It's crunch time for Palm

Despite talk of a potential sale, analysts expect good earnings results from the Treo maker.
Written by Erica Ogg, Contributor
Palm pioneered the smart phone, but if rumors prove true, the Treo maker may not survive as an independent company to watch its creation move from the corner office to the street corner.

The Sunnyvale, Calif., company in recent weeks has been the subject of increasingly noisy takeover talk, with everyone from private equity firms like Silver Lake Partners and Texas Pacific Group to handset makers like Nokia and Motorola purportedly interested.

Those rumors say a deal could be announced as early as Thursday, the same day Palm is scheduled to announce the results for its most recent quarter.

While it's hardly expanding at Google-like rates, Palm is still, in fact, growing. The company is expected by most analysts to beat the modestly disappointing guidance it issued last quarter after its latest model, the Treo 750, was delayed. Palm expects revenue of $400 million to $410 million in the quarter that just ended, up from $389 million in same quarter a year ago.

Meanwhile, Palm managed to push more Treo smart phones out the door in the last quarter of the 2006 calendar year than any other quarter. In 2005, Palm shipped 2 million Treos worldwide, and in 2006 that number climbed to 2.4 million, a 20 percent increase. The major U.S. mobile carriers continue to stock both the Palm OS and Windows Mobile versions of the Treo. Its carriers bought 617,000 Treos in the last quarter of 2006, a record, and a 42 percent jump over the previous year.

"In a fast-moving industry like this where we've moved to thinner and cheaper devices...the Treo is looking fat, heavy and expensive."
--Todd Kort, Gartner analyst

That sounds good until you add some context: the smart phone market grew 50 percent in the same time period, to 73.9 million units, according to Gartner, and Palm now has a meager 3.2 percent share of the market.

Why the disconnect? Some say it's because the Treo has become tragically unhip.

"The problem is that the Palm product is relatively old, the design has not changed substantially since September 2003 with the Treo 600," said Todd Kort, analyst with Gartner. "But that's a bad thing in a fast-moving industry like this where we've moved to thinner and cheaper devices. The Treo is looking fat, heavy and expensive."

The clock is ticking for Palm, Kort said.

"Things could still go reasonably well for Palm for another six months or so, but I think longer term, the hardware problems, the operating system problems are going to catch up with them," he said. "That's why it makes sense for Palm to be shopping themselves around now before thing go down the tubes."

Old rumors, new details
Though Palm has been a regular target for takeover speculation, the latest round of rumors have an unusual amount of detail. In February, Palm was reportedly seeking a suitor. Then came a report in The Wall Street Journal two weeks ago that said the company had retained Morgan Stanley to look into a potential merger or buyout. On Monday, the technology blog Unstrung, citing unnamed sources, claimed a deal is in the offing and that Morgan Stanley preferred to close a deal by Thursday, the day of the company's quarterly conference call with investors.

Not surprisingly, Palm isn't talking. "We try to make it a practice and policy not to comment on rumors and speculation," said Palm spokeswoman Marlene Somsak.

Getting bought out by a hardware manufacturer could mean the Treo would get branded under that manufacturer's name. And the Palm OS--which has been stalled at version 5.4.9--could be switched out for another platform, like Symbian, if Nokia were to make the purchase, in order to avoid having to invest in two different operating systems.

But that could do more harm than good, say analysts. Palm's software may well be the key to the latest round of alleged interest from a handful of potential suitors. The company made itself far more attractive when last year it spent $44 million to buy back the naming rights to the Palm OS from Access, the company that purchased PalmSource in 2005.

"I don't see a logical reason why any potential buyer would purchase Palm and then do away with the Palm OS. To me, that's where a lot of the value is," said Tavis McCourt, equity analyst with Morgan Keenan. The operating system has long been the reason that Palm loyalists are so enamored of the products. And that's despite the demonstrated ability of handset makers like Motorola, Samsung and HTC to rapidly churn out slimmer, cheaper, and more fashionable smart phones. The successful Motorola Q, Samsung BlackJack and T-Mobile Dash each boast thinner form factors and price tags significantly below the $399 Treo 750.

For that reason, between Nokia and Motorola, the latter's hardware know-how might pair better with Palm's software expertise. And it would follow a similar model in the smart phone industry in which handset makers see the benefit of having control over both the phone and the operating system, a la Research in Motion, McCourt said.

But it's clear Palm needs to do something--and fast. Executives there may have realized how important the cool factor is for gadget buyers: The New York Times reported the company recently hired a former designer from Apple, ostensibly to gussy up its hardware.

There's always time to innovate, but for Palm, the quicker the better, said McCourt of Morgan Keegan. Hitting big with a product like RIM's BlackBerry Pearl or LG's Chocolate, could instantly change the company's future prospects. "They've got to get better at design and be more aggressive at listening to what the market wants, rather than trying to dictate to the market what it should want."

But Palm also isn't saying much about technology being developed by one of its founders, Jeff Hawkins, lauded as the "third arm" of the company's business. Hawkins is staying mum about it for now, but recently said in an interview that Palm fans should "keep a close eye" on Walt Mossberg's D-Conference to be held in May, at which Hawkins will be a featured speaker.

While still working at Palm, Hawkins founded another company, Numenta, which is working on designing an operating system that works like the human brain. For that reason, some have guessed the mysterious new Palm product could involve artificial intelligence. An ultramobile PC, has also been floated as an idea.

Either way, said Kort, "You have to think if someone does buy Palm, more than half the reason has to be because they think that product is going to be a hit for the company."

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