Plunge in Palm shares could mean price cuts

Analysts blame a 50 percent drop in Palm shares on overestimated demand, and say the company will have to get rid of unwanted inventory

Palm shares plunged nearly 50 percent on Wednesday when investors realised the handheld giant vastly overestimated demand amid a weak economy and let inventory build up.

"The revolution is not over, but it has been put on hold," said C.E. Unterberg Towbin analyst Scott Miller.

Palm has become a victim of its own optimism. Buoyed by strong consumer demand for its products and shipments that have doubled and tripled at times, the company expected to ride out the US economic downturn in style. Palm must now deal with a bloat of excess inventory, cost-cutting measures, and layoffs.

The company is experiencing the downside of being the market leader, as nearly every other competitor is trying -- often successfully -- to take market share away from Palm.

Several financial analysts said the number one handheld maker will need to shift quickly to adjust to a market in which sales are falling to levels seen a year ago. Price cuts and lower profit margins could materialise.

A number of financial institutions reduced their expectations Wednesday based on the company's outlook, though some analysts urged investors to stick it out, saying that the handheld market is not fading away and that Palm's market-leading position should help the company recover.

On Tuesday, Palm beat analyst estimates for its third quarter by one cent. At the same time, it reduced revenue expectations for the current quarter to between $300m (£210m) and $315m (£210m) -- far below the $573m (£400m) previously predicted by Wall Street.

The company now expects to lose eight cents per share for the quarter, despite measures to trim 10 percent to 15 percent of operating costs. Cost-cutting measures include reducing its work force by 10 percent to 15 percent, or 250 employees and contract workers. In addition, it will postpone construction of its new corporate headquarters.

Palm may be forced to take more cost-cutting measures, Miller said. "I think you should read it as a developing story," he said. "It is not clear how long the downturn will last, and it is not clear how deep the cuts will need to be."

Several analysts are expressing concerns about "channel stuffing," saying that there is far too much inventory sitting on the shelves of retailers and distributors at a time when consumer spending is decreasing. Channel stuffing refers to the situation when companies continue to ship their products to distributors and retailers, despite a slowdown in demand.

"Clearly, the impact to Palm will be in the next quarter 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, UBS Warburg analyst Don Young wrote in a research note.

Young cut his price target on the stock from $14 (£9.75) to $10.50 (£7.30) and dropped earnings estimates for 2002 from 26 cents per share to 12 cents.

Gartner analyst Abha Garg said Palm will have to continue to build revenue in Palm operating system licenses and other segments to guard against pressure on its hardware revenue.

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