The Treo maker's largest investor signals confidence in the company's turnaround plans with a big injection of capital
If ever there were a technology company known for performing when its back is up against the wall, it's Palm (PALM).
In its 16-year history, the company that made handheld computing commercially viable first with its PalmPilot devices, then later with its Treo line of smartphones, has seen its identity and even its name shift several times. And often those changes have come at times when circumstances were darkest, usually turning things around for the better.
There was the time in 2003 when Palm and Handspring, a cousin company started by three original Palm founders, decided they belonged together after competing for three years. The merger resulted in the Treo, originally conceived at Handspring, which was strapped for cash. Another time, in 1999, Palm, then a unit of 3COM (COMS), was dismissed as a one-hit wonder as sales of the original PalmPilot slowed. Then came the sleek Palm V, and sales rocketed once again.
Perhaps now is one of those times as well. On Dec. 22 the company announced it had secured a $100 million capital infusion from its largest single investor, Elevation Partners. The investment comes on top of a prior investment from the firm in 2007, of $325 million for a 25% equity stake in Palm.
Expectations for New Operating System
Looking back, it doesn't seem to have been a very smart move. Elevation valued Palm at 17.50 a share. The latest investment values the company at 3.25 a share, and the stock closed on Dec. 23 at 3.50. (At least $9 of the drop can be attributed to a repricing of the stock in late 2007 as part of the closing of Elevation's first investment.)
The move comes at one of the moments in Palm's history when the clouds are indeed rather dark, but when there appears to be, once again, the prospect of a turnaround. This latest investment looks like a bet by Elevation and its head, Roger McNamee, that just such a reversal is at hand.
And it may be. Palm has announced plans for a press event on Jan. 8 at the International Consumer Electronics Show in Las Vegas, and has been rather cagey about what will be announced. The company is expected to show the latest version of its long-anticipated new operating system, code-named Nova, and perhaps to show a new device running it.
McNamee is as convinced as ever that Elevation's investment in Palm will prove fruitful in the end. "When we invested in Palm, it was pointed in the wrong direction," he says. "It was our view that a big phase shift was beginning in mobile devices that would disrupt the cell-phone industry. When we invested, smartphones were about 3% of a billion units; now they're 6% to 7% of 1.2 billion units. Within 10 years, we expect smartphones to be half of all cell shipments." Just getting a small piece of that, he argues, will be very profitable indeed.
Palm's Future Lies with Apple Veteran
Hopeful? Perhaps, but at least he's putting his money—or at least that of his investors—where his mouth is. A cynic might argue he's throwing good money after bad, and at first glance it would be hard to disagree. Sales at Palm for the first six months of its 2009 fiscal year, as of Nov. 28, were $558.5 million, down more than 21% year-on-year. In its most recent quarter, sales of its Treo smartphones were down to 599,000 units, a drop of 13%. Meanwhile, Palm's cash reserve had dropped to $144 million, plus $80 million in short-term investments. Not counting restructuring charges, that works out to about two quarters' worth of operating capital.
Palm's slowdown comes as smartphone sales have been buzzing. Research firm Gartner (IT) pegged global sales in the third calendar quarter at 36.5 million units, up from 32.7 million a year ago, a surge of more than 11%. Who accounted for most of the growth? Research In Motion (RIMM), the Canadian company behind the BlackBerry, saw its shipments grow 81%, Gartner says, while Apple (AAPL) saw sales of its iPhone grow an astonishing 327% in the same period.
So why $100 million more and why now? It's simple, really. McNamee says the credit crisis has put a crimp on the $80 million in short-term investments that have since become illiquid. Palm, he says, anticipated needing those funds fairly soon.
So what's Palm got up its sleeve this time? Jon Rubinstein, for one thing. Palm's executive chairman in charge of hardware development is a nine-year Apple veteran who ran the teams that developed, among other things, the iPod and many of Apple's key Macintosh computers, starting with the iMac. Helping Rubinstein build the team is Dan Walker, Apple's former head recruiter. "This is no longer the Palm of Jeff Hawkins and Donna Dubinsky," says analyst Michael Gartenberg of JupiterMedia (JUPM) in New York, mentioning the two Palm founders who still sit on its board. "This is really the Jon Rubinstein show. Maybe Jon has a few tricks up his sleeve that he didn't use at Apple."
Big Investors Hold Most of the Shares
The new team has caught the attention of investors. If Palm gets a new phone out by May, and four products by the end of the year, plus commitments from a few wireless carriers to offer the device in their lineups, then "the business model could explode," and revenue could grow 150% in 2010, says Dave Eiswert, a portfolio manager at T. Rowe Price (TROW) who's responsible for the firm's 17% stake in Palm.
Institutional investors have been accumulating Palm stock. When Elevation made its first investment, it offered current investors $9 in cash per share, and most took the opportunity to sell. The result is that more than 80% of Palm's equity is held by six investors. Aside from Elevation and T. Rowe Price, mutual fund giant Fidelity (FMR) holds a 15% stake; Dallas-based Maverick Capital, a stake worth 9%; Credit Suisse (CS), a stake worth 7.5%; and Barclays' (BCS) share accounts for just less than 6%. Both Fidelity and T. Rowe Price already had a position, and both increased it after a meeting with Palm CEO Ed Colligan.
Or perhaps he's got them on the hook. As one banker put it, "Once these big investors take a big position, they really can't get out because they'd trash the stock." It's helpful here to know that McNamee made his name as a buy-side investor for T. Rowe Price, and so understands what these large firms are looking for, though he credits Colligan with keeping them faithful to the company.
Will their faith in Palm pay off? JupiterMedia's Gartenberg says the launch of the new operating system and any new devices will have to be flawless, and will have to satisfy many constituencies at once: consumers, wireless carriers, and software developers.
Next: Courting Software Developers
And it's with the software developers that Palm could have some serious problems. Apple has thousands of developers selling programs for the iPhone via the iTunes store. Meanwhile, Google (GOOG) has its Android platform gaining attention. Even RIM is boosting efforts to attract and keep developers. "Palm now has to reinsert itself into that equation with something new that is going to have to be demonstrably different from everything else," Gartenberg says. "There will be no room for errors, and no time to allow for buggy devices or buggy software."
McNamee wouldn't say much about the forthcoming operating system, but expects it to give Palm the lift it needs right now. "We're not looking for some sort of miracle," he says. "We're looking for a slow and steady buildup, and then to take off at some point in the future."