Palm's Market Starts to Melt in Its Hands

A lack of cash for new technology is paving the way for rivals

Just six months ago, Palm Chief Executive Carl J. Yankowski was flying high. The longtime marketing guru was at the helm of a company that owned the rapidly growing market for personal digital assistants. Consumers had snapped up 13 million units in only five years. Palm Inc. (PALM ) accounted for three of every four handhelds sold. And it licensed its operating system for a tidy sum to the likes of Sony, Handspring, and Nokia.

Now, the company that's helped organize the lives of the digerati could use some help itself. A series of management miscalculations, tough competition, and weak market conditions have left the company reeling. Sales have tanked, losses are mounting, and Palm is bleeding cash even as it must spend millions updating its technology to fend off a renewed challenge from onetime handheld also-ran Microsoft Corp. (MSFT ) Says CIBC World Markets analyst Tom Sepenzis: "This company got into trouble so fast it makes your head spin."

TAKEOVER BAIT? Worse, investors are fleeing, and the once dominant company looks increasingly vulnerable. Shares have plummeted more than 90%, from the high of 95.06, hit on Mar. 1, 2000, its first day of trading, to just 6.50. Some analysts believe Palm may now be takeover bait, with Apple Computer Inc. (AAPL ) and IBM (IBM ) as potential suitors. What went wrong? Like much of the tech industry, Palm was caught off guard by last fall's slowdown. Coming off five consecutive quarters of triple-digit unit-sales growth, Palm revved up production in late November to meet what it thought would continue to be soaring demand.

But as consumers' worries began to build in January, sales of Palm's low-end models weakened. Worse, economic problems were compounded as rivals made inroads into Palm's grip on the market. Handspring (HAND ) and others, for example, have snagged consumer market share with colorful, low priced models.

A bigger problem is that handheld makers using Microsoft's PocketPC operating system, such as Compaq's iPaq (CPQ ), began to win over business buyers with feature-packed devices that boast more power and better screens. After just a year in stores, the PocketPC-based devices have grabbed 26% of the U.S. market for handhelds running $350 and up, says market researcher NPD Intelect.

That's the high-profit sweet spot of the industry--and continued erosion there could spell disaster for Palm. Late last year, Palm made about $150 profit on each sale of the top-shelf $399 Palm V, compared with only $26 for its $149 entry-level m100 model.

Palm has created its own problems, too. To steal thunder from Handspring's new Visor Edge, Yankowski moved up the announcement of Palm's m500 and m505, which replace the best-selling Palm V line, to March. But after the rollout was pushed back until mid-May, Palm sales fell off a cliff.

Now, Yankowski faces hard choices. He must trim ambitious growth plans and possibly sell part of the company. "We are taking a hard look at more or less dramatically changing our business model," he concedes.

Getting money is top priority. Palm started the year with more than $700 million in cash, but analysts estimate that could drop to less than $100 million by November. To beef up its bankroll, Palm hopes to recoup $238 million selling the San Jose (Calif.) site it bought for a new headquarters. But even CFO Judy Bruner admits that "it's a very soft market right now." And given their troubles, the markets may be unwilling to provide financing.

Palm doesn't have much leeway. Adding to its technology woes, it canceled its acquisition of enterprise-software maker Extended System Inc. The deal would have given it a leg up in the corporate market for handheld-network software. Meanwhile, Microsoft is committed to spending $300 million on new technology to grab share.

For now, Palm says sales of its new m500s and m505s are again boosting U.S. revenues. But that may not be enough. Yankowski will announce plans in late June for returning the company to health. Until then, he admits, Palm "is a work in progress." True enough, but right now time is no ally.

By Cliff Edwards in Santa Clara, Calif.

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