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For Palm, a Successful Parting...

Sometimes divorce is a very good idea, at least in the business world. Palm (PALM) is a case in point. Ever since it started licensing its software to other companies in the late 1990s, the hardware and software sides of the company have lived in the uncomfortable tension of conflicting goals and strategies. Now that PalmSource, the software outfit, and Palm Solutions, the much bigger maker of Palm-branded hardware have separated -- the divorce will become final when market conditions allow -- the platform's future looks bright (see "...But Maybe Only Half Successful").

Ever since Microsoft (MSFT) entered the handheld field in 1998, reports of Palm's imminent demise have been rampant. But the Palm platform has more than held its own in both market share and technology. Estimates of the share of handhelds running PalmSource software range from 50% to 80%, depending on just how the market is defined and who's doing the counting. No one questions, however, that Palm retains a very hefty lead over second-place Microsoft and an assortment of also-rans that includes Research in Motion (RIMM), Nokia (NOK), and Sharp (SHCAY).

THIRD-PARTY SUPPORTERS. Two obvious keys account for the Palm platform's continuing success. One is the ease of use designed into the original 1996 Palm Pilot and retained as the hardware has grown more powerful and complex. Second, especially important in business markets, has been an army of third-party programmers who found clever ways to overcome the limitations of Palm software and hardware.

Now that PalmSource has released a new version of the operating system that supports faster processors and better displays, these programmers are learning how to take advantage of the new power. Although a major claim of Microsoft's rival Pocket PC software has been that it allowed software developers to use their familiar Windows programming tools, Palm developers have managed to at least keep up.

PalmSource has also pursued a clever licensing strategy that allow its products to cover a broad range of markets while avoiding excessive competition among licensees. Sony Electronics (SNE), which bought an approximately 6% equity stake in PalmSource for $20 million last year, has focused on entertainment-oriented consumer markets, especially at the high end.

PRO-FORMA LOSS. Handspring (HAND), started by Palm's founders, is making hybrid communicators including wireless phones and minikeyboards for e-mail. HandEra and Symbol Technologies (SBL) make handhelds for specialized business markets, while AlphaSmart focuses on education. Garmin (GMN) is about to ship a unit with an integrated global-positioning-system receiver and mapping software, and this summer, Fossil (FOSL) will bring out the first Palm wristwatch.

But PalmSource is hardly without challenges. Although it has a comfortable cash position, in part because of the Sony infusion, it's still losing money. In fiscal 2002, a dreadful year for handhelds, the business suffered a pro-forma loss [using pro forma in the old sense of what PalmSource's financials would be if it were an independent company] of $17.1 million on revenues of $66.9 million, compared with a $7.9 million loss on $86.6 million in revenues the previous year.

Under CEO David Nagel, who formerly headed research at both Apple Computer (APPL) and AT&T (T), PalmSource last year finished the overdue version 5.0 of the operating system, but it's only half a solution. It allowed designers much more freedom in hardware -- the first three OS 5.0 products, from Palm Solutions, Sony, and Garmin, use processors from Texas Instruments (TXN), Intel (INTC), and Motorola (MOT), respectively.

MANY TO-DOs. The updated OS, however, focuses almost entirely on enabling the new hardware while maintaining compatibility with existing applications. While it pulled off that difficult trick, much remains undone, including networking and security features that will make Palm OS fully competitive with Microsoft's Pocket PC software in those areas, especially in corporate markets. That will have to wait for version 6.0, which has a release target of next summer.

In the short term, PalmSource must still cope with a lousy market, especially for business products. But for the longer haul, handhelds continue to have vast growth potential, and PalmSource stands to get more than its share. By Stephen H. Wildstrom in Washington, D.C.

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