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As Microsoft Gains From Behind, Palm Gives Its OS a Push

Palm (PALM) is fighting a deadbeat reputation.

Lately, the handheld-device maker has been fending off scowls as it tries to deflect bill collectors and component inventories at the same time it struggles to raise a hungry operating system. After the daily grind fighting device-side price wars, Palm faces outsider concerns that all it's got to give its growing OS is a bag of McDonald's and an exhausted silhouette silently passing evenings on the couch.

This week, Palm tried to prove itself a loving parent with a pair of announcements that give its OS some much-needed attention.

Most importantly, it split off the OS group into a subsidiary, allowing for its own management and advisers. This is supposed to keep the OS from getting lost in the shuffle as its own staff focuses exclusively on bettering the platform that runs the Palm, Handspring (HAND) and Sony (SNE) lines.

Additionally, it's a preliminary step before taking the operating system public -- something that likely won't happen until the market thinks Palm is worth more than its Thursday $5.35 closing price. Palm makes less than 10% of its revenue from OS licensing ($7.7 million in the fourth quarter).

Secondly, Palm unveiled a partnership with Intel (INTC - Get Report), Motorola (MOT) and Texas Instruments (TXN) to expand chip options for the Palm OS to include more vendors and the potential for diverse devices beyond the traditional handheld.

Not quite mother-of-the-year candidacy, but two good steps in the right direction. Now all we need is to see some growth and happiness on the operating system itself, because competitors such as Microsoft's (MSFT - Get Report) Pocket PC aren't exactly in the same financial straits.

"It's not fair to accuse them of doing nothing," says J.P. Morgan analyst Paul Coster, whose firm has no banking ties to Palm. The analyst reads down a list of features the newest upcoming version of Palm will provide, including text messaging, 16-bit color, USB port supports to match your Apple computer, as well as some telephone support. Palm is moving in the right direction, but Coster nods that it's not moving fast enough.

"It is still fundamentally the same architecture we currently have. It's geared toward current-generation chips; it's not geared toward always-on networks yet. The new release that reaches completely for that kind of a scenario will not come until 2002."

Meanwhile, competitors are becoming a more credible threat to the Palm OS because of Palm's sudden, mostly self-inflicted fall into troubled-company status. Palm's market share among units sold in June slipped to 84.5% from its May share of 85.7%, losing ground to what market tracker NPD Intelect coins "proprietary" systems. Microsoft's PocketPC and Windows CE market share fell from 9.5% in May to 8.8% in June.

"Microsoft is certainly going to capture a large part of the market going forward," says Tom Sepenzis of CIBC World Markets. "It will be evenly split for a while. The question is whether eventually Microsoft can end up wrestling the entire market from Palm."

Sepenzis applauds this week's chip development, which will give the Palm OS access to the ARM chip technology that runs the Compaq iPaq, the most successful Pocket PC-based handheld. He also believes Palm can deliver on its promises to provide a BlackBerry-like mobile email device at Christmas, before PocketPC competitors. But that's progress on the device side.

J.P. Morgan's Coster puts the timing of the ARM-technology-based devices later in 2002. He expects Palm to see revenue come in the second half of 2002 for those efforts. "It's all good stuff; it's just awfully slow," Coster says of upgrades to the OS, outlining accelerating rivals such as the BlackBerry proprietary OS, Qualcomm's BREW for mobile devices and even Linux for small devices. "Palm has to move ... the question is can they move faster, because the competitive environment is speeding up."

The past week has been a proud parenting moment. Now to step up the pace to keep this baby developing.

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