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Will Palm scrap businesses to survive?

With sales falling well short of even its worst forecasts and its cash dwindling, the company faces a number of tough decisions in the coming months.

Palm executives have their hands full.

With sales falling well short of even its worst forecasts and its cash dwindling, Palm faces a number of tough decisions in the coming months.

Analysts say there are no easy answers. The company may have to scale back its far-flung effort to be the device manufacturer, operating-system developer, Internet service provider and portal for handheld devices for both businesses and consumers.

After telling analysts that sales for the quarter would be roughly half of already lowered expectations, Palm CEO Carl Yankowski said Thursday that the company is looking at various options that would involve "more or less dramatically changing our business model."

It is a dramatic turn of events for Palm, a company that launched a very successful initial public offering just 14 months ago. In its first day of trading, the company had a market value of $53 billion.

As recently as six months ago Palm was generating $1 billion a year in sales and was still enjoying 100 percent year-over-year growth.

Now the company faces dwindling cash and a glut of its products, some of which may be thrown out to avoid destroying the pricing structure in the handheld business. In late trading Friday its shares had tumbled nearly 30 percent to $5 as analysts issued a series of bearish reports on the company. Its market capitalization is now about $3 billion.

"I've never seen anything go from so great six months ago to so bad in such a short period of time," said financial analyst Thomas Sepenzis, who covers Palm for CIBC World Markets.

During a conference call after the dire announcement, Yankowski refused to outline the alternatives Palm is considering.

A handful of options
The company could take several paths.

It could scale back its business in which it tries to be both portal and Internet service provider to customers with wireless Palms. It could also look to split off the part of the company that develops and licenses the operating system from the business that makes and sells Palm-branded devices.

Palm's dwindling
sales Exiting the hardware business--where Palm's greatest losses have come--may seem attractive. Cellular phone company Qualcomm, for example, made such a move in late 1999 and watched its stock price soar.

But in Palm's case, more than 95 cents out of every dollar of revenue comes from sales of its devices. Further, Palm gets far less for each handheld that uses its operating system than, say, Microsoft gets for each PC that uses Windows.

While the licensing arrangements vary, Palm has said that in most cases it gets a mid-single-digit percentage of the revenue collected by licensees for each device they sell.

For example, if Company X uses the Palm OS in a handheld that generates $150 in revenue, Palm might get about 5 percent, or $7.50. Even though the Palm OS has a large share of the handheld market, a business built solely on the revenue from licensing the OS would generate substantially lower sales than Palm now collects.

While Palm's OS is increasingly being used in cell phones, which represents a growth opportunity, the company has said the percentage it collects from phone makers is less than from handhelds.

By the same token, the device business alone could be less attractive.

"If you are just selling devices, you will be commoditized," said J.P. Morgan H&Q analyst Paul Coster. He also believes that Palm will get little value if it tries to sell parts of its business.

"I don't think there is any miracle cure," he said. "If you spin out some of these businesses, they are so minuscule (that they) won't command the premiums they deserve."

Apple Computer has struggled for nearly 20 years with similar questions. The company briefly licensed other companies to build Mac clones but reversed course after the move started to eat into Apple's own sales and margins.

For sale?
Palm could also put itself on the block.

"At these prices, sure, it's an acquisition target," said Lehman Brothers analyst Joseph To. However, To sees that as more of a last resort for Palm. "I think management wants to try and work it out."

Apple made a play for Palm a few years ago, To said, but now appears more focused on selling Macs than on expanding into new areas.

No matter

Meta Group says Palm's current financial woes are a result of market conditions, changing consumer tastes, and its own business miscalculations.

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what course of action Palm takes, it needs to move quickly.

Though the company had already been expected to burn through half its cash, some analysts now question whether it might run out of money as soon as November. Palm Chief Financial Officer Judy Bruner did not provide a direct answer on how quickly the company could burn through its cash but acknowledged it faces a crunch.

"I agree that cash will be tight," Bruner said on a conference call after Thursday's earnings warning. "It is very possible that we will seek to raise additional capital."

That may be easier said than done, however.

"Obviously they are going to have to come back to the market for cash," CIBC's Sepenzis said. "I'm not sure if the market is going to be willing" to give it.

Coster thinks that given Palm's brand and share of the market, it should find banks willing to lend it money or investors willing to provide other financing. He added, however, that Palm's stock may continue to get battered.

"I don't think investors are going to touch this stock for at least two quarters," he said.

First steps
To focus on its core business and preserve cash, Palm is already scaling back its effort to sell to large businesses. The company on Thursday canceled its deal to buy Extended Systems and says it will now rely far more on partners to help convince corporations to use Palm products.

But that move has Sepenzis worried. Selling to large businesses is the one strategy that has worked, he said, pointing to the success of Research In Motion, maker of the popular BlackBerry pager.

"In the near term, when the economy is struggling and people can't afford to buy a $500...toy, you need to focus on people who can afford it--and that's the enterprise," he said.

Coster, too, said that sales to businesses seem to be a key part of the long road back to profitability. But "now that they have terminated the Extended deal, I'm not sure how they do that."

Palm, which has already cut 15 percent of its work force and canceled plans for a new headquarters, may have to cut deeper.

"They need to be brutal about expenses," Coster said.

Palm has said it will outline its plans when it reports its final results for the quarter in late June.

"Until then it's a work in progress," Yankowski said.