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Palm's Fortunes: Cloudy Again

After rumors of a Motorola buyout faded, investors were left wondering what the future holds for the Treo maker

It was all supposed to be decided this week. Palm, the storied Silicon Valley company made famous in the mid-1990s for its innovative line of personal digital assistants starting with the PalmPilot, and leading up to the current Treo line of wireless smartphones, would become part of Motorola.

At least, that is what the market appeared to have decided by Mar. 21, as media reports spread—the most notable of which appeared on CNBC—citing an anonymous Motorola (MOT) shareholder saying a deal appeared as certain as a windy day in March at the company's headquarters outside Chicago. Investors bid Palm (PALM) up by $2.51 over the course of six trading sessions, culminating in a Mar. 21 close at $19.45.

One day later, investors sent the stock sliding nearly 9%, or $1.71, once it became clear that Motorola is in no condition to do a high-profile acquisition that could cost between $2 billion and $3 billion. Sources close to another rumored acquirer, Finland's Nokia (NOK), dismissed rumors that it was also in the running to acquire Palm.

On Mar. 21, Motorola Chief Executive Ed Zander disclosed that the company now expects first-quarter sales to be in the range of $9.2 billion to $9.3 billion, down more than $1 billion from its January forecast of $10.4 billion to $10.6 billion (see, 3/22/07, "Motorola's Zander: On Razr's Edge").

Unlikely Target

With the prospect of an imminent sale rapidly diminishing, Palm CEO Ed Colligan sounded a defiantly positive note on an earnings conference call with analysts and reporters on Mar. 22. In reporting an $11.8 million profit on sales of $410.5 million, Colligan batted aside questions about the rumors of a sale, saying the management was "focused on operating our standalone company and driving our plan."

Meanwhile, analysts slammed the very idea of a buyout by the likes of Motorola or Nokia as ludicrous on its face: "There is no way a large company would be buying Palm as a strategic play at its current price," says Rob Sanderson of American Technology Research in San Francisco. "It would be easier to beat them up in the marketplace and then buy the operation on the cheap later."

Sanderson also questioned whether Palm would make sense as the target of a private equity buyout—as has also been reported. "I could see this thing having very serious margin declines, and that would make it a very sketchy investment, even with all the private equity action that's going on right now."

Rivals Aplenty

Does Palm need a white knight? Sure, the market is tough, but there's no immediate crisis on the horizon. Palm's results were better than expected on many fronts. Earnings per share came in at 16¢, vs. a consensus estimate of 12¢. Colligan also trumpeted solid sales of handheld devices and smartphones that hit a record 738,000 units for the quarter, a year-over-year improvement of 30% and a 20% improvement over the prior quarter. Additionally, the company has approximately $500 million in cash, which compared with operating expenses of $368.7 million for the latest nine-month period, suggests a year's working capital would avert an immediate crisis if sales of Palm devices were to nosedive inexplicably.

But when you dissect Palm's sales by product, the picture isn't quite as rosy: Of its units sold, 354,000 were Treo smartphones, the company's flagship product, which would place it far behind Research In Motion (RIMM)—the Canadian company that owns Palm's biggest rival, the BlackBerry—which added 950,000 subscribers in its most recent quarter. And while other would-be competitors have sputtered—Motorola's Q phone is one notable example—multiple rivals are gunning for Palm, and the field isn't getting any smaller. Apple's iPhone will be on the market by summer and, if successful, will likely take a bite out of Palm's business.

An Experienced Player

With its legacy as the company that proved the viability of handheld computing devices, Palm still commands a certain amount of consumer loyalty, much like Apple (AAPL) does with its Macintosh computers. And buzz is beginning to build around a rumored new product that Jeff Hawkins, the designer behind the original PalmPilot, has started to drop hints about. That device will be revealed at a conference in May, and Hawkins has been hinting at a "third arm" of business for Palm; so far, he has declined to be more specific.

It's often been this way for Palm. In its history, Palm has gone through many strange corporate contortions, having been a unit of USRobotics and 3Com (COMS). It's also been independent and divided in two—as it was during the period that Hawkins, Colligan, and co-founder Donna Dubinsky went off to run Handspring—then reunited after Palm acquired Handspring. Very often during periods when corporate fortunes looked weak and buyout rumors picked up, it was a cool new Hawkins-designed device that propped up investors' hopes, kept acquisitive wolves at bay, and gave Palm the wherewithal to fight another day.

That's precisely what happened when Palm stepped in to buy Handspring, founded in 2000 to build handhelds aimed at consumers. While its products won rave reviews, it suffered under competitive assaults from Microsoft (MSFT) and its many handheld hardware partners, including Dell (DELL), Compaq, and later Hewlett-Packard (HPQ), not to mention Palm itself. But when Palm and Handspring decided to merge in 2003, much of the motivation for the deal was based on what was then Hawkins' latest breakthrough, which is now the Treo.

Not All Bad News

The ever-changing fortunes can be rough on Palm stockholders. Shares fell once it became clear that there would be no Motorola buyout for the foreseeable future and, as such, no premium paid to Palm's loyal shareholders. However, the earnings news did push up Palm's stock in after-hours trading, as it gained 23¢, or more than 1%, within an hour of the close of the earnings conference call.

Palm did get some other good news as a federal judge ruled that the patent lawsuit by NTP—the same NTP that extracted a $612.5 million settlement from RIM (see, 3/3/06, "Blackberry Won't Get Squashed") to close a bitter patent feud—would be stayed pending a review of NTP's patent portfolio by the U.S. Patent & Trademark Office. That review will determine once and for all whether NTP should have been awarded the disputed patents in the first place.

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