Palm Pins Its Hopes on Nova

The smartphone maker debuts its new operating system, code-named Nova, at January's CES. Palm says its phones for it will bridge the BlackBerry-iPhone gap

Jon Rubinstein got the call in mid-2007 while he was living on the Pacific Coast of Mexico, working on his dream house after a storied nine-year stint at Apple (AAPL). Former Apple finance chief Fred Anderson and Silicon Valley financier Roger McNamee, partners at private equity shop Elevation Partners, were considering an investment in struggling smartphone maker Palm (PALM). They wanted Rubinstein, who's known informally as "Ruby," to come aboard. Having led development of products such as the iMac and the iPod that had saved Apple from oblivion, Rubinstein thought the opportunity smelled intriguingly familiar.

A few days after getting the hard sell in person from Palm Chief Executive Officer Ed Colligan, Rubinstein agreed to become Palm's executive chairman in charge of product development (Colligan would handle the business stuff). Rubinstein's rationale was that for all its problems, Palm could still manage a comeback. It boasts a well-known brand, close ties with key phone companies, and a track record of making breakthrough products like the original Palm PDA and the Treo smartphone. The company was already working on an ambitious new operating system that would be a foundation for a wide range of useful mobile tools. With the right leadership, Palm could find a niche in a critical area for tech: mobile Internet. "The next 10 years is all about the transition from notebook to mobile computing," Rubinstein says.

Aiming for the "Fat Middle"

Rubinstein's efforts are about to bear their first fruits. On Jan. 8 at the Consumer Electronics Show in Las Vegas, Palm is due to unveil the long-awaited operating system, code-named Nova, as well as the first of a family of products that will run on it. While Palm has protected its plans with Apple-like secrecy, Rubinstein and others say the goal is to create products that bridge the gap between Research In Motion's (RIMM) BlackBerry devices, oriented to work and e-mail, and Apple's iPhone, oriented to fun. "People's work and personal lives are melding," Colligan says, adding that Palm is aiming for the "fat middle of the market."

Palm needs to hit its mark. The company has lost share and its stock price has plummeted 80% since Rubinstein joined. With about six quarters of cash currently in the bank, Palm's last best hope may be Nova, to be released by mid-2009. Cash-strapped carriers are loath to take on the cost of supporting another platform and software developers are busy building software for other devices, including the iPhone, BlackBerry, and phones that use Google's (GOOG) Android software. "If they can't show me a large, active audience, I'm not going to be interested," says Jeff Holden, CEO of Web 2.0 company Pelago, maker of a social networking tool for the iPhone. "At this point in the game, you're toast unless you have something completely unbelievable."

Palm insiders are optimistic. "I'm fundamentally convinced we're onto something huge," says Mike Bell, a 16-year Apple engineering star who joined Palm last year. "Some of the stuff we're working on here is mind-blowing—better than anything I've seen before."

The All-Around Smartphone

Executives won't be specific about Nova, though Palm is not looking to go toe-to-toe with the iPhone or BlackBerry. The general idea is to create a platform that's flexible enough to support a wide range of customer desires. No single product can satisfy all the unmet needs of today's digital consumers, McNamee says. Today, people carry iPods, cell phones, and (AMZN) Kindle e-book readers. But there's no mobile-phone software that can handle complex games like those played on a Nintendo DS handheld, or let a working parent manage both corporate e-mail and family calendars.

The iPhone comes closest to handling such divergent needs, but is so packed with features that its battery power is quickly depleted, McNamee says. "Because of power limitations, nobody dominates the whole market," he says. He believes over time, the iPhone will be the device of choice for the 10% of cell-phone users interested primarily in mobile movies and other professionally produced fare. BlackBerry will remain the go-to phone for people interested in basic communications and so RIM will command greater share in the long term. What about Palm? During an interview at Elevation's offices, McNamee declines to say how much share he expects Palm to get, when Anderson pipes in, "Two percent would be just fine." With more than a billion cell phones sold each year, every point counts.

Sources say Rubinstein's team also hopes to create phones that make smarter use of data about you. For example, your smartphone could send you an e-mail the day before your next business trip, advising you on the weather conditions in your destination city.

Palm hasn't made good on any of these promises yet. But while the company has earned a reputation for missing deadlines—analysts expected a new OS a year ago—backers note that the company's engineering corps has undergone a radical makeover under Rubinstein. The company says it's hired 150 engineers since Rubinstein's arrival. Among them are Jeff Devine, a top operations executive with Nokia (NOK), and Way Ting, an operating system guru from Silicon Graphics (SGIC). "We haven't had any trouble selling our story," says consultant Dan Walker, who was Apple's chief talent officer from 2000 to 2004 and now leads recruiting for Palm.

Betting on a Miracle?

All the talent in the world won't prevent a dismal next few months. On Dec. 1, Palm said sales will be nearly 50% short of analysts' projections this quarter. It has laid off around 10% of the workforce in an effort to conserve the $215 million or so it will have at the end of the quarter. "There are so many issues, it's not clear even Jon Rubinstein can turn it around," says Global Crown Capital analyst Pablo Perez-Fernandez. Indeed, about 40% of the 108 million Palm shares are held by people who are betting the stock will go down rather than up.

Rubinstein—known for a steady hand that made him the perfect foil for Steve Jobs' impulsive management style—is nevertheless preaching calm. "I can see why [the bad financial news] makes everyone nervous," he says. "But we're crossing the chasm."

If Palm somehow does pull off a miracle, its financial recovery would be steep. That's the bet being made by T. Rowe Price (TROW) analyst Dave Eiswert, whose firm owns 15% of Palm. If the company fields three or four products in 2009, he thinks 2010 sales would rise 150%, to $2.4 billion. Even moderate success would lift the stock from 2.20 to 20, or many times that if Nova is a hit. That's based on the vastness of a smartphone market that's expected to grow to 300 million in 2012—and the likelihood that an old-guard phonemaker like Samsung might be compelled to buy the company.

Other key investors are patient, too. When Elevation cut the deal that brought Rubinstein to the company, it issued a one-time, $9-per-share payout that cut the stock from 19 to 9—along with warnings that the near-term outlook was brutal. With that rosy news, most investors sold, while T. Rowe Price, Fidelity, and two other big investors loaded up. Now, Elevation and four others own more than 70% of Palm, and none are likely to sell. "Palm going to zero would be bad for me as an analyst, but it's not going to hurt T. Rowe Price," Eiswert says. "But if it works, the upside is tremendous."

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