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The Day Ahead: Don't dismiss Palm's competition

The stage is set for Palm's market debut

If there was ever a no-brainer IPO success story, Palm is it. The maker of handheld computers Palm VII, V and III will make its highly anticipated market debut this week. But investors shouldn't dismiss the boilerplate warnings about competition in Palm's regulatory filings.

Palm is expected to price 23 million shares with a price range of $14 to $16 (£8 to £9). Goldman Sachs is the lead underwriter with Morgan Stanley, Merrill Lynch and Robertson Stephens assisting.

In the short-term, it's hard not to get excited about Palm. "Palm has been one of the most widely anticipated IPOs since it first came into the system," said David Menlow, analyst with IPOfinancial.com.

Renaissance Capital gushes that Palm is at the "heart of the wireless revolution against cumbersome desktop PCs."

The company, which will become independent after operating as a unit of 3Com, boasts a whopping marketshare of more than 65 percent and has sold over 5.5 million Palm devices worldwide. It also has a proven track record.

For the six months ending 26 November, the company reported a profit of $22.5m (£13.9m) on sales of $435m (£269m). For the year ending 28 May, Palm reported a profit of $29.6m (£18.3m) on sales of $563.5m (£349.4m).

Palm also introduced new colour models last week, which gave it plenty of time to create some pre-IPO buzz. The company said that the Palm IIIc is now colour-enabled and there are new pricing plans for its wireless Internet access service. The new Palm handhelds threw cold water on some of the competition, which have also been using colour. However, colour alone won't be able to fend off the growing ranks of competitors. "The long-term success will be dictated by direct competition," said Menlow. "A lot of companies are nipping at Palm's heels."

In regulatory filings, Palm said it has to keep pumping out new products and technology to stay ahead of the pack. "The lifecycle of our handheld devices is generally 12 to 18 months or less," the company said.

Palm said it primarily competes with Casio, Compaq, Hewlett-Packard, Psion (quote: PON), Sharp and Palm platform licensees, such as TRG and Handspring. On the operating system side of the business, Palm competes with Microsoft's CE software. The operating system could become one of Palm's biggest revenue streams as it licences its software to others.

Other competitors for Palm fly under the radar. These include keyboard-based devices, sub-notebook computers, smartphones and two-way pagers, the company said. Palm said licensees such as Nokia, Sony or Qualcomm use its platform in devices, such as mobile phones or other similar products, that can compete indirectly with its handheld devices.

So, if smartphones supplant the Palm, the company's revenue could suffer. And European wireless service providers are already planning to give a free smartphone away with all the Palm functionality included.

Palm said it is working to diversify its revenue stream through licensing and expansion of its Web sites, but 99 percent of Palm's revenue comes from handheld sales.

With competition looming, Palm is forging some big alliances. America Online (AOL), Motorola and Nokia will buy Palm shares in a private placement that will occur concurrently with the IPO. After the IPO, 3Com will own about 93 percent of Palm. 3Com plans to distribute its Palm shares to 3Com shareholders within six months.

Here's an interesting tidbit buried in the Palm regulatory filings: 3Com isn't obligated to give its shareholders Palm shares. Instead, it plans to distribute shares after its board approves the move, and the Internal Revenue Service rules the distribution will be tax-free. "This distribution may not occur by that time or at all," said a Palm spokesperson. "At the time of this offering, we will not know what the ruling from the Internal Revenue Service regarding the tax treatment of the separation and the distribution will be. If 3Com does not receive a favourable tax ruling, it is not likely to make the distribution in the expected time frame or at all."

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