Beatrayed by Dre?

Noel Lee says he built the headphones Apple paid $3 billion for. His take? $0. Now he's suing for his share.
Photographer: Julian Berman for Bloomberg Businessweek

The most fateful product test of Noel Lee’s career took place in 2007 on a sunny day in Santa Monica, Calif. Starting in a proverbial suburban San Francisco garage, Lee had built a successful company called Monster that made and sold high-end speaker cables. In the mid-Aughts, he decided consumers would part with a couple hundred dollars for a more stylish set of headphones. After burning through millions of R&D dollars, Lee finally got a meeting in the office of entertainment magnate Jimmy Iovine, co-founder of Interscope Records. Joining Iovine was his business partner Andre Young, better known as Dr. Dre, the rap pioneer and a mogul in his own right. It would be difficult to identify a duo whose influence on popular culture in the 1990s exceeded that of Iovine, collaborator with everyone from Bruce Springsteen and U2 to Eminem, and Dre, a member of the seminal hip-hop group N.W.A., known for such anthems of black anger as F--- tha Police.

A large man with a shaved head, Dre put on Lee’s headphones. He turned up the volume on 50 Cent’s bass-heavy In Da Club. “That’s the s---!” he exclaimed.

Beats by Dr. Dre, the headphones built by Monster and backed by Dre and Iovine, reshaped the audio marketplace almost from their debut in January 2008. Lady Gaga, Justin Bieber, Sean “Diddy” Combs—all wore their signature branded Beats models marked with a lowercase “b.” LeBron James and Serena Williams favored Beats; so did British soccer idol David Beckham and Apple co-founder (and longtime Iovine friend) Steve Jobs. The candy-colored headphones became required accessories not only for celebrities but also for subway riders and mall rats everywhere.

Noel Lee attends the Heartbeats by Lady Gaga headphones unveiling with, Interscope Geffen chairman Jimmy Iovine, Dr. Dre, and Lady Gaga in 2009.

Noel Lee (R) attends the Heartbeats by Lady Gaga headphones unveiling with, Interscope Geffen chairman Jimmy Iovine (L), Dr. Dre, and Lady Gaga in 2009.

Photographer: Dimitrios Kambouris/WireImage

For several years, Lee lived an entrepreneur’s dream. “Dre is an icon,” he says. “He’s the pinnacle of pop music. Jimmy Iovine is a legend. And I [was] in business with them.” In late May 2014, Apple agreed to buy Beats by Dr. Dre and a co-branded streaming music service for $3 billion, in the tech giant’s largest acquisition ever. Lee got nothing.

“We designed, built, and marketed the headphones, and we were getting none of the credit,” he says. In January he filed suit in California state court, accusing Dre and Iovine of stealing the design, manufacturing, and distribution rights to Beats. Lee alleges the duo achieved this “corporate betrayal” by shuffling ownership of Beats and triggering a contractual provision that cut him out of the action.

Although Lee didn’t name Apple as a defendant, its lawyers are defending Dre and Iovine, now employees of the company. Apple has retained Boies, Schiller & Flexner, the New York-based firm headed by preeminent corporate litigator David Boies. Company spokeswoman Rachel Wolf declined to make Dre, Iovine, or Apple executives available for comment. “Lee apparently regrets his business decisions and now asks that he and Monster be excused from as many of their contractual obligations as possible, but regret is insufficient,” Apple’s attorneys assert in court papers.

Lee concedes he was naive in his dealings with Iovine and Dre; the legal question is whether he was also a victim of fraud. “We’ve got a real claim that a jury will understand: Someone got cheated,” says Joseph Cotchett, the well-known Northern California trial lawyer Lee has hired. Cotchett estimates his client’s damages should be at least $150 million.

Cutting past the legalities, the suit represents a cry of emotional pain by a star-struck nerd-engineer who thought he’d made real friends in the shark tank that is the music business. One senses that, as much as he’d like a pile of Apple lucre, Lee would also value an apology and access to the VIP lounge. “They’ve erased Monster from a great business story,” he says. “That’s not right.”

Was Noel Lee Betrayed and Pushed Out of Beats?

 

Noel Lee at the Monster headquarters in Brisbane, Calif.

Noel Lee at the Monster headquarters in Brisbane, Calif.

Photographer: Julian Berman for Bloomberg Businessweek

Lee receives visitors at Monster’s headquarters south of San Francisco not in his spotless office, decorated with heavy oak audio units of his own design, but in a brightly lit salesroom chock-full of plastic-wrapped merchandise. Dressed black-on-black, à la Johnny Cash, Lee, 66, wears oversize aviator glasses and combs his auburn hair straight back. He’s a classic low-tech geek who grew up taking appliances apart and putting them back together. He loves the virtuoso guitarists of two generations back, men like Carlos Santana and George Benson. He’s an obsessive fan who got to know these heroes and prominently displays autographed photos and electric guitars to prove it.

