Will Investors Spring for Handspring?

Its new Treo PDA-cell phone hybrid is getting raves. But Wall Street isn't convinced folks will pay $400 a pop for them

By Jane Black

Are you a true believer? That's the question investors need to ask themselves when it comes to buying shares of Handspring (HAND ). The maker of hip handhelds has garnered headlines recently with the debut of Treo, a combination personal organizer, cell phone, and wireless e-mail device.

The launch heralds a new strategy for the four-year-old company. With Treo, Handspring is exiting the stand-alone organizer business -- which its leaders Jeff Hawkins and Donna Dubinsky established as founders of Palm (PALM ) -- and entering the competitive cell-phone market to battle the likes of Nokia (NOK ), Ericsson (ERICY ), and Samsung.

So far, so good. Treo, which went on sale in Europe in December and in the U.S. in February, has received glowing reviews (see BW Online, 12/17/01, "Finally, a Hybrid That Really Works"). Now comes the tricky part. Analysts' projections for 2003, when Handspring is looking to have Treo gain traction, are wildly divergent. Some expect the company to earn profits of just a penny a share, while others are projecting profits of as much as $0.15.


  It all depends on whether consumers are willing to spend $400 for Handspring's latest brainchild. "This is a tension stock. We won't know if we have a huge hit on our hands for a couple of months," says Charles Wolf, an analyst with Needham & Co.

Investors certainly have good reasons to join the cult of Handspring. Its stock took a hit in 2001 along with the rest of the handheld market (shares traded for as much as $22.60 as recently as last May). Its price has been hovering at around $5 or $6 a share, which looks cheap by historical standards.

Treo has also been widely hailed as the best hybrid phone/organizer to date. At 2.7 inches wide and 4.3 inches long, it's slightly smaller than standard Palm handhelds. But it can make calls, send e-mail, and keep track of appointments and contacts. Users can choose between a conventional QWERTY keyboard, which they tap with their thumbs, or the traditional Palm stylus.

BusinessWeek's Stephen H. Wildstrom called the Treo a "marvel of thoughtful design" while The Wall Street Journal's Walt Mossberg proclaimed it a "terrific product perfect for both phone-centric and data-centric people who want it all."


  Then there's the track record of Handspring founder Hawkins, who created Treo as well as the Visor organizer before that. In 1994, when PC makers such as Apple had washed their hands of personal digital assistants, Hawkins set to work designing a little something called the Palm Pilot -- small enough to fit in your pocket and powerful enough to store thousands of addresses. The product launched in 1996, and within 18 months it had shipped 1 million units -- making it the fastest-selling computer product in history.

Hawkins, along with partner Dubinsky, left Palm in 1998 after disputes with owner 3Com, which had earlier acquired Palm. The two launched Handspring and once again became the industry's innovators. Visor included add-on ports that let users attach components, such as a digital camera, to their PDA. At the end of 2001, Handspring had grabbed 15% of the market, according to NPD Intellect, a market research firm in Virginia. Palm's market share fell from 71% to 58%.

A tough 2001 forced Handspring to innovate again. Demand for handhelds fell sharply in the spring as the economy slowed. Prices also fell precipitously -- thanks in large part to inventory problems at Palm and a glut in components. According to NPD Intellect, the average price of a handheld computer fell from $260 in 2000 to $218 in 2001. Discounting quickly ate into margins.


  Handspring had to follow suit in the price wars or eat its inventory. In its second quarter, which ended Dec. 31, gross margins were just 16.9%, down from 31.4% in the year-earlier period. Operating margins fell to -21.3% from -8% in the year-earlier period.

Given Handspring's recent troubles, Treo's launch certainly appears well timed. Research firm International Data Corp. estimates that the market for "smart phones" is about to bloom. It's predicting that 2 million devices will be sold in the U.S. in 2002. Worldwide, sales are expected to range between 7 million to 8 million.

Handspring already has deals with eight carriers around the globe, giving it access to 40 million to 45 million consumers. If Treo, which retails for $399, grabs even a small portion of those customers, Handspring's revenues and margins will soar. Wit Soundview analyst Mark Specker estimates that gross margins will hit 30% by December, though other analysts put the number somewhere in the high 20s.


  This won't be a cakewalk, however. Handspring is introducing an innovative product in a crowded sector populated by powerful rivals. "It's not just a convergence of technology but a convergence of the competition," warns IDC analyst Alex Slawsby. With Treo, Handspring goes up against mobile-phone giant Nokia's Communicator, Samsung's I300, and Kyocera's Smartphone -- not to mention the latest BlackBerry, the 5810, which launched on Mar. 4. (Though Palm's i705 has wireless data access, it does not offer voice communication.) These giants aren't going to simply cede the high-end market -- especially as they're now facing slackening demand.

According to research firm Gartner Inc., mobile-phone sales fell for the first time in 2001 by 3.2%. Total unit sales were 399.6 million, down from 412.7 million in 2000. "It's a great product but, at best, they have a short-term lead. They'll have their hands full fighting off the competition," says Andrew Cole, a wireless analyst at strategy consultancy Adventis.

Already, a common refrain from users is that they can't imagine living without their Treos. But how many people -- or corporations -- are willing to shell out $400 for a very sophisticated cell phone? Handspring could see sales stalled by the high price. It's not deterred, however. Says Brad Driver, director of investor relations: "The transition to the communicator business gives Handspring a much bigger market opportunity, higher price points, and higher gross margins."

Lucky for Handspring, it has enough cash to be patient. In January, it raised $57 million. Moreover, analysts insist that in this sector, style and innovation reign. "Handspring's culture is one of change and adaptation," says Thomas Sepenzis, an analyst at CIBC World Markets. "They have a seasoned, passionate management team. And in the end, you always bet on the management." And that may be enough to help Handspring devotees keep their faith.

Black covers the handheld market for BusinessWeek Online

Edited by Douglas Harbrecht

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