucked.

Here are some links to vaguely back up some of what I've said above. It's late, though, and I can't reference everything. You can pretty much Google it all though.

http://www.billboard.com/articles/news/950594/beats-by-dre-t...

http://teksocial.com/socialblog/2012/5/13/exploiting-the-con...

http://9to5mac.com/2014/05/13/beats-music-had-only-111k-subs...

http://www.completemusicupdate.com/article/spotify-tops-ten-...