Palm Under Pressure After Sales Shortfall

Palm may be running short of options. The smartphone maker on Feb. 25 cut a key revenue forecast and said demand for its flagship Pre device isn't meeting expectations, refueling speculation that Palm may soon need to seek a buyer.

Fiscal third-quarter sales will be no more than $310 million, Palm (PALM) said, blaming "slower-than-expected consumer adoption of the company's products." That's about $100 million less than the $409.3 million expected by analysts in a Bloomberg News survey. Shares plunged 19% to $6.53.

The Pre, boasting a new operating system called Web OS, was released to fanfare in 2009 and considered by many analysts a make-or-break product for a company that pioneered handheld computing. A plummeting market value and rising concerns that Palm can't drum up demand for its most heavily marketed products may put the company in the crosshairs of an acquirer. "The possibility for merger at these levels is certainly more reasonable, given the valuation, than it was nine months ago," says Scott Searle, an analyst at Merriman Curhan Ford & Co. in New York who rates the stock neutral. "The question is, can Palm achieve enough scale to be relevant? They need more products, more distribution and more applications." Palm spokeswoman Lynn Fox declined to comment.

The reduced forecast demonstrates Palm is struggling to revive its reputation as an innovator in smartphones, a category it helped define but that in recent years has been dominated by Apple (AAPL) and Research In Motion (RIMM). Palm has failed to win customers back with the touchscreen Pre and other models, and would need to broaden its offerings to succeed, says Lawrence Harris, an analyst with CL King & Associates in New York. "The situation for Palm is rather serious right now and they need to develop new products," he says.

Potential Acquirers

Palm's disclosure also comes as a blow to Elevation Partners, the private equity firm that has invested $460 million in Palm since 2007 and now owns about 30% of the company. Today's closing price leaves Palm below $6.85, the average price at which Elevation acquired its stock. In September, Elevation bought $35 million in stock at $16.25 a share. Ron Low, a spokesman for Elevation Partners, declined to comment. Palm's market value is at $1.09 billion.

Potential acquirers include PC maker Dell (DELL), which said on Jan. 6 that it will build a smartphone for AT&T (T), and Nokia (NOK), the world's largest mobile-phone maker. Nokia could use the deal to gain Palm's software and add customers in the U.S., a market it has struggled to penetrate. North America accounted for only 3.8 million, or less than 3%, of the 126.9 million phones Nokia sold worldwide in the fourth quarter of 2009. Dell spokesman Jess Blackburn and Nokia spokeswoman Laurie Armstrong declined to comment.

Ken Dulaney, an analyst with Gartner Group (IT), suggested that Research In Motion would be a logical buyer. "RIM has had difficulty with its touchscreen products, something that Palm has done well," Dulaney says. RIM spokeswoman Tenille Kennedy didn't immediately return a message seeking comment.

Integration Concern

Should Palm put itself on the block, finding a buyer won't necessarily be easy. Many would-be acquirers might already have examined whether to make a bid, says Peter J. Misek, an analyst with Cannacord Capital in Toronto. Besides Nokia, Motorola (MOT) and Cisco Systems (CSCO) may have eyed Palm but gotten cold feet on concern integration would take a long time, Misek speculates. "We think they've tried to actively sell themselves over the last two years, but that all the potential buyers have taken a pass because they know that integrating Palm's operating system with their own hardware would take at least two years," he says. Motorola spokeswoman Jennifer Erickson and Cisco spokeswoman Kristin Carvell declined to comment.

Another option: Palm could press ahead and try to compete with a new device. Matthew Thornton, an analyst at Avian Securities in Boston, says a new version of the Palm Pre is likely to debut before the end of the second quarter. "If they bring out something that's competitive on the hardware and distinguishes itself from its competitors, and then buy a more impactful marketing campaign, they might carve out a small profitable niche for themselves," he says. "But Palm really only has one shot left."

And it would need to take that shot sooner rather than later. The company has about five quarters' worth of cash, based on its current cash level and burn rate, says Misek. He notes that for Palm, "time is short."

Before it's here, it's on the Bloomberg Terminal.