Lee gets around on a chrome-plated two-wheel Segway, necessary because of nerve damage he attributes to his work in the 1970s as a junior nuclear technician at the Lawrence Livermore National Laboratory. Workplace protections weren’t what they should have been, he says, and employees unwittingly exposed themselves to heavy doses of radiation, the effects of which weren’t immediately understood. Lee suffered spinal problems that made it difficult and then impossible for him to walk. All the same, he never sued the government, because, he says, “it didn’t seem worth the trouble.”

He tells a classic American immigrant story, beginning with his parents’ arrival on a freighter from China in October 1948. Noel was born in San Francisco three months later. He attended public schools through college at California Polytechnic State University, where he received a mechanical engineering degree in 1971. He played drums in an all-Asian-American folk-rock group called Asian Wood (Crosby, Stills & Nash covers in matching Hawaiian shirts and white bell-bottoms). To support a wife and young son, he took the lab job, but given the choice, he preferred tinkering at home with stereo gear. “Noel is wired internally—no pun intended—to have a passion for sound reproduction,” says David Frangioni, a close friend in Miami who builds recording studios and luxury home-audio systems. “Some people listen to the melody, to the lyrics—Noel and I listen to those—but what we’re really eccentrically obsessed with is how to make the overall sound amazing.”

In 1979, having left his government job, Lee launched Monster based on the insight that serious music fans would pay more for heavier copper speaker wire that conveyed “more dynamic sound.” Until then, hi-fi cable had been an afterthought. “We un-commoditized a commodity product,” he says.

He describes Monster Cable as selling “the cure with no disease.” Apparently not alienated by the patronizing slogan, consumers began forking over $50 for Lee’s more expensive wire. Performers ranging from Guns N’ Roses guitarist Slash to Keith Richards of the Rolling Stones became loyal Monster Cable users.

Over the years, Lee applied the same strategy to other audio accouterments. He got consumers to trade up from a $10 power strip to a $150 Monster Power device that promised both surge protection and “sound filtration” for a clearer musical tone. He alchemized a $2 bottle of spray cleaner into a $20 product suitable for swiping dust from a gigantic plasma TV. In pep talks to salespeople, he suggested adapting McDonald’s “Would you like fries with that?” approach. “We were the accessory kings,” he says.

It wasn’t a huge leap in Lee’s mind to persuade mobile device listeners to graduate from cheap earbuds to high-priced headphones. In 2005 he introduced the padded over-ear Monster Turbine Pro. At $400, the Turbine didn’t fly off the shelves. At the same time, the company was looking for business partners for high-definition audio software that Lee had developed to remix and remaster two-channel recordings for “surround-sound” play.

Lee sent his son, Kevin, then a Monster employee, to Los Angeles to look for partners for the new audio software. Kevin scored an audience with Iovine, then at Universal Music Group. Iovine wanted to talk about headphones. That meeting, according to the Lees, led to Iovine and Dr. Dre paying a call. Photos of the 2006 gathering at the company’s offices show Dre in a dark-colored designer sweatsuit, a grinning Noel Lee with his hand on Dre’s expansive shoulder, and Iovine in a ball cap and faded jeans.

“We gave Dre and Jimmy an education in sound,” Lee says. “They were talking about building a better speaker, and I said, ‘Headphones are the new speakers. Let’s make headphones together.’ And that’s where Beats came from.”

 

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Photographer: Julian Berman for Bloomberg Businessweek

Iovine and Dre tell a different creation myth. Theirs begins on the Santa Monica beach next to a sparkling Pacific Ocean. The two old friends bumped into each other while exercising in 2005. They fell into conversation about next steps in their professional lives. Iovine had begun as a recording engineer in the 1970s for John Lennon and Springsteen, later produced records for Tom Petty, Stevie Nicks, and U2, and in the 1990s turned Interscope into one of the most successful labels by selling hard-edge black rap to white suburban teenagers. After releasing his 1992 debut album, The Chronic, on Death Row Records, Dre moved to Aftermath Entertainment, a division of Interscope, where he lent his Compton (Calif.) street cred to Iovine’s burgeoning business. Dre helped shape the careers of fellow rappers Snoop Dogg, Xzibit, and The Game, while Iovine produced the Academy Award-­winning Eminem movie 8 Mile (2002) and was executive producer of the 50 Cent documentary Get Rich or Die Tryin’ (2005). Dre and fellow former N.W.A. member Ice Cube share producer credits on the film Straight Outta Compton, which is due in theaters in August and recounts the group’s rise. (Already soaked in controversy, the film made news when another rap producer, Suge Knight, was charged with murder for running over two men on the set of a promotional video shoot. Knight claims it was an accident.)

