Holding Out for Handhelds

Long-term prospects look bright, but some don't yet see a bottom for palmOne and RIM.
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Last year, shares of

palmOne

(PLMO)

and

Research In Motion

(RIMM)

were sizzling. But since each company gave investors a jolt in December, their stocks have started to shiver.

The reasons behind the flameouts differ. RIM received an unfavorable ruling in a patent suit, the reaction to which pushed its shares below its moving average. Meanwhile, palmOne has cooled its shares with management changes, inventory troubles and an earnings warning.

Regardless of the causes, it may be a while before either stock gets reignited.

"Both of those companies are dead money at the moment. They will trade with the market," said Jay Somaney, a portfolio manager with TSG Capital Group, which has a long position in RIM.

And some analysts believe things could get much worse before they get better. Even with a slight recovery for both stocks in recent days, both could lose 10% or more before they finally bottom, they warn.

"There are enough red flags around

palmOne to be a little more cautious," said Rob Sanderson, an analyst at American Technology Research. "When the wheels come off, the wheels really come off." (American Technology Research does not do investment banking, and Sanderson does not hold shares in the companies he covers.)

While many investors are still betting on the long-term performance of both companies, that kind of outlook may pour cold water on a buying opportunity for short-term investors.

PalmOne was a stock market star for most of last year. Through the middle of December, its shares were up more than 260% for the year, sparked by improving results and strong sales of its new Treo smartphones.

But then the company started sending stiff winds toward investors. Although the company

met earnings expectations with its second-quarter report, it

warned that third-quarter results would come in far below Wall Street's forecasts. The company also alarmed investors by acknowledging that it had a backlog in its inventory amid a transition to a newer version of its Treo smartphone.

That wasn't the end of the bad news, though. In recent weeks, the company has announced the

resignations of both CEO Todd Bradley and Angel Mendez, the company's head of global operations.

Since the earnings announcement in December, palmOne shares have fallen some 40%. On Monday, palmOne shares closed regular trading up 44 cents, or 1.7%, to $25.88.

"The management changes are obviously spooking people," said one portfolio manager, who asked not to be named. "It appears that

palmOne's board was not that pleased with their execution," added the fund manager, who is long palmOne's shares.

Shares of Research In Motion have seen a similar dynamic. With both its revenue and subscriptions to its BlackBerry email service growing like wildfire, the company's shares were up nearly 170% for the year through the middle of December, regularly setting all-time highs.

But then came the court decision. An appeals court in December

upheld a lower court ruling finding that the company had infringed on patents held by

NTP

. Although the appeals court overturned an order that would have blocked RIM for selling its BlackBerry service and devices in the U.S., the decision seemed to awaken investors to the possibility of that outcome.

Recent days also have seen fears of increased competition from the likes of smaller competitors such as privately held

Good Technology

and cell-phone giants

Nokia

(NOK) - Get Report

,

Sony Ericsson

and

Motorola

(MOT)

.

The court decision extinguished the upward run of the company's stock and sent it backpedaling. Since the decision, RIM's shares have fallen below their 20-, 50- and 100-day moving averages and have come close to breaking through their 200-day moving average.

Indeed, since the court decision, RIM's shares are down more than 20%. The stock closed Monday up 93 cents, or 1.3%, to $71.29.

Falling below the moving averages was a "catalyst for guys who like to look at charts," said Sanderson. In the meantime, "you have the backdrop of heightened concern around legal. People are nervous about that," he said.

The declines in both companies' shares have come as investors have given greater scrutiny to -- and become more skeptical of -- technology shares that they bid up last year. Since mid-December, the

Nasdaq

has declined about 6%. Particular names within the index have been hit even harder, as investors have sold off

eBay

(EBAY) - Get Report

,

Qualcomm

(QCOM) - Get Report

and

Yahoo!

(YHOO)

, in addition to RIM and palmOne.

"All the high-multiple tech stocks have been getting hit," said Sanderson. "When the Nasdaq is off, they're going to be off more. They're all pretty much rich stocks."

The unnamed fund manager believes palmOne's stock will stop its fade at some point, but that turning point might be closer to $15 than the stock's current price of more than $25. At that point, the company's valuation would be somewhere close to half its projected sales for the year, the fund manager noted.

"People think the Treo is a good product," the fund manager said. "You're going to get people saying that

a valuation of one-half sales is too cheap, especially when Research In Motion is trading at 11.5 times sales." (The fund manager is short RIM.)

But Sanderson believes any comparison favors RIM, which he says is outgrowing palmOne and has much better operating margins. And palmOne has a history of problems with product transitions, which is another risk to its shares.

"If things go badly,

palmOne's shares could get cut in half and then some," Sanderson said. "It's hard to find a downside on a business such as this when things are going terribly wrong, if that in fact is what is going on here."

But some think the outlook for RIM isn't much better. Although he's bullish long term, Scott Rothbort of LakeView Asset Management sees few short-term sparks for RIM's stock, and thinks the shares could trade down as much as 10% in the near term.

"It's had some weakness, and could still have some weakness, but I'm not looking to trade it here," said Rothbort, a contributor to

TheStreet.com's

sister site,

Street Insight

. Rothbort has long positions in both palmOne and RIM.

In contrast, the fund manager has a hard time seeing the bottom for RIM's shares. Not only is the patent case hanging over the company, he warned, but as the market for the company's devices expands, RIM likely will see increasing competition from the big cell-phone makers. Both trends likely will put a crimp in RIM's revenue and earnings prospects, throwing into question its current valuation.

"It's anyone's guess if these guys can hold their market share or not," the fund manager said, adding that palmOne's shares are closer to hitting bottom than RIM's.

And over the long term, the prospects look brighter for both companies.

"There's this tremendous, untapped marketplace for BlackBerries in the U.S. and Europe. That's before you get to the Far East," Rothbort said. "We're going to wake up, and there's going to be this surge in growth," he said, adding that he can see RIM's shares "easily" tripling their current price over the long term.