Five questions about HTC’s role in the Beats lawsuit

On Tuesday, Monster, the first manufacturer of Beats headphones, filed a civil complaint in California court alleging that Beats essentially swindled Monster when the two companies split in 2011.

It’s no surprise that [company]Monster[/company] and its CEO Noel Lee are suing Beats. It’s been clear that the separation wasn’t amicable since at least 2013. And Beats Electronics ended up being worth a lot — Apple paid around $2.5 billion for the company in May, plus another $500 million for the Beats Music streaming service.

Monster’s case may turn on the actions of another smartphone maker — [company]HTC[/company], which is mentioned 162 times in the complaint. Monster claims that the mechanism that allowed Beats to allegedly steal its intellectual property, suppliers and clients was based on a “change of control” provision in the original Monster-Beats deal which was triggered by HTC buying a majority stake in Beats in September 2011.

Monster says HTC purchased its $309 million stake in Beats for the sole reason of releasing Beats from its contract with Monster, a claim that on the surface appears to be backed up the odd saga of HTC divesting from Beats in 2012 (when Beats bought back a 25 percent share) and 2013 (when the Carlyle Group effectively bought the remaining HTC stake for $265 million).

HTC is named as a defendant along with Beats Electronics, its founders Dr. Dre and Jimmy Iovine, and Beats board member Paul Wachter.

If HTC helped Beats wrest a $3 billion business from its initial hardware partner, it raises a lot of questions.

Did HTC know it was helping Beats ditch Monster?

Monster alleges it did know, saying that HTC entered into its “sham” partnership with Beats “driven by greed” and with “full knowledge of the fraud.” Monster’s main evidence is remarks made by HTC board member David Yoffee this past summer.

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But a large part of Monster’s case is based on Beats having a pattern of ripping its partners off by taking their ideas and poaching their employees. From the complaint:

This is not the first time Iovine, Dre, and others have engaged in this course of
conduct. These misdeeds are not isolated transgressions; rather, they exemplify a pattern and
practice… (a) lure entrepreneurs, musicians, and electronic product developers with promises of growing a business as partners; (b) then extract the intellectual property, production, and supply mechanisms that underlie the venture and that create value

The complaint says that Beats did the same thing to its first design partner, Pentagram, and first manufacturing partner, Jibe Audio. Could Beats have treated HTC in the same way?

Still, the actual recorded financial transactions are odd. Why would HTC sell back half of its Beats stake only a year after the original partnership was announced — and only a month after the official close of the deal — while Beats was still growing so quickly?

It’s also possible that the HTC-Beats deal was initially struck in good faith, and eventually fell apart due to trouble integrating the two corporate cultures as well the timing: HTC took a stake in Beats at the beginning of HTC’s three-year decline.

If HTC was in on the deal, what did it stand to gain?

[company]HTC[/company] profited from holding part of [company]Beats[/company] for a little while. Though HTC reportedly turned a small loss when it sold half of its stake in Beats back to the company in 2012, it made $85 million when it sold its remaining stake in 2013. The company has had a very difficult past few years, and that $85 million helped it dodge quarterly losses.

Few commercially important products came out of the partnership. A few HTC phones — like the HTC Rezound — came with Beats branding, but the Beats contribution to those devices was mostly “audio tuning,” or a fancy equalizer. Some HTC handsets came with Beats-branded earbuds, but even those were quickly dropped.

At the time, Om Malik wrote that the initial deal looked like an attempt for HTC to buy cool:

It is paying $300 million for coolness and a brand, though it is not very clear how it allows the company to overcome problems that are much bigger than a few cool adverts can paper over.

Even if HTC was trying to buy cool, it didn’t do a great job. Beats-endorsing celebrities like Lady Gaga and LeBron James showed up at HTC launch events, but the Beats halo never rubbed off on HTC in a commercially meaningful way.

Another possibility is that HTC was going to be the partner for Iovine’s planned streaming service. Did Iovine mislead HTC about that partnership? Or was it really in the works, but then something prevented it from taking off?

Was HTC CEO Peter Chou involved?

HTC Rezound Launch Event

It’s hard to imagine a company taking a $300 million stake in another company without the CEO signing off. The complaint details emails from Iovine to Monster saying:

a. “I don’t know what to say. I’m meeting with peter the ceo of htc what doI say to him???? (sic)”
b. “I’m in Taiwan (sic) met with peter ceo of htc…this is me talking we have to get this deal done Friday if we don’t it all could unravel” (sic)

If HTC was never really a strategic partner to Beats, as Monster claims, what did Iovine discuss with Chou? At the time, Iovine told the Los Angeles Times that Beats was “going to be in business with HTC and they’re going to help us and we’re going to help them in every way they can.”

