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HP's Palm Plans May Leave Microsoft Out in the Cold

At the Consumer Electronics Show in Las Vegas on Jan. 6, Microsoft Chief Executive Steve Ballmer brandished a prototype Windows tablet computer made by the company's largest hardware partner, Hewlett-Packard. The device, among a group of "slate PCs" Ballmer showed, would be "almost as portable as a phone" and "as powerful as a PC," he said.

Microsoft (MSFT) may not be deriving such joy from Hewlett-Packard (HPQ) products for much longer. HP's Apr. 28 acquisition of Palm for $1.2 billion makes Palm's (PALM) WebOS, not Windows, the center of HP's mobile computing universe. "We looked to acquire them for the WebOS" and Palm's portfolio of patents, Todd Bradley, the executive vice-president in charge of HP's personal systems group, told Bloomberg News the day the acquisition was announced.

HP has said it wants to make Palm's WebOS, which has been praised for its intuitive user interface and ability to run several applications simultaneously, the basis for a new generation of smartphones and tablet computers that would compete with Apple's (AAPL) iPhone and iPad, as well as smartphones from Research In Motion (RIMM) and Nokia (NOK).

HP's acquisition of Palm is the latest speed bump in the complicated relationship between Microsoft, the No. 1 PC software maker, and HP, the world's largest computer maker. HP has developed its own user interface technology for desktops and laptops that run Windows, in a bid to make computers easier for consumers to navigate. Now it's poised to pursue its own direction in the smartphone and tablet markets at a time when Microsoft is trying to gain share in the growing categories.

Pressure on Microsoft

While HP hasn't publicly changed its plans to release a Windows-based tablet this year, buying Palm "doesn't show a lot of confidence [in] Windows," says Matt Rosoff, an analyst at the technology consulting company Directions on Microsoft.

Microsoft has had a difficult time matching the success of its PC software franchises on other types of computing devices. The company has lost traction in the market for smartphones, and is counting on upcoming software called Windows Phone 7 to rekindle consumers' interest. Between November 2009 and February 2010, the number of U.S. smartphone subscribers who own a device that runs Windows declined from 19.1% to 15.1%, according to an Apr. 5 report from market researcher ComScore (SCOR).

Microsoft's tablet computer efforts have also been unable to gain much momentum. Windows-based tablet PCs introduced in 2001 never gained widespread acceptance. In a blog post on Apr. 29, Microsoft spokesman Frank Shaw said the company wouldn't commercially release a new, uniquely styled two-screen tablet in the near future.

HP's embrace of WebOS puts pressure on Microsoft in a number of ways. Analysts say HP will likely use the operating system in upcoming tablets, smartphones, netbooks, and even wireless printers. Richard Shim, an analyst at market researcher IDC, says Palm's software would let tablets boot up faster and run longer on a charge.

Morgan Stanley (MS) analyst Adam Holt, who has an overweight rating on Microsoft shares, said in an Apr. 29 report that HP could sell 3.5 million tablet computers running WebOS this year, about half of its total tablet sales.

Hardware Route

In the smartphone market, HP will also shift its focus from Windows-based iPaq-branded smartphones and personal digital assistants, whose sales "have been disappointing," to WebOS-based phones, says Shaw Wu, an analyst with Kaufman Brothers who has a buy rating on HP shares.

To respond to shifting forces in computing, Microsoft may need to move even more aggressively into combining its software with custom-designed hardware that takes advantage of it. Microsoft, which sells the Xbox video game console and Zune music player, is behind an upcoming mobile phone to be sold under a Microsoft brand called Kin, and may create more portable computing hardware, says a source familiar with the company's plans. Microsoft may also consider buying a hardware vendor, says the source. "It's been considered, along with a lot of other things," he says.

Stacy Drake, director of Microsoft's Mobile Communications Business, said in a statement that "HP is a strategic partner and will continue to be so," and declined to comment on its plans.

HP still needs to close its Palm acquisition and prove it can turn the ailing company's fortunes around. Still, says Kaufman Brothers analyst Wu, "If Palm does well, it could be very material" to Microsoft's fortunes.

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