Analysts eye Palm's new strategy as IPO looms

Palm Inc., set to go public this week in one of the most anticipated recent offerings, could face a tough road ahead as well-heeled competitors close in on the handheld market.

Slated to start trading Thursday, Palm has been a primary force driving the industry shift to wireless handheld computers capable of Internet communications, such as email and instant messaging.

Watch video

Palm's stock offering is expected to raise upward of $368 million, analysts say. The 3Com spin-off should reap the rewards from the growing popularity of so-called personal digital assistants (PDAs).

"It's great that they're the first, but they're also going to be subject to the vagaries of the market forces because they're the bellwether," said Jill House, an analyst with International Data Corp.

The market for handheld devices has become increasingly more competitive since Palm debuted. Yet even with the emergence of products from Handspring and Windows CE-based devices from Casio, Philips and Compaq, Palm has maintained its edge.

The company also is looking to transistion its business from focusing on hardware to licensing its operating system software. Recently, Palm signed high-profile partners such as Handspring, started by Palm co-founders Donna Dubinsky and Jeff Hawkins, as well as Nokia, Motorola and Sony.

"We believe the main driver for Palm exists in licensing of its operating software," said a recent research report from Lehman Brothers. "Major wireless players such as Nokia, Motorola and other (handheld) vendors such as Handspring have joined the licensee list alongside e-commerce partners such as Amazon and Yahoo. "

By moving from a business plan based solely on low-margin hardware to a more diversified software plan, Palm is attempting to ensure its long-term, continued revenue, the company says. Palm currently counts 99 percent of its revenues from hardware sales.

But the transition may be rocky, analysts caution, and Palm may be especially susceptible to threats from competitors as it revamps its strategy.

The company faces threats from Microsoft, which has shown no indication that it will abandon its floundering Windows CE operating system for handheld devices. Microsoft is expected to release an update this spring. In addition, the Symbian group, whose Epoc operating system competes with Palm, is aggressively courting the same cell phone manufacturers Palm counts as its customers.

Palm's new software licensing business may be a tough sell to investors and may not be as lucrative as standalone hardware sales, at least in the short term, analysts warn.

Still, Microsoft's scaled-down operating system has failed to make much of a dent in the handheld market, taking only about 10 percent, according to IDC. Several manufacturers, including Philips, dropped out of the market altogether.

At the same time, Palm seems to be steadily gaining momentum. The company's market share has stayed around 70 percent, while its product mix has expanded with a wireless device, the Palm VII, and a device with color display, the Palm IIIc, which was released last week. The products have a devoted base of fans, many of whom write software or design peripherals for the devices. Palm refers to this group as the "Palm Economy."

Palm will rely heavily upon the Palm Economy in its bid to diversify its business beyond sales of devices alone. Company executives have said in the past that they would not be averse to losing market share at the expense of creating a robust business of companies using the Palm operating system.

While analysts generally support the diversification strategy, they also caution that licensing fees will probably not be enough to offset the loss of hardware market share that may go along with it. In addition, there may be some technical problems. The Palm operating system was not originally built with cell phones or multimedia devices in mind, and it may not be easy to extend to these devices.

If successful, however, the plan is a reliable way to secure long-term revenues, House said.

"It makes you a commodity vendor and a broker," she said, especially if the handheld market follows the example the PC market has set and starts giving away hardware for free in exchange for service contracts. "In the long term, it's better to have recurring revenue or licensed revenue so you know that you're providing something worth money."

Using the proceeds from the IPO, Palm will have to recreate a corporate infrastructure to replace the services 3Com offered without recreating the 3Com bureaucracy that stymied the company, analysts have said.