Updated from 9:54 a.m. EDT

Consolidation came to the handheld computer market Wednesday, as Palm ( PALM) agreed to acquire rival Handspring ( HAND) in a stock swap.

Palm's board also gave final approval for the spinoff of PalmSource. Under the proposed terms of the transaction, and following the spinoff of PalmSource, Palm will exchange 0.09 shares for each share of Handspring. Palm will issue about 13.9 million shares to Handspring's stockholders. Handspring's holders will own about 32.2% of the merged company, and Palm's shareholders will own 67.8%.

The transaction, encompassing the spinoff of PalmSource and the merger of Handspring with the remaining Palm Solutions Group, is expected to close in the fall.

The value per share that Handspring shareholders will receive will be based on Palm's share price following the spinoff of PalmSource. The spinoff of PalmSource will be completed immediately before the closing of the Handspring acquisition.

Based on Palm's Nasdaq closing price of $12.15 on Tuesday, the deal would be valued at nearly $170 million.

"This has been a merger that I think most people that followed the industry would have liked to have seen a while ago, in order to get some of the efficiencies of personnel as well as reduce costs," says James Faucette, an analyst at Pacific Crest. "Just from a pure operations standpoint there's been a positive reaction. There's also the potential that some of the people that know the ins and outs of handhelds best would be able to come to market with some compelling new products."

But from the financial standpoint, there will be no quick fixes. "In terms of their ability to re-ignite the market and become profitable, that's far from certain. The potential for doing such a thing has probably improved," says Faucette, who has a neutral rating on both stocks. He says it's too early to say whether he'll grow more positive on the shares, but the first step for most companies will be simply to reduce losses. Financially, "we probably won't know whether this was successful for a couple of years."

His firm hasn't done banking for either company.

The merged companies expect greater revenue opportunities and cost savings of around $25 million a year. The projected savings assume combined employee reductions of around 125 people and the elimination of overlapping programs and unnecessary real estate. Palm expects to move Handspring's employees to Palm Solutions headquarters in Milpitas, Calif.

As part of the agreement, Palm will provide an initial $10 million line of credit to Handspring for working-capital purposes until the transaction closes. Under certain conditions, the line of credit may increase to $20 million, and its maturity could be extended.

Both companies have been hard-hit by slumping demand for handhelds. For the most recent quarter ending in February, Palm's revenues fell 29% from last year's levels and the company posted a net loss of $172 million, according to generally accepted accounting principles (the loss was partly due to heavy restructuring and impairment charges).

Handspring's sales dropped in half from last year for the quarter ending in March, while it lost $90 million.

Palm gained a hefty $2.20 or 18.1% to $14.35 in afternoon trading, while Handspring was up 16 cents or 14.4% to $1.27.

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