Investors may have to wait for Palm riches

The handheld computer maker is expected to sell 23 million shares to investors tomorrow at a recently increased initial asking price of $30 to $32 per share. Palm, which is being spun off from parent company 3Com, could raise more than $819 million.

Some analysts expect shares to soar on the firm's opening day, as the unit's profitability sets it apart from many other dot-com and e-commerce firms that still bleed red ink. Palm's position in the hot wireless market also helps boost its prospects, given the hefty valuations Wall Street has awarded firms like Phone.com and Qualcomm.

The deal's underwriters, Goldman Sachs and Morgan Stanley, will most likely offer Palm shares primarily to their own clients and other institutional investors, analysts say. Which means the only way ordinary investors and the Palm faithful can get in on the IPO is to buy 3Com shares, as the company plans to eventually convert the shares to Palm shares according to a somewhat complicated formula.

"In terms of retail investors from Schwab and E*Trade getting in on this, the chances are absolutely none," said Richard Peterson, an IPO analyst with Thomson Financial Securities Data.

3Com shares have seen an extraordinary run in the last few weeks. Investors have pumped the stock up in anticipation of the Palm offering, with the mind that the networking equipment firm will also garner enormous profits from the IPO. Yet analysts say it could be months before those who have recently purchased 3Com shares will see actual profits as a result of this week's offering.

By the same token, 3Com and Palm executives who tomorrow will become paper millionaires--or maybe even billionaires--will most likely not be able to exercise their stock options for at least six months. And at that time--if some recent trends hold--Palm shares could be trading much lower.

"If history repeats itself, this could very well be trading between $120 and $140 on the first day. The question is, where does it go from there," Peterson said, noting that many other so-called instant Internet millionaires watched profits disappear before they could exercise their stock options.

"Tens of millions of dollars evaporated" in these instances, he said.

3Com shareholders--including executives and employees--will have to wait at least six months after the IPO before they get their prorated Palm shares, according to a prospectus filed with the Securities and Exchange Commission. After this distribution, 3Com shareholders will own stock in both companies.

The conversion rate, or the number of Palm shares to be distributed per 3Com share, has not yet been determined. This essentially means that some investors could be disappointed, as Palm mentions in its prospectus that under certain circumstances, it may not dole out Palm shares at all.

"3Com has advised us that it would not complete the distribution if its board of directors determines that the distribution is no longer in the best interest of 3Com and its stockholders," according to the filing.

3Com declined to comment on the distribution formula. But issues that would affect the distribution moving forward are largely tax related, analysts say.

The company would be more likely to approve a distribution if the Internal Revenue Service allows a tax-free distribution for 3Com shareholders, as well as approves the transaction as a reorganization for federal income tax purposes. If there are no other regulations or court orders prohibiting such a distribution, it should go forward, analysts said.

Granted, it would be in the financial interest of Palm and 3Com executives to make sure all the conditions are met to make sure the distribution happens.

"The only people that ever really benefit are the top executives," said Jeff Hirschcorn, an analyst with IPO.com.

For example, Palm chief executive Carl Yankowski stands to reap a tidy sum from the offering. His employment agreement calls for a yearly base salary of $600,000, with an option grant valued at a healthy $48 million. The grant would vest a quarter every year over a four-year period.

Alan J. Kessler, Judy Bruner and Stephen Yu, all former 3Com executives who moved to Palm along with other former 3Com employees, are also in line to capture a piece of Palm's action. Palm employees holding 3Com options will have them converted to Palm options once the distribution takes effect.

Palm president Kessler was given an option grant of 83,500 3Com shares last year, with strike prices ranging from $24 to $39 per share. He also had 286,340 3Com options, with nearly two-thirds yet to vest, based on the company's May 1999 fiscal year-end, according to the firm's prospectus.

Bruner, Palm's chief financial officer, received a grant of 35,000 options last year, with exercise prices ranging from about $20 to $28. She also had another 114,736 3Com options, roughly split between vested and unvested shares.

Yu, general counsel for Palm, was awarded an option grant of 10,950 shares--with strike prices ranging from about $20 to $28.50 a share. He also holds 23,865 3Com options, with about two-thirds of the options yet to vest.

The option conversion rate, however, will be based on the closing price of 3Com's stock on the eve of the distribution date and Palm's opening price the day of the distribution, according to the prospectus. The number of shares and exercise price for the conversion has not yet been determined.

3Com directors who will also serve on Palm's board, such as 3Com chief executive Eric Benhamou, Jim Barksdale and Gordon Campbell, will not have their 3Com options converted.