Apple's Universal gambit goes for broke

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For the second time in a little more than a month, reports of a music-related initiative by Apple Computer Inc. have touched off a flurry of speculation.

But last week's article in the Los Angeles Times, which reported that Apple has been in talks for months with French media giant Vivendi Universal to buy its Universal Music division for $5 billion to $6 billion, dwarfs last month's news of Apple's as-yet-unannounced service for downloadable music.

Some confirmation arrived Wednesday, when Vivendi director Claude Bebear told Bloomberg News that his company expected Apple to make a $6 billion offer for Universal Music.

Bebear's statement prompted a highly uncharacteristic denial from Apple CEO Steve Jobs Wednesday afternoon.

"Apple has never made any offer to invest in or acquire a major music company," Jobs said in an official statement. "The press statements attributed to Vivendi board member Claude Bebear are untrue, as Mr. Bebear has confirmed in a later report."

Of course, Jobs statement doesn't say Apple hasn't been talking to Vivendi about Universal Music, just that there's been no offer. And it looks like Bebear had his wrist slapped for speaking out of turn.

Wall Street took a dim view of the brewing deal on Friday. Apple's stock fell more than 8 percent, shedding $1.17 to close at $13.20, a five-year low. Vivendi's stock fell as well, though only by 4 cents.

In trading Wednesday, Apple fell 15 cents, while Vivendi's shares were up 25 cents.

Crushed by a $12.9 billion debt and a 2002 loss of $25 billion, Vivendi has been shopping pieces of itself since last year, but potential buyers haven't exactly been lining up.

Before the news of Apple's possible bid for Universal Music surfaced, Vivendi had heard only from billionaire oilman Marvin Davis, who has offered $15 billion for the entire Universal Entertainment group, which includes the music division.

Analysts struggled to interpret the news, with many concluding that while Vivendi certainly needs the money, the deal makes no sense for Apple.

Both The New York Times and The Wall Street Journal expressed pessimism at the likelihood of the deal ever being consummated.

The general thinking is that the deal represents too great a risk for Apple, which has struggled over the past two years just to eke out a small profit.

Buying into another struggling industry -- the Recording Industry Association of America reports U.S. CD shipments fell 9 percent in 2002 and already are down a further 6 percent so far this year -- strikes many observers as unwise.

"It seems odd to me that Apple would acquire [Universal Music] unless they got it real cheap," said Roger Kay of IDC, the research firm based in Framingham, Mass. "The audio archive has already escaped," he said, referring to the illegal download services that started with Napster Inc.

Apple, based in Cupertino, Calif., would need to resolve several very formidable issues if it were to follow through on purchasing Universal Music.

First, Vivendi needs cash, and Apple's cash hoard of $4.4 billion -- it only has a relatively small $320 million in long-term debt -- is well short of covering the $5 billion-plus it would need.

Apple could raise the money, but the transaction would turn its cash position inside out. The company's cash holdings translate to about $12 a share -- and for the past several years have served as a backstop preventing further erosion in the price of its stock.

Second, owning Universal suddenly would make Apple a rival to the other four major record companies that it reportedly has persuaded to license their catalogs to Apple's pending online music service.

Third, the combined entity would generate tension between Apple's traditional role as a computer software and hardware vendor and its new role as a content owner. Apple's "Rip, Mix, Burn" slogan of 2001 was criticized widely by music industry executives, who claimed it encouraged the illegal copying they blame for killing CD sales.

So, why would Apple do it?

Pundits spun a plethora of theories. Among them:

