April 11, 2003 3:21 PM PDT

Apple may buy Universal Music

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Shares of Apple Computer fell Friday after a report that the company was in talks to buy the music company of Vivendi Universal for as much as $6 billion.

The Los Angeles Times reported that Apple has been in talks for months with Vivendi, with recent discussions centering on Apple acquiring the music business outright. With annual sales of about $6 billion, Universal Music Group is the largest of the five major record companies, commanding roughly a quarter of the worldwide market.

A source familiar with the situation confirmed with CNET News.com that there have been discussions between the two companies, but stressed that the exchanges are still at a "very preliminary" stage. "There has been interest expressed," the source said. "There have been talks."

A record label acquisition would radically transform Apple from a computer maker into a company with hardware and music operations of similar sizes. At the same time, investors worried that a deal could also deplete the company's more than $4 billion in cash.

Apple's stock closed Friday at $13.20, off $1.17, or about 8 percent.

Representatives of both Apple and Universal Music Group declined to comment. The L.A. Times report said that talks could still fall apart, but also that Apple might make a bid ranging between $5 billion and $6 billion before Vivendi's April 29 board meeting.

A Vivendi Universal representative said that a number of third parties have expressed interest in various parts of the company's entertainment business, which includes movie studios and theme parks as well as the music division. However, the representative said that the company is not commenting on specific negotiations.

One analyst questioned whether it makes sense for Apple to purchase a record label at a time when media and the Net are transforming key label functions such as talent searches, promotions and distribution.

"Apple's rumored bid for Universal Music group would be a big mistake in an era when artist discovery is being transformed by TV such as 'American Idol,'" said Steve Harmon, a media analyst with Marketsnap Research Group. "Owning a stable of artists, no matter how well known, cannot compete with fan-based networks that find and nurture talent. In addition, distribution is becoming fully digital which again, speaks to reasons not to acquire an old-fashioned company."

Although the combination sounds unusual, it might not be as surprising as it appears at first blush, said analyst Phil Leigh of Raymond James & Associates.

"We believe that Apple Computer has been slowly evolving into a digital media company anyway," Leigh said in a research note on Friday. "Their computers are focused on digital media applications."

Apple is also developing its own digital music service, according to sources. The service is rumored to be launching later this month, Leigh said.

The deal, if it were to go through, would allow Apple to evolve beyond its PC heritage. "The company is clearly attempting to evolve away from being merely a personal computer company," Leigh said. "It does not want to be controlled by the same economic dynamics that govern the conventional business PC market."

At the same time, the music unit that resulted would likely be the most aggressive in terms of moving its content online. Leigh said that online sales are the key to a recovery for the music industry, which has seen flat or declining CD music sales for the past five years.

"Ultimately the transition is as certain as fleas on a yard dog," Leigh said. "The only way to offset the declining revenues from CD sales is to adopt Internet distribution."

The record label's artists range from Elton John to Limp Bizkit to Shania Twain.

Music performance
Talk of a marriage between Apple and Universal Music Group comes amid an industrywide slump in music sales and as debt-ridden media conglomerates are seeking to unload underperforming assets.

Worldwide sales of music CDs, records and cassettes fell for the third year in a row last year, with a 7 percent drop in global music sales and a 10 percent fall in units sold in the United States, according to figures for 2002 released Wednesday by the International Federation of the Phonographic Industry (IFPI).

The root cause of the decline is hotly debated. The record labels have consistently singled out Internet piracy as the biggest factor behind the trend, while others have pointed to missteps such as high CD prices and promotional tactics that aim to produce megastars at the expense of consumer choice.

Either way, the industry's top task is solving the use of digital technologies and Internet distribution. Online subscription services now offer consumers a wide selection of music for a monthly fee, including the ability to burn songs onto homemade CDs. But paid services face an uphill struggle against free file-swapping alternatives such as Kazaa, where millions of songs continue to change hands despite legal efforts to stop it.

The short-term prospects for the music business have turned record labels into hot potatoes at the media companies that in some cases only recently paid billions of dollars to acquire them.

In addition to Vivendi Universal, media leaders AOL Time Warner, Bertelsmann and EMI Group are all considering sales of their music divisions.

A potential Apple acquisition of Universal Music Group raises a tantalizing question: Can technology--widely seen as the root of the music industry's problems--emerge as its ultimate savior?

Apple has benefited from the boom in digital music, pitching its iTunes software as a way for consumers to "rip, mix and burn" their own CDs, a campaign that drew the ire of the music industry. The company has also had a smash hit with its iPod digital music player. However, in both cases, Apple profited without necessarily generating business for the record industry.

With the proposed music service, though, Apple is clearly looking for a way that it, as a hardware maker, along with the content owners, can profit from the popularity of digital music.

However, Sony's experience offers a somewhat-cautionary tale. The consumer electronics giant purchased CBS Records in 1988 for $2 billion, but has built little cooperation between its music and its gadget operations.

Piracy remains a key point of disagreement between the company's media and electronics executives, with the record side of the company endorsing antipiracy schemes that make it more difficult for consumers to play songs back on digital devices. When Sony label artist Celine Dion released her single "A New Day Has Come" last year, for example, the track included encryption technology that rendered it unplayable on most PCs, including Sony products.

Sony's internal conflicts are mirrored in the larger industry, where the digital piracy issue has pitted the entertainment and electronics companies against each other in a lobbying battle in Washington. Legislation has been proposed that would allow the government to mandate copy protection technology for consumer electronics devices, if the industry cannot work out voluntary standards, sparking bitter complaints from PC makers.

In a sign of Sony's disarray, Sony Music in January appointed an executive with no music experience to lead the division upon CEO Tommy Mottola's resignation after 15 years at the helm.

Andrew Lack, former president of NBC and longtime head of the network's news operations, faces a tough task turning around Sony Music, which lost $142 million last year. He recently announced a restructuring plan that will combine some operations and could see as many as 1,000 employees cut from the payroll.

 

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