Is weakened Palm ripe for acquisition?

Six months ago, the handheld maker appeared to have the business world in its hand. Now the company has broken into a cold sweat, spurring speculation of an acquisition.

John Borland Staff Writer, CNET News.com
John Borland
covers the intersection of digital entertainment and broadband.
John Borland
6 min read
Six months ago, Palm appeared to have the business world in its hand. Now the handheld giant has broken into a cold sweat, spurring speculation of a major restructuring or even an acquisition.

Santa Clara, Calif.-based Palm, still the largest handheld maker by far, announced Friday that it will lay off a second round of workers this summer. Palm already laid off 300 people, or nearly 16 percent of its work force, in April.

In addition to the upcoming layoffs, a number of signs point to Palm's growing weakness: an inventory glut, a recent earnings warning, zapped cash reserves, a depressed stock price, a failed acquisition, and scuttled plans to move its headquarters.

Analysts stop well short of saying that Palm is shopping itself to potential buyers. It's clear the company needs an infusion of funds, though there are other ways to raise the money. Nevertheless, some analysts say, Palm is an increasingly attractive target.

"An acquisition would be one way to deal with the cash issue," U.S. Bancorp Piper Jaffray analyst William Crawford said Friday. "The decline in stock price without a commiserate decline in product or brand value makes Palm even more attractive."

In the circle of potential buyers, analysts said, are IBM, Apple Computer and Sony. Apple CEO Steve Jobs has long coveted Palm. When he resumed the leadership of the Mac maker three years ago, he tried to buy the company from 3Com, but Palm held out for the public market instead.

It's unclear whether Jobs is still eyeing the company with a taste for acquisition, but in a May 14 article in Fortune, Jobs lavished praise on Palm and other handheld computer makers.

"I still wish we had been able to buy it," he told Fortune. When the reporter asked whether he was still interested in Palm now, Jobs curtly replied, "I don't know what you're talking about." He glanced at the ceiling, smiled and then changed the subject.

On several levels, Apple would appear to be a possible suitor as the companies share similar businesses.

Apple and Palm, for example, provide the operating system and the hardware for their devices. Apple also is credited with creating the first palm-sized computer, the Newton, in 1993.

IBM is also viewed as a logical suitor, chiefly because Palm's latest sales campaign targets corporate customers--businesses with legions of sales representatives and other workers who use handheld computers.

"Where Palm needs to go, IBM already is," Crawford said.

As for Sony, the company already licenses the Palm OS for its Clie handhelds, which have yet to catch on with U.S. consumers.

Palm spokeswoman Marlene Somsak flatly denied that the company is flirting with acquisition.

"Our intention is to remain an independent company," she said.

Somsak noted that any acquisition bid would be made considerably more expensive by the tax liability related to Palm's spin-off from 3Com last year. Federal regulators gave the transaction tax-free status. But anyone purchasing more than 50 percent of Palm before June 2002 will potentially have to pay those taxes.

The company also adopted a "poison pill" shareholder rights plan last year that would make a hostile takeover attempt more difficult than without it, Somsak noted.

Still, Palm's current weakness is visible on several fronts.

Last month, Palm warned Wall Street that fiscal fourth-quarter revenue will be about half of its previous forecast--which already was sharply reduced. Its fiscal first quarter begins Saturday.

In the past year, Palm's market share has withered from more than 80 percent to about 60 percent of the overall handheld market, as Silicon Valley rivals such as Handspring grow stronger.

The company's stock price has reflected the decline. On Friday, Palm closed at $6.19. That's a 10 percent boost from the closing price Thursday as Wall Street applauded the newest round of penny-pinching, but still a far cry from its 52-week high of $67.38.

Wall Street has criticized Palm managers, particularly CEO Carl Yankowski. Analysts say the company needs executives who can remedy the supply-chain management flaws that have resulted in a glut of Palm devices this spring and botched product launches.