Making things more complicated is that one of the driving forces behind the deal, Matthew Costello, at the time was both HTC’s COO and on the Beats board. Costello is now the COO of Beats.

When did Apple enter the picture?

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One of Monster CEO Lee’s main claims is that Beats leadership told him there was no “liquidity event” on the horizon at the same time as [company]Apple[/company] was doing due diligence in order to purchase the company.

Iovine has said that the deal was in the works as early as 2012, and Apple SVP Eddy Cue has also said the purchase was years in the making.

Did anyone at HTC know about the potential Apple sale? If it did know, why would it sell back its stake for a return a fraction the size that it would have received if had held through when Apple purchased Beats Electronics for $2.5 billion? It’s possible that Apple wouldn’t touch Beats as long as HTC held a stake.

What’s next?

Beats launched a streaming service in early 2014, and it’s expected to form the core of a new Apple-backed music streaming service. The majority of Beats’ current headphone lineup owes little to the first-generation Monster versions — and in my opinion, display clearly superior build and sound quality. A Beats executive told me in 2014 that the company has spent a lot of time revamping its lineup and removing leftover design elements from its Monster-era headphones.

A Beats spokesperson declined to comment for this story. Requests for comment from Apple and HTC have not been returned. The lawsuit does not specify a specific dollar amount that Monster is seeking.

Finally! Beats has acquired music service MOG

After months of speculation, it is finally confirmed that headphones maker Beats Electronics is buying online music service MOG. Beats is the company behind Beats by Dre series of iconic headphones and is part owned by handset maker HTC. Terms of the deal were not disclosed.

Yo, HTC — you got problems. And Dr. Dre can’t fix them

HTC spent $300 million to buy majority of Beats Electronics, a lifestyle brand that makes headphones. That deal might buy the company coolness but it might not be enough for a company fighting a tough fight with well funded and more motivated rivals like Samsung.

Lessons of Dr. Dre

All right, so Dr. Dre, born André Romell Young, 42, might not have always been the quintessential role model for khaki-wearing entrepreneurs. He once threw TV host Dee Barnes down the stairs after she aired a feud within his rap group on air (the incident gained him a place at #37 in Spin’s 100 Sleaziest Moments in Rock.)

But it becomes clearer when you think about Dr Dre’s successful career in the music and entertainment industries –- starting as a member of the groundbreaking rap group N.W.A., to co-founding Death Row Records (where he released the seminal album _The Chronic_) and later, his own label Aftermath Entertainment. Throughout Dre has produced some of the most successful hip hop talents of the last decade, including: Snoop Dogg; 50 Cent; and the Grammy and Academy Award-winning Eminem.

Together, Dre’s artists have sold over 100 million albums. Translate that into, say, software licenses and you have a very healthy, IPO-calibre tech start-up. Since bucks are the chief barometer of success in the Valley, Dre has made Rolling Stone’s Richest Rock Stars list since 2001, the year he earned $52 million, mostly off the sale of a percent of his label.

So say what you will about the virtues of “gangsta rap.” But if Dr. Dre’s track record in the most fickle of hits-driven businesses is any guide, entrepreneurs and venture capitalists can learn plenty from the Andre Romell Young School of Management.

First off. Be a perfectionist. If the product or service (in his case an album) isn’t ready, don’t release it. Hey, it might never be ready for airtime. Dr. Dre is famous for taking years to produce certain albums, and has often indefinitely shelved what could have been promising projects. His own solo album, Detox, has been many years in the making, and is expected to be released sometime this year.

Of course when he stalls or nixes albums from artists signed to his label, it makes for unhappy partners. Artists like Hittman, King Tee and Rakim are among a list of creative folks that worked on albums for Aftermath and met the Dre filter head-on. Young’s mantra, according to an interview with Scratch Magazine from 2004, “Nothing leaves this studio until I get that feeling.”

Hopefully you’ve had that ‘it’s a hit’ feeling a few times yourself. But let’s be honest: how much time have you wasted banging your head—and your employees’ heads–against a wall trying to make a so-so service work? Put as many resources as you can muster into the product that you believe in, but Dr. Dre would say, also know when to say when. If you’re not happy with the final results, don’t release it. And if it never comes together, close it down.

Young’s perfectionism isn’t the only trait that makes him a role model for company founders. (Did anyone put together that perfectionist Dre’s 100 million records-sold bests even perfectionist-Jobs’ 100 million iPods-sold!?). Dre has also made the difficult leap from ‘talent’ to ‘talent-cultivator’ — not unlike the entrepreneur who’s technical talents lead him to a big company exit, and who later joins a venture firm. (Vinod Khosla comes to mind.) The comparison might seem a stretch, but both men revolutionized their industries with disruptive products – the Sun Microsystems work station and genre-changing rap – ultimately moving on to mold the next generation of risk-takers. These are careers worth emulating, sho nuff!