Balmy Weather ahead for Palms?

The markets have battered Handspring and Palm, but both companies have underlying value--and both are tantalizing as targets

The term "Palm Economy" down in Florida where I live might mean tourism, or maybe even the brisk trade in palmetto berries, craved for their extract by prostatitis sufferers. In Silicon Valley, the Palm Economy is a whole other thing: a network of software, computer, and telecom companies that rely on Palm OS, the leading operating system for handheld computers. Right now, it's craving relief of its own.

Instead of any herbal remedy, what the Palm Economy needs is a quick hit of Prozac. After greeting the two pure-play stocks, Palm and Handspring, first with enthusiasm and then with manic abandon, investors today could hardly be more depressed (table). Last November, the sum of the two companies' market values nearly hit $50 billion. Lately, the market says these businesses aren't worth $2 billion.

Investors: Get a grip! Yes, the Palm Economy is uncertain. (Will Palm produce a badly needed new version of its operating system next year, as planned?) Yes, it faces anyone's last choice of competitor. (Microsoft just released a new version of its rival Pocket PC software.) And yes, Palm and Handspring, an independent licensee of the Palm OS, both have been losing money. (Wall Street foresees current fiscal-year losses totaling $135 million on sales of $1.9 billion.)

So the next couple of quarters don't figure to be pretty. But the way I see it, this is already reflected in the prices of Palm, under $3 a share, and Handspring, near $2.30. What's not reflected are a few simple realities that suggest the companies will crawl out of today's slough of despond:

-- New customers, products, profits. For all the panic about Palm, you would think its base of clients is shrinking. Instead, it's expanding beyond yuppie workaholics to new groups, such as this fall's freshman class at the University of South Dakota. USD gave each new student the latest Palm, a $400 m500 model, and placed infrared ports around campus where they can link to e-mail, the Web, and updated class information. Upperclassmen, not included in the bounty, are envious. One hit up freshman Chelsea Tripp to buy her Palm at a small discount. Her response? "No way," she told me. "It's really cool." Handspring expects this year to announce new wireless models, and CEO Donna Dubinsky sees it posting a profit in the June quarter of fiscal 2002. As for Palm, after clearing inventories and cutting costs, it is expecting fresh operating profits in its current quarter, ending November.

-- Balance-sheet fortitude. We're not talking another Lucent Technologies-Teetering-on-a-Cliff's-Edge here. Neither Palm nor Handspring is burdened by a penny of long-term debt. Each has ample cash--Palm, at last report, had 90 cents a share in cash and short-term investments; Handspring, 94 cents a share. In other words, liquid assets and not just hope, are supporting these stocks as the companies strive for profitability.

-- The value of dominance. If these stocks don't turn up soon, it's a fair bet someone will come along to buy one or both companies. Microsoft's Pocket PC software is unquestionably taking market share. Yet Palm OS now runs more than 16 million devices around the world, and in this year's first half, Palm and Handspring still took 83% of U.S. unit sales, according to NPD Intelect. Palm remains synonymous with handheld computing.

Despite this sway in the marketplace and minds of consumers, the total stock market value of Palm and Handspring now comes to one times their annual sales. Not counting the cash on its balance sheet, Handspring's underlying business sells for half its $340 million in sales--a tempting target. Palm, with its control of--and licensing revenue from--Palm OS, is even more tantalizing. In a recent reorganization, Palm split itself into discrete hardware and software units. It did not indicate a future asset sale or division into separate public companies. But such moves would be a fast way to uncover Palm's value.

Whether a deal eventually will save investors in the Palm Economy, I don't know. But only chronic depressives could miss that the balance of risk and reward at last is running their way.

By Robert Barker

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