Palm's Pre Is Trying to Live Up to the Hype

Palm's road to a comeback is hitting a few speed bumps.

When Palm (PALM) launched its Pre smartphone on June 6, expectations were high that the long-troubled company could have a hit with the device, the biggest launch by the new management team led by a former Apple (AAPL) executive. Now analysts estimate that Palm likely will sell just 300,000 to 500,000 Pres in their first three months on the market. That's not bad, but it's short of the outsize expectations ramped up by the phone's advanced technology and splashy debut.

The modest sales performance for the Pre, which sells for $199 with a two-year contract from Sprint Nextel (S), is raising questions about Palm's ability to land other wireless carriers to offer the phone, and how large the carriers' subsidy payments and marketing support for the Pre might be. "Some carriers will be looking through less rose-tinted spectacles than before, [and] expectations will be pushed back" for the Pre, says Neil Mawston, a director with tech consulting company Strategy Analytics. "If Sprint can't prove that the Pre is an iPhone killer, it'll really affect the level of subsidies" carriers pay to make the Pre cheaper in stores.

Competition with Apple's coveted iPhone is just one of Palm's challenges. For now, the Pre appears to be a niche product, with a particular appeal to Palm devotees. A spat with Apple over Pre's ability to gain access Apple's iTunes music store led to a complaint by Palm to an industry standards group. And Palm is still trying to persuade more software developers to write applications for its device, which could increase its appeal.

Blockbuster Status Not Needed Palm, a seminal Silicon Valley company with roots that stretch back to the early '90s, has been counting on an impressive debut for the Pre to become a relevant player in the market for mobile computers that are the tech industry's center of activity right now. The Pre features software called WebOS that's been praised by reviewers for its intuitive design and ability to run multiple software programs at once.

Palm won't release sales figures for the Pre until it reports first-quarter results next month. Most analysts still say Palm can sell 3.5 million devices during the current fiscal year that ends next May. During Sprint's second quarter earnings call on July 29, CEO Dan Hesse said the Pre "did very well, in terms of its launch and demand." Palm declined to comment on Pre sales.

Some Wall Street analysts say it's not imperative the Pre produce blockbuster sales, especially with a rumored $99 smartphone expected later this year that could expand Palm's estimated 2% U.S. handheld market share. "They need to continue producing innovative products; the Pre is just one device," says Shaw Wu, an analyst with Kaufman Bros. "I don't want to get carried away with expectations yet."

Analysts Paring Forecasts Other analysts see Sprint's lack of specificity about Pre sales as a worrisome sign that it hasn't performed as well as expected, and say U.S. and overseas carriers may scale back their plans to market and subsidize Palm's smartphones. That could further dampen the outlook for the company, which lost $91.5 million on sales of $86.8 million during its fourth quarter ended May 31.

Palm Chief Executive Jon Rubinstein unveiled the Pre to great fanfare at the Consumer Electronics Show in Las Vegas in January, so any stumble in its sales will be closely watched. Private equity firm Elevation Partners (ID), which took a 25% stake in Palm in 2007, brought Rubinstein, a former Apple executive, to turn the company around. Palm put handheld computers on the map in the '90s with its hit Palm Pilot device, but has foundered this decade.

But Wall Street analysts have pared their Pre forecasts the past few months. Jonathan Goldberg, an analyst with Deutsche Bank (DBK) who is among the more bullish on the Pre's prospects, expects about 300,000 units to ship in the quarter ending in August. In May, UBS analyst Maynard Um released a report speculating the new smartphone could rival the Apple's iPhone in sales, and ship 865,000 units in Palm's fiscal quarter that ends in August.

All Eyes on Sprint By contrast, Apple's new iPhone 3G S, released June 19, sold 1 million units during its first weekend of sale and has driven millions of new users to AT&T (T).

Carriers planning to offer the Pre to their subscribers are watching Sprint's results. The Pre is expected to make its debut on Verizon Wireless' network in early 2010. European carriers Telefónica (TEF) and Vodafone (VOD), and Latin America's America Movil, will likely offer the device within a year, according to Charles Wolf, an analyst at Needham & Co..

Pre has done less for Sprint than Apple's iPhone and Research In Motion's (RIMM) BlackBerry have for its competitors. Although the Pre went on sale three weeks before the end of Sprint's second quarter, the carrier still lost 991,000 wireless subscribers during the quarter, an even steeper decline than it had posted a year earlier. While about 9% of Sprint subscribers upgraded to new devices and plans during the quarter, that was only a "slight increase" from the first quarter, Sprint said.

A Lot to Like The Pre attracted fewer new customers to Sprint than RIM's BlackBerry Storm did for Verizon, according to Matt Thornton, an analyst with Avian Securities who surveys U.S. wireless retail stores monthly. Verizon Wireless has a close relationship with RIM and has extensively advertised the Storm. Later this summer, Verizon is expected to introduce the BlackBerry Storm 2, which could echo the success of the first-generation device.

To compete better, Palm may need to raise money to step up its own promotion of Pre, says Needham's Wolf. Palm could try to raise $300 million through a sale of stock, he says. Otherwise, "Palm is at the mercy of the carriers in terms of what they spend," says Wolf.

Consumers who've been longtime Palm fans have found a lot to like in the Pre. "It feels more like an Apple product than a Palm product," says Mark Hayes, a 46-year-old graphics designer in San Francisco. Software developers, too, have cottoned to Palm's approach. "We found that Palm's [software] has been easier to develop for than other platforms," says Josh Garnier, a product manager at (OPEN), which wrote a Pre application for making restaurant reservations.

Wall Street Is WaitingTo stanch its losses and return to tech industry relevance, Palm will need to expand its market and grab a slice of equally loyal iPhone and BlackBerry users. So far, Wall Street is waiting for the evidence.

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