  • Unable to break out of its 3 percent to 5 percent market share in the PC market, buying Universal Music would bring diversification to Apple;
  • It's a defensive move against Microsoft Corp.'s DRM (digital rights management) technology, which is Windows-only. If the major labels adopt Microsoft's DRM, Mac users would be left out;
  • It's part of Apple's strategy to sell more Macs. The Universal deal is the last piece of the puzzle to a complete a best-in-class Apple integrated music solution that will drive people to the Mac.Actually, there could be truth to all these theories.By purchasing Universal, Apple would own a vast catalog of extremely valuable content -- Universal's roster includes such acts as U2 and Shania Twain -- that it could leverage with its Mac technology. Apple already builds devices on which music can be played (Macs and iPods), along with software to manage it (iTunes).When it launches its iTunes-based music service, Apple will have the means to deliver its content to the consumer as well.Apple's experience in providing both goods and services puts it in a unique position to construct the new, service-based model of music distribution the record labels need, but haven't had the courage, or smarts, to create.The slump in revenue the music industry is experiencing stems not from the public's loss of interest in music, but from a lack of willingness to recognize and adapt to the realities of the digital world.Consumers have grown tired of paying an average of $18 for CDs that contain only one or two songs they want. It's more practical to download those tunes off the Internet, but the pay services created by the record companies are poorly designed to compete with the illegal file-sharing services that allow people to trade songs at no cost.Thus the pay services -- such as PressPlay, American Online Inc.'s MusicNet and Listen.com -- have a combined 500,000 subscribers compared with the estimated 14 million people who use such illegal file-sharing services as KaZaA and Gnutella.The pay services have foundered because they charge too much -- usually 99 cents per song -- and include a myriad of restrictions, known as DRM, or digital rights management. In some cases, downloaded songs can't be burned to CDs or transferred to portable MP3 players; in others, the song "expires" after a set time period, such as 30 days.The record companies, through the RIAA, have spent more time, money and effort fighting illegal file-sharing services than seeking an Internet download solution acceptable to its customers.Only a cheap, reliable download service that offers a complete catalog of high-quality digital music with few or no restrictions has a chance of winning back a significant chunk of the music-buying public.Enter Apple.The company has built its reputation on making the complex easy for the average user, and reports on its impending music service -- expected to launch within weeks -- say it makes purchasing music as easy as buying a book from Amazon.com.But as long as the Big Five labels control the content, Apple must play by their pricing and DRM rules, dictated by their paranoia over losing profits to new technology.Enter Universal Music."If Apple bought Universal, they can say, "This is how it's going to work," said Cambridge, Mass.-based Forrester Research Inc.'s Josh Bernoff.He surmised that Jobs may have gotten frustrated during the music-service negotiations with the record companies, concluding that the music executives "just don't get it."In typical Apple fashion, Jobs then could have decided to "buy a music company and show them how it should be done," Bernoff said."If anybody can do it, it's Apple," he added. "People trust them to get things right. They can create change in an industry even if they don't end up dominating it."Bob Lefsetz, a commentator based in Santa Monica, Calif., who writes about the music industry in his e-mailed "Lefsetz Letter," sees great potential in an Apple acquisition of Universal.Lefsetz maintained that the simplicity of Apple's pending music service can make it successful if it can supply the content for a reasonable price. Lefsetz says reasonable is not the 99 cents-per-song the pay services generally charge, and what reports say Apple's music service would charge.He's backed up by none other than the chairman and CEO of Sony Corp., Nobuyuki Idei, who said last month in an interview with the news site AlwaysOn that he had urged Sony's music division 6 years ago to start working on a way to offer secure distribution of low-cost content over the Internet."They have to change their mindset away from selling albums, and think about selling singles over the Internet for as cheap as possible -- even 20 cents or 10 cents -- and encourage file-sharing so they can also get micro-payment for these files," Idei said.Lefsetz said Jobs' gaining control of Universal could be a "Trojan horse," to allow him to "get into the game."Since Universal holds a dominant 30 percent share of the music market, with the next three majors each having 14 percent to 16 percent, Lefsetz said that would put Jobs in a position to "control the game.""If you don't think that Universal controls the music business, you're not in it," Lefsetz said. "[Universal Music group president and COO] Zach Horowitz sets policy, the other four majors obey it."Lefsetz thinks if Jobs had such power, he could use it to compel the other labels to support his model of music distribution.Whether or not all this comes to pass, many people already have changed how they obtain music.Forrester's Bernoff said the enduring popularity of file sharing is pushing the record labels to change, but "somebody is going to have to bust things open."Apple may have just the right vision and technology to be that somebody, if, as it appears, Jobs is willing -- literally -- to bet his company on such a venture.And given Steve Jobs' track record, that wouldn't be a shock.

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