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Psion You Crazy Diamond

Even without the "Microsoft threat," pugnacious Psion faces plenty of obstacles.
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Despite two scares this week, analysts are still clinging to their buy recommendations for handheld computer maker Psion. But justifying such optimism for a company trading around 85 times forward earnings and with a history of snatching defeat from the jaws of victory is becoming increasingly hard.

The first piece of news to hit Psion's shares came on Monday, when


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British Telecom


announced that "they will work together to develop a new range of Internet, intranet and corporate data services for mobile customers worldwide."

Psion shares closed 5.6% lower at 876 pence that day, as people panicked over whether this agreement constituted a threat to the firm's EPOC operating system as the de facto standard for intelligent mobile phones.

But then reality set in, and everyone realized this "wooly agreement" -- as Michael Hennigan of

Williams de Broe

described it -- doesn't alter the fact that the EPOC system is still superior to Windows CE. So Psion's shares rallied on Tuesday to close at 947.5 pence.

Indeed, the president and CEO of



-- which, together with






and Psion own the

Symbian partnership that will develop these intelligent phones -- felt bemused enough to ask analysts in Paris on Tuesday what all the fuss was about.

Since no telephone manufacturer is involved in the Microsoft and BT venture, it doesn't exactly represent a direct competitor to Symbian. And in any case, Microsoft's agreement with BT is nonexclusive, meaning that if BT wants to sell phones with the EPOC system rather than Windows CE, it is welcome to do just that.

Wednesday's Surprise

That's why, with ruffled feathers smoothed, everyone got back to the business of bidding up Psion's shares. Until Wednesday, that is, when Psion, true to form, surprised the market with a warning that its revenues and profits will be "severely affected" in 1999 because personal computer makers are building modems into their products instead of using suppliers such as Psion to offer it as an accessory. The cheek of it!

Psion's shares tipped off their precipitous heights and closed in London down 12% at 835 pence.

Analysts rushed to revise down their profit forecasts, which had stood at 12.2 pence per share for 1999, but at the same time waved off concerns about Psion by stressing that


, the division of Psion that makes the modems, was irrelevant and the future lies in Symbian.

They may have a point. Dacom is likely to represent about 35% of Psion's sales in 1998 and in terms of valuations, Williams de Broe's Hennigan said that, based on his forecast of 10.1 pence per share in 1998, he places a value on Dacom of around 140 pence per Psion share, compared with his estimate of 600 pence for Symbian. "This news today knocks at the most 100 pence off Dacom, so it's terrible in terms of valuations for Dacom but it's not a great part of Psion's business," Hennigan said. He still has a buy recommendation on the company.

The Future Lies in Symbian

Psion's current high valuation comes largely from the promise of Symbian, which has yet to turn a profit but is set to be the main driver of future earnings growth.

Nomura International's

Nainish Bapna, who also has a buy recommendation on Psion, estimates that Symbian will lose about $25 million this year, break even in 2000 and be profitable by 2001. Hennigan calculates that Symbian's revenues will be over $215 million by 2002.

For those who fret about a company that trades over 85 times to earnings, Hennigan points to the high valuations of telecom companies such as

Colt Telecom




. He argues that Symbian's high margins from its licensing activities, its focus on software and industry support all argue for a higher multiple than that of a telecom company.

Troubles in the Handheld Market

The company's profit warning, however, serves as a stark reminder that Psion's businesses outside of Symbian remain questionable.

Psion can no longer lay claim to being the trendsetter in its core business of handheld computers. That honor goes to


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Palm Pilot. In fact, Psion has not launched a new product since 1997, when it came out with the Series 5. Not only did Psion royally botch the launch of Series 5, the product itself proved unpopular because it can't synchronize with a desktop computer from a remote site.

In light of the increased competition from the Palm Pilot and Windows CE-based machines, Hennigan expects the revenue from Psion's core business to fall by 18% in 1998. So, more than ever, a bet on Psion is purely on its 31% stake in a technology that has yet to be proven.

The supremacy of EPOC over other operating systems such as Windows CE seems secure, at least for now. But one should never underestimate Bill Gates. Gates has singled out Psion as one of the biggest threats to Microsoft, and the confusion that still reigns in the mobile market over U.S. and European standards gives him time to hone a more sophisticated challenge to EPOC.

Psion also has a history of problems ranging from botched product launches to uneven quality control, an unfortunate trait for a company involved in making high-tech machines. According to Nomura's Bapna, the company wants to outsource a growing proportion of the assembly of its handheld and modem products this year.

Although a strong antipathy toward Microsoft is holding the joint venture together, Psion shouldn't take the continued support of its partners for granted. The investments by the phone makers are relatively small, and if Symbian fails to meet deadlines for developing suitable EPOC systems for the phones, one of the mobile phone partners can simply look outside for its software needs.

As Bapna put it: "In essence, the game is there for Symbian to lose." Hardly encouraging words for a company with Psion's history.