Describing their 2005 beach encounter at a New York conference last October, Iovine said he’d just negotiated a new contract with Universal Music that allowed him to pursue tech innovations. Dre’s lawyer had proposed that he endorse sneakers. Iovine said he advised his friend to sell speakers instead. Dre’s version of the story has him saying, “F--- sneakers. Let’s make speakers.” Whoever came up with the sneaker/speaker quip, the conversation eventually shifted to headphones, according to Iovine. Dre proposed the brand “Beats by Dr. Dre.”

In their telling, Iovine and Dre selected Monster merely as their manufacturer—the company that would oversee the factories in China, among other things. Lee describes Monster as the prime mover and Iovine and Dre as the frontmen. Monster, says Lee, shifted 100 of its 600 employees to the newly named Beats project and later hired Robert Brunner, a former designer for Apple, to refine the headphones’ sleek Apple-esque look. Financing the initiative, Monster built more than 30 test models, culminating in the one Lee brought to the late 2007 listening session during which he says Dre issued his scatological blessing.

In January 2008, Monster signed a licensing agreement under which the company would make, market, and distribute the headphones and pay Dre and Iovine a 19 percent fee for use of the Beats name and their access—the ability to get the product onto the heads of top entertainment and sports figures in videos, news conferences, and clubs. In his lawsuit, Lee alleges that at the time, Beats “had no employees, no engineers for headphone technology, and had no role in engineering or developing the ‘Beats by Dr. Dre’ high-end headphone line.”

To call the headphones a winner would be an extreme understatement. In 2007 the $100-and-up headphone segment generated less than $500 million in total sales. By 2012 the total had grown to $1.2 billion, with Beats grabbing two-thirds of the high-margin market. The rest was divided among established rivals Bose and Sony and several smaller upstarts.

Audiophiles gave Beats mixed reviews, with some praising their thunderous bass thump and others carping about crude sonic overkill. What wasn’t disputed: Beats turned headphones into a must-have $200-to-$300 fashion-statement-cum-status-symbol. Many consumers wore their Beats around their necks even when they weren’t listening to music. “Like he did with wire, Noel created a new category with headphones,” says Gary Shapiro, head of the Consumer Electronics Association, a trade group. “He’s a marketing genius.”

Interscope and Geffen Records chairman Jimmy Iovine, Producer and musician Dr. Dre and Monster founder Noel Lee pose with the Boston Red Sox president and CEO Larry Lucchino before the game against the New York Yankees on April 4, 2010 during Opening Night at Fenway Park in Boston, Mass.

Jimmy Iovine, Noel Lee, and Dr. Dre pose with the Boston Red Sox president and CEO Larry Lucchino before the game against the New York Yankees on April 4, 2010 during Opening Night at Fenway Park in Boston.

Photographer: Elsa/Getty Images

In August 2009, after 18 months of phenomenal performance, Lee, Dre, and Iovine signed an amended licensing agreement that adjusted several aspects of the relationship among the parties. Beats Electronics, constituted as a separate company with a payroll of its own, now joined as a party to the amended agreement. The revised contract’s most consequential provision stated that a “change of control” of Beats Electronics would result in Monster losing all rights to manufacture, sell, and promote the brand. New owners, in other words, wouldn’t be obliged to continue to do business with Monster.

“We didn’t think that much about it,” Lee says of the change-of-control provision. “We saw ourselves as in business with Dre and Jimmy for the long term.”

For a while the Monster-Beats venture continued to swim in cash, generating hundreds of millions of dollars in annual revenue for Monster and tens of millions a year in licensing fees for Dre and Iovine. Then, in August 2011, Lee learned that without seeking his opinion, let alone approval, Iovine and Dre had agreed to sell 51 percent of Beats to the Taiwanese cell phone company HTC for $309 million.

Lee had acquired some stock in Beats Electronics, but his 5 percent stake gave him no way to stop the sale, which, according to Iovine and Dre, triggered the change-of-control clause. “I was shocked,” Lee says. HTC and Beats made clear that they intended to separate from Monster and go their own way. How exactly Iovine and Dre planned to manufacture and distribute the headphones without Monster wasn’t clear to Lee.

For public consumption, both Monster and Beats Electronics presented the split as amicable. At the January 2012 Consumer Electronics Show, Iovine cheerfully showed a Bloomberg Businessweek reporter photos on his iPad of celebrities wearing Beats: the late Jobs, Nicole Kidman, and Kobe Bryant, who sported a pair in L.A. Lakers purple. Citing two people who asked not to be identified because the separation talks were private, the article reported the Monster-Beats relationship had “turned sour over financial terms,” with “Beats balking at its share of the revenue.”

