Palm's Problems Almost Out of Hand

The handheld maker has the cash, but not the new products, it needs to survive.
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Palm (PALM) is on the ropes. The handheld maker has taken punches from all sides: It's had component chain difficulties, product rollout mistakes, layoffs, price wars, waning consumer interest, a new product pushback, a canceled campus build-out and, finally, a cash crunch, all in the course of 2001.

If you invested in Palm on Jan. 2, 2001, you've lost more than 90% of your money; if you invested a quarter ago, you've lost more than half. Everyone knows that Palm is bruised and bloody, but the most important question is, will the handheld maker stay on its wobbly legs until the market can ring in a recovery? The stock won't get back on its feet until it can prove to the Street and investors that it can keep up with a widening array of new competitors with next-generation products.

Palm has a few quarters in the meter before it will run out of money. The company ended the August quarter with $328 million in cash. At some point it also will be able to bank the proceeds on the sale of 39 acres of San Jose, Calif., land once earmarked for a campus, and CFO Judy Bruner has a $150 million credit line at the ready should Palm need it. Palm's average quarterly cash burn in fiscal 2001 was $41.09 million -- which would give it two years of life on its current financial stash, not including the real estate. However, as it seems with all things Palm, its cash burn has gotten worse, and in the first quarter of fiscal 2002 ended Aug. 31, the company plowed through $180.9 million to fund operations.

"The notion that they go out of business because of a lack of cash is a bit far-fetched. It'll be more like 'death by a thousand cuts,' " says JP Morgan analyst Paul Coster. "I have no doubt that these are smart people that know what to do. But they can't seem to do it, and, unfortunately, they have less cash to do it with."

On the sunny side, according to recent Gartner numbers to be unveiled this week, Palm has halted the slide of its worldwide personal digital assistant market share. After enjoying a market percentage in the high 60s, then sliding to a 49% stake in the second quarter, Palm's reach has stretched forward again to include 52% of the handhelds sold worldwide, according to Gartner's Todd Kort. Kort says some of those gains came from the Oct. 4 timing of competitor


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Pocket PC 2002 operating-system launch, which could have persuaded iPaq and Jornada fans to put off buying a device in the third quarter.

Not Investors' Favorites

Even as the dominant PDA player in the world, Palm trades at 1.39 consensus estimates for fiscal 2002 revenue and 0.97 times estimates for fiscal 2003 revenue. (Compare that with device maker, but OS-less,



, however, which is valued at 0.88 and 0.60 times fiscal 2002 and 2003 revenues, respectively. The market is not impressed with these two stocks. Microsoft is richly valued at 11.7 times fiscal 2002 sales.) Palm could be a cheap takeover candidate once the requirement that it operate independently after its tax-free spinoff from


expires July 27, 2002.

While Pocket PC is a big worry for investors, the Street's current attitude toward Palm reflects the importance of a newer generation of devices that incorporate wireless connectivity. Palm was expected to have a wireless communicator with email and PDA capability out for Christmas to compete with

Research in Motion's


BlackBerry pager. In September Palm delayed the product indefinitely, leaving investors to wonder if the company would be able to compete in a world in which


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is gobbling up European consumer PDA market share, mobile-phone makers are scurrying to provide data-capable applications in small devices, and Handspring has unveiled a combo GSM/GPRS mobile phone and PDA due out in the spring. Palm has mobile-phone/PDA projects in the works, but the company is quickly getting a reputation for lagging the market. That goes for its Palm operating system as well, a media and consumer darling that needs an update.

Palm OS fans think that segment of the business can generate some serious value if unlocked from the staggering company. But OS hopes won't jog the company to health soon enough for investors' tastes -- the licensing business declined in the first quarter to a simple $5 million of Palm's $214.3 million in revenue.

"It really doesn't look good at the moment, but just thinking law of averages, Panasonic is still making phones," says Tom Sepenzis of CIBC World Markets. "Palm is clearly in trouble, even if they do come out with phones. It's tough to compete in the long run with phone manufacturers. The margins will be pretty low. They're going to have to find a way to leverage the software model, to get people backing Palm OS. God knows."

Palm can survive in the interim. That's the good news. Palm has to win back the faith of the Street and investors with a snazzy new product or two, and a step forward for the Palm OS. Until then, Palm is stuck with the same problems, burning up money.