"I think we can all safely say that there needs to be some changes, or some shifts in the management team," IDC analyst Kevin Burden said. "A clean sweep is not what they need. But they need to show some improvements, some reaction."

It wasn't always so grim
Palm's current plight is a far cry from its perceived brilliance as few as six months ago.

The company's handheld computers became symbols of the New Economy--the most cutting-edge way to pass resumes, keep appointments and swap files via infrared beaming. "Palm" was synonymous with personal digital assistants and had the same status as "Rollerblade," "Jeep" or "Kleenex"--brand names that consumers embrace as descriptions for entire product categories.

In the first 18 months on the market, consumers bought 1 million Palms. According to marketers in the handheld industry, the original PalmPilot caught on faster than the VCR, the color TV, the cell phone, even the personal computer. About 13 million people now own a Palm-branded handheld.

Parent company 3Com spun off Palm, which went public in February 2000. Investors quickly bid up the stock's initial price: It soared from $38 to more than $160 on its first day of trading.

At the time, Palm handhelds accounted for about three out of every four handheld devices sold. But competitors were jealously eyeing the company's dominance. Mountain View, Calif.-based Handspring, whose founders defected from 3Com in 1998 in what they called lack of vision for the spinoff of Palm, became the most aggressive rival and most lauded newcomer to the market.

Palm and Handspring recently escalated a long-simmering price war that has been shaving the industry's once stellar profit margins.

In early May, Handspring cut 20 percent off the price of its flagship Visor Deluxe, which now costs $199, tossing in a free leather case worth $24.95 and free shipping for online orders. In April, Palm slashed 14 percent from the price of its Palm Vx, discounting it to $299, and took $20 off the $149 sticker price of the low-end m100 model.

Palm's discounts came as the company has struggled to unload $200 million in unsold inventory for the quarter, in addition to $100 million in inventory from the quarter before that. Like its peers in the personal computer industry, Palm underestimated the severity of the economic downturn, which particularly hammered the broad technology sector.

Even more worrisome: The pace of price cuts seems to be accelerating--and affecting top-of-the-line and new models that used to keep Palm's profit margins near 40 percent. The company warned analysts recently that margins could erode to 25 percent within a few months.

As competitors knock down prices, Palm retailers have taken matters into their own hands by selling the devices well below the listed prices--even on brand-new m500 and m505 models. Electronics retailer Best Buy, for example, has chopped the m500 price tag by $70, selling it for $330.

Dead opposite
Discounts are the dead opposite of Palm's halcyon days last year, when stores couldn't stock enough handhelds and Palms were icons of the digital age. Back then, would-be members in the cult of Palm resorted to paying $50 or more above retail price on eBay and other online auction sites.

Handspring is a tough No. 2 in the market for handhelds, but Palm is also slogging against no less a competitor than the world's largest software company.

Redmond, Wash.-based Microsoft licenses its Pocket PC operating system for handheld computers to Casio, Compaq and Hewlett-Packard. So far, Pocket PC-based handhelds have captured less than 10 percent of the market. But no one denies the deep pockets of its benefactor. Pocket PC has an annual budget for research and development of $300 million, second only to Microsoft's Xbox project in terms of budget allowances.

Although Pocket PC-based devices continue to lag Palm systems, Microsoft-enabled machines have nabbed 26 percent of the U.S. market for handhelds that cost $350 or more, according to researchers at NPD Intelect.

In addition to inventory gluts and heated competition, Palm faces a cash crunch. The company had $700 million in cash in January, but analysts expect the company to have no more than $100 million by year's end.

In its drive to save on short-term expenditures, Palm has cut back on its sales efforts to large businesses, even as Yankowski has pinned long-term hopes on selling to markets such as corporate sales forces. To beef up its bankroll, Palm hopes to recoup $238 million selling the site it bought in San Jose, Calif., to build a new, bigger headquarters.

The exact extent of Palm's current crisis will become clear soon. The company reports fiscal fourth-quarter and full-year results during the week of June 25.