In the same article, Lee said Monster would start over in headphones, vowing: “We can be the Apple of the headphone space, with or without Beats.” In June 2012, Beats and Monster signed a definitive separation agreement.

Less than a month later, Iovine and Dre again caught Lee by surprise when they bought back half of the 51 percent interest they’d sold to HTC. “Whoa, what’s this?” Lee recalls thinking. In September 2013 the private equity firm Carlyle Group bought the rest of HTC’s stake in Beats. When the dust settled, Carlyle had acquired almost a third of Beats for $501 million. Lee says his head was spinning: “Now I knew I didn’t know what was happening.”

Noel Lee at the Monster headquarters in Brisbane, Calif.
Photographer: Julian Berman for Bloomberg Businessweek

In early May 2014, rumors rippled through tech and music circles that Apple planned to acquire Beats. On May 27, two of Lee’s top lieutenants, David Tognotti and Leo Lin, happened to be visiting Harvard Business School, where they ran into David Yoffie, a professor and member of HTC’s board of directors. According to Lee’s lawsuit, Yoffie told the Monster executives they’d been had. Iovine and Dre had orchestrated a “sham” HTC acquisition two years earlier to trigger the change-of-control provision and push out Lee and Monster, the professor supposedly said. (Yoffie declined via e-mail to comment for this article, citing the Monster v. Beats litigation. Neither Marcus Woo, HTC’s general counsel, nor the company’s outside lawyers responded to multiple requests for comment.)

On May 28, 2014, Apple announced it would acquire Beats for $2.6 billion, with $400 million more to come over time. Dre, who owned 20 percent of Beats, appeared in a YouTube video boasting he’d become the “first billionaire in hip-hop.” Iovine, who held 25 percent, according to data compiled by Bloomberg, stood to collect $750 million from the sale. In its announcement, Apple said it planned to improve Beats headphones, but analysts observed that the tech giant’s main interest was Beats Music, an online subscription streaming service unveiled by Iovine and Dre earlier in 2014. On June 8, Apple announced that Beats Music would get folded into a massive new initiative, Apple Music, a competitor to startups such as Pandora and Spotify. Apple’s service will combine continuous, streaming playback of music from the iTunes library, as well as custom playlist creation, autonomous DJing features, and even a global radio station.

In a December 2014 interview with GQ magazine, Iovine said he’d first approached Apple about Beats in 2012: “I convinced them that they had to buy this company. I said, ‘I don’t want to work for anybody else. … I wanna come here, to Steve’s company. … I know you have a hole in music right now; let me plug it.’ I think it was two years before they said yeah.”

Finally, the full picture became clear, as far as Lee was concerned: Iovine and Dre had decided in 2011 or 2012 that they wanted to sell to Apple and sought to get him out of the way first. Apart from a lot of contract parsing, Lee’s suit reveals the ache of wounded pride: “Defendants built the Beats name on Monster’s back, and then attempted to re-write history by erasing Lee and Monster’s name from the product’s history.” Monster is struggling to get back into headphones; the company’s in the process of dismissing 200 employees, or one-third of his payroll.

At their client’s instruction, Apple’s attorneys, William Isaac­son and Karen Dunn, partners at Boies Schiller, declined to speak on the record. The outline of their defense emerges, though, from preliminary filings and interviews with people familiar with the case. HTC’s short-lived relationship with Beats wasn’t a sham, according to Apple. Money and control changed hands. In any event, the Monster-Beats licensing agreement would have soon expired regardless of the HTC change of control, Apple’s filings maintain. (Monster’s court papers claim that if the agreement had expired, Monster would have retained rights to manufacture and distribute Beats-branded merchandise.)

The legal provisions at issue aren’t terribly esoteric, and Monster might have a stronger case against its own contract lawyers than it does against Beats/Apple. Moreover, Apple’s defense team notes that before Apple announced its acquisition, Lee had sold back his 5 percent interest in Beats Electronics. If he were so dedicated to a long-term partnership, he’d have kept the stake—and been due about $150 million in connection with the Apple buyout. Instead, the defense contends, Lee played a short-term game: Monster took healthy revenue from his collaboration with Beats and—for whatever reason—­surrendered its rights in the event of a change of control.

Lee’s attorneys claim in the complaint that he’s “an industry icon,” similar in stature to Apple co-founder Steve Wozniak. In the world of consumer electronics, that boast is only mildly hyperbolic, says Shapiro, the trade group executive: “Noel is really loved by retailers. He’s inspirational.”

All well and good, says Apple, but the man behind Monster made a deal, and he has to live with it. Lee can’t accept that. “The headphones,” he says, “were my idea.”