Palm: The new comeback kid?

Smart phone inventor sells off big stake and shuffles its board in hopes of reinvigorating product lineup amid increasing competition.
Written by Marguerite Reardon, Contributor
Palm, which lost its footing in the competitive smart phone market this past year, is turning to private equity and some former Apple execs to help it reinvigorate its product lineup.

But will it be enough?

That's the big question that Wall Street investors and gadget gurus will be looking at over the next 18 to 24 months.

On Monday, Palm said it would sell 25 percent of the company to private equity firm Elevation Partners for $325 million. Elevation Partners was founded by Fred Anderson, Apple's former CFO, and Roger McNamee, who will now sit on Palm's board, replacing Eric Benhamou and D. Scott Mercer. The company also said it would bring on Jon Rubinstein, who formerly ran the iPod division at Apple, as executive chairman of the board.

The deal comes as Palm, which essentially invented the smart phone category with its popular Treo product, tries to regain its position as a leader in an increasingly crowded market. Over the past couple of years, everyone and their brother--from BlackBerry maker Research In Motion to the big handset makers Motorola, Nokia and Samsung--have been introducing so-called smart phones that combine phone functionality with e-mail and Web surfing capability, competing directly against the Treo.

And now Apple's iPhone, which is already generating unprecedented buzz, is only weeks away from launch on AT&T's network.

Meanwhile, Palm has been struggling to keep up with competitors in terms of new features and functionality. In recent months, rumors have floated around Wall Street that the company might be ripe for a takeover, with bigger players such as Motorola and Nokia mentioned as potential suitors.

In the middle of this ultracompetitive market, Palm introduced its latest product, a miniature Linux-based laptop dubbed the Foleo, which has left many experts scratching their heads. The 2.5-pound keyboard and computing device, which is designed to attach to a Treo so people can type more easily, was announced last week, but so far has gotten a lackluster reception.

"The company has been under tremendous pressure to do something," said Tavis McCourt, a managing director at Morgan Keegan & Company. "The company has missed a product cycle, and it's good to change things around to signal to investors that something new is coming."

The Rubinstein effect
The equity investment from Elevation Partners should appease frustrated investors in the short term by helping pay for the one time $9 dollar per share dividend Palm will pay out as part of this arrangement. But the deal will also have longer term strategic benefits. Specifically, the addition of Fred Anderson, Roger McNamee, and Jon Rubinstein should help the company fine-tune its vision and execute more effectively moving forward.

Palm President and CEO Ed Colligan told investors during a conference call Monday that Jon Rubinstein will lead the company's product development. Anderson and McNamee will not likely be involved in day-to-day operations of the company, but their presence on the board will help the company forge new relationships, as well as help ensure a source of future investment capital.

"We think this transaction will reinvigorate our management team and help us attract new talent," Colligan said. "John will focus on helping us turn our product engine. He'll take a leading role in the development of the product organization."

Rubinstein, who helped turn Apple around in the late 1990s by leading development of the iMac and the iPod, appears to be well-suited for the job. He's known throughout the industry as someone who can take a vision and execute on it by building successful products, an approach many believe Palm needs right now. McNamee said he believes Rubinstein's strong execution history will fit well with Palm's founder Jeff Hawkins.

"We are intensely attracted to the idea of teaming Jon with Jeff Hawkins," he said. "We feel like that is a team that can't be beat."

But analysts say Rubinstein's presence on the management team doesn't necessarily mean a slam dunk for Palm.

"Rubinstein is a good addition for them," said Charles Golvin, an analyst with Forrester Research. "And there is a lot of potential for success. But the cell phone market is not the MP3 market. Palm is not creating a new category. It needs to evolve the market. So there are a whole set of other challenges associated with that."

Dealing with carriers who distribute the phones and competing against entrenched handset makers that are much larger than Palm are only some of the challenges Rubinstein did not face when conceiving of and building the iPod, Golvin said.

But there is little question Palm faces a tremendous opportunity. According to IDC, roughly 1 billion handsets will be sold in 2007. And less than 10 percent of those handsets will be smart phones. But that will change over the next few years, said IDC, which predicts that by 2012 or 2013, smart phones will account for about 25 percent of all handsets sold.

Increasing competition
Today BlackBerry is the clear leader in the smart phone market with its various BlackBerry phones. RIM, which up until recently focused exclusively on the corporate market, has expanded into what's known as the "prosumer" market. These are consumers who also want to use their phones for work, and expect to get e-mail and other multimedia functionality on their phones.

The BlackBerry Pearl was the first RIM product to make it into the prosumer/consumer market. And this year the company introduced the Curve, a multimedia phone geared toward consumers rather than enterprise users. Last year Motorola and Samsung introduced their own versions of the consumer smart phones, the Moto Q and the Blackjack, respectively. And Nokia, with its N-series phones, and Sony Ericsson, with its Walkman phones, have been selling such products for more than a year throughout Europe and Asia.

Palm, which introduced the new Treo 680 this year, has lost some ground to these competitors. Critics have complained that the Treo 680 only offers incremental improvements over older models of the phone.

Palm executives say they are already working on a new lineup of Treos. Even though Jon Rubinstein's influence on the product portfolio won't likely be felt for at least 18 months, McNamee said he is pleased with Palm's current product road map, which calls for new products on the market toward the end of this year and into early next year.

But in the future, McNamee said there is huge potential for Palm to innovate around its software.

"If you look at the industry over the past 12 months there has been huge innovation in hardware," he said. He pointed specifically to the Motorola Q, BlackBerry Pearl and the Samsung Blackjack, which have gotten smaller and thinner. "But now we're hitting a point where you can't get too much smaller without sacrificing functionality," he added. "We think the game is all about software. And software innovation is where Palm truly excels."

But catching the competition, especially Apple, could be difficult for the company, say some analysts.

"The iPhone has been very hyped," said Sean Ryan, a research analyst with IDC. "But it will have an impact on the market. It's particularly scary for Palm because they haven't diversified their design much, and Apple is also known for software development."

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