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Palm (PALM)Stock (Computer Hardware Manufacturing Industry, Technology Industry)
Based in Milpitas, California, Palm, Inc. (PALM) designs, develops, and markets smartphones, handheld devices, and accessories. Approximately 80% of Palm's revenue comes from its smartphone line, branded the Treo. The company shipped its current iteration, the Treo 600, in September 2003. Since then, it has shipped a number of upgraded versions based on the design of the Treo 600, including the Treo 650 in 2004, and the current flagship version, the Treo 700, that began shipping in 2006 and runs on 3G networks from Verizon and Sprint. The Treo 700 comes with either the Palm operating system or the Microsoft Windows Mobile operating system, dubbed either the 700p or 700w to identify the operating system. Palm offers several other versions based on the design of the Treo 700. For the AT&T network, which is based on GSM technology, Palm offers the Treo 680 and 750. The Treo 755p is offered on the Sprint and Verizon networks and offers an internal antenna. The company recently launched a low-end version of its smartphone, the Centro, which was initially launched through Sprint for a price of $99.99. For international markets, Palm offers the Treo 750, which is a world GSM phone, compatible with international GSM networks. Also internationally, Palm partnered with Vodaphone to launch the Treo 500v, which runs on the Windows Mobile platform. The market for handhelds or PDAs has declined over the past several years due largely to the cannibalization by the smartphone market and accounted for approximately 20% of revenue in fiscal 2007. Palm currently offers three major handhelds, including the Z22 aimed at the low-end of the market, the T/X for the high-end business user, and a mid-range offering, the Tungsten E2. The mobile computing device market is intensely competitive and is characterized by rapid changes and complex technology. Although Palm was a pioneer in the smartphone market, its core product, the Treo, has not had a major redesign since the launch of the Treo 600 in 2003. The Treo 650 was launched one year later with a number of upgrades, including Bluetooth, a high resolution screen, removable battery, more memory, and other improvements. However, improvements to later models have been in much smaller increments. We therefore view current offerings as more evolutionary and believe that it is losing ground to new entrants that have had the benefit of designing a product from the ground up. Palm is working on a Linux based version of its proprietary platform however this is not expected to be released until the end of calendar 2008. In the meantime, the company will focus on its current system and Windows based products, which lack differentiation and the high gross margins that the company has enjoyed in the past. In the high-end of the consumer market, Palm will likely face intense competition from Apple's iPhone. Just two months after launch, Apple has slashed its iPhone price by $200 to $399, bringing its price tag much closer to Palm's Treo (that sells for up to $399 at Verizon Wireless, or $199 at Sprint Nextel Corp to customers who sign a contract) and Motorola's Razr2 (that sells for$249 to $299 in United States). We believe that with this lower price point, iPhone will appeal to a broader range of consumer customers and likely take share from Treo. Consumers are typically more price sensitive, and part of Treo's advantage had been a much lower price point. Other major competitors to Palm include mobile handset and smartphone manufacturers such as Motorola, Nokia, Samsung, Sony-Ericsson, Research in Motion, Microsoft and Google. To help it compete, the company has been offering discounts at Verizon Wireless stores on Treo 700 models, and the introduction of new, lower-cost 680 models at Cingular will further drive average sales prices down in the coming quarters. Although we expect Palm to gain ground in the low-end of the market with the new Centro, where the Motorola Q phone and other low-end models have been strong, we are concerned about the company's ability to maintain strong margins given its $99.99 price target. Motorola's acquisition of Good Technologies also concerns us as the combined company is likely to make an aggressive push into enterprise email, competing more directly with both Palm and RIM. Moreover, this combination could threaten Palm's partnership with Good, which has been the largest driver behind its recent success in the enterprise segment. To counter this, Palm has been working closely with Microsoft and offers the ability to send email directly from Exchange Server to the handheld without installing a third party client. In an effort to remain competitive, Palm has been growing its investment in research and development and sales and marketing. R&D grew to 12.3% of revenue in 2007, up from 8.6% of revenue for fiscal 2006. Meanwhile, sales and marketing expenses grew to 15.9% of revenue in 2007, up from 13.0% for 2006. For the first six months of fiscal 2008, R&D has increased to $106.2 million compared to $83.2 million in the first six months of fiscal 2007, while sales and marketing expenses appear to be leveling off. This increased investment should help smooth future product transitions and accelerate the introduction of new products, but has accelerated operating losses. We are positive on the company's commitment to launch new products, but are concerned about the pace. We are also optimistic that the hire of Jon Rubinstein, who previously worked at Apple, will breathe life into the company's products. However, its next major platform change is still a year away, which could be too late given the rate of deterioration in revenue and gross margins. Moreover, Palm is a relatively small player in the market that was able to compete on the strength of its offering. With much of its competitive advantage gone, we believe that the company will have trouble competing with larger competitors during calendar year 2008. On a positive note, United States District Court for the Eastern Division of Virginia, Richmond Division, has granted a stay on the proceedings of the patent infringement litigation brought against the company by NTP. Moreover, the company also accepted a $325.0 million investment from Elevation Partners (a 27% stake) under which the company recapitalized and raised $400 million through the sale of senior secured debt to finance a $9.00 per share cash distribution to the shareholders. The amount of total proceeds is estimated to be approximately $939.6 million at a conversion price of $8.50 per share.
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