Palm slumps yet further on outlook

Handspring follows suit, after Palm profit warning

Shares of Palm took a hit Wednesday after the company predicted that sales would slump $250m below estimates for its fourth quarter.

The news sent the Palm stock plunging 44 percent, down $6.88 to $8.63 in early morning trading. Other rivals also fell. Shares of Handspring, which makes a competing handheld using the Palm OS, were down $4.75 to $11.44, and Research in Motion, which makes two-way messaging devices, slumped $4.63 to $20.05.

Analyst reaction to the Palm news was mixed. While most reduced estimates based on the company’s outlook, some urged investors to stick it out, saying that the handheld market was not fading away, and that Palm's market leading position should help the company recover from an economic slowdown.

But others questioned the company’s ability to maintain its dominance with competitors like Handspring and Pocket PC vendors.

On Tuesday, Palm reported a profit of $9.3m, or 2 cents per share, on revenues of $470.8m. That figure excludes amortisation and goodwill charges. Analysts had been expecting the company to report a penny per share profit, on sales of $473m, according to First Call.

For the fourth quarter, revenue is expected to be between $300m and $315m, below the $350 million reported in the year ago quarter, and far below the $572m predicted by Wall Street. And the company expects to lose 8 cents per share for the quarter, despite cost-cutting measures that should trim 10 percent to 15 percent of operating costs.

Palm also announced plans to lay off 250 employees and contract workers and postpone construction on its new corporate headquarters in San Jose, where work was scheduled to begin this month.

Several analysts expressed concerns about "channel stuffing", saying that there was far too much inventory sitting on retailers' shelves and at distributors at a time when consumer spending is decreasing. Channel stuffing refers to when companies ship their product to distributors and retailers, despite a demand slowdown.

"Clearly, the impact to Palm will be in the next quarter [May] where Palm will have to work off channel inventory by slashing production, reducing sales into the channel and providing incentives to stimulate sales out [of the channel]," wrote UBS Warburg analyst Don Young.

Young cut his price target on the stock from $14 to $10.50, and dropped earnings estimates for 2002 from 26 cents per share to 12 cents.

Even analysts who were upbeat on the stock noted that the company would have a tough time resolving its inventory issue as it rolls out new product lines.

Palm saw its cash levels drop from $743m to $596m during the quarter. Inventory increased from $34m in the previous sequential quarter to $102m, and accounts receivables rose to $274m from $246m, pointed out Bear Stearns analyst Andrew Neff.

Neff lowered his fourth-quarter earnings estimate to an 8 cent loss from a 4 cent loss, and dropped revenue estimates for the quarter from to $313m from $596m. He also lowered his price on the stock to $17 from $45, reflecting the reduced expectations, but maintained a "buy" rating "based on our view of the secular growth trend in the handheld market and Palm's position within it".

But while Palm continues to dominate the field, it faces increased competition, both from the PocketPC platform, and from Handspring, which said it was confident with its fiscal 2001 estimates.

While some analysts argued that Palm's position as both a hardware firm and a software company could help it, others said that its competition with Handspring could end up damaging the entire Palm OS market.

"Palm was pressured into announcing its m500/5 product line before it was ready to ship because of Handspring's launch of the Visor Edge, a product aimed squarely at the Vx, Palm's best selling product," wrote Vik Mehta, an analyst at Goldman Sachs.

"Palm counter-attacked by announcing the m500/5 and lowering the price point of the Vx to make way for the m500/5, even though the m500/5 will not be available until the end of the quarter. Had Handspring not launched the Visor Edge, it is possible that Palm may have maintained the Vx price and pushed back the m500/5 announcement until it was ready to ship."

Mehta lowered his rating on Palm to "market outperformer".

Others argued that Palm’s struggles could benefit the upstart competitor.

"Specifically, Hand [Handspring] has rising weighted ASPs [average selling prices] a lower revenue base, significant new channels being introduced in the quarter, stronger sell-through, market share in-roads with new products, and a more linear revenue stream," wrote CS First Boston analyst Marc Cabi.

Cabi did lower estimates for Handspring based on Palm’s report, dropping revenue for 2001 from $575m to $540m, and earnings per share for 2001 from a 14 cent loss to a 25 cent loss, but maintained a "buy" rating on that stock.

However, there was some concern that Palm’s news could signal trouble for the entire sector, despite a statement from Handspring reiterating that company’s outlook.

CIBC Oppenheimer analyst Thomas Sepenzis lowered his target price on Handspring to $25, noting that "we feel it prudent, although we have seen no evidence of slowing growth at Handspring, to take numbers down a bit to reflect the current economic environment".

His colleague at CIBC, Barry Richards, dropped his target price Research in Motion from $115 to $50, citing similar concerns.

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