THE DAY AHEAD: Don''t dismiss Palm''s competition

If there was ever a no brainer IPO success story, Palm Inc. is it. The maker of handheld computers Palm VII, V and III will make its highly anticipated market debut this week. But investors shouldn't dismiss the boilerplate warnings about competition in Palm's regulatory filings.

Palm (Proposed ticker: PALM, profile) is expected to price 23 million shares with a price range of $14 to $16. Goldman Sachs is the lead underwriter with Morgan Stanley, Merrill Lynch and Robertson Stephens assisting.

Palm: A great investment?

In the short-term, it's hard not to get excited about Palm. "Palm has been one of the most widely anticipated IPOs since it first came into the system," said David Menlow, analyst with IPOfinancial.com.

Renaissance Capital gushes Palm is at the "heart of the wireless revolution against cumbersome desktop PCs."

The company, which will become independent after operating as a unit of 3Com Corp. (Nasdaq: COMS), boasts a whopping market share of more than 65 percent and has sold over 5.5 million Palm devices worldwide. It also has a proven track record.

For the six months ending Nov. 26, the company reported a profit of $22.5 million on sales of $435 million. For the year ending May 28, Palm reported a profit of $29.6 million on sales of $563.5 million.

Palm also introduced new color models last week -- plenty of time to create some pre-IPO buzz. Palm said the Palm IIIc now has color and there are new pricing plans for its wireless Internet access service. The new color Palm handhelds threw cold water on some of the competition, which has been using color.

But color alone won't be able to fend off the growing ranks of competitors. "The long-term success will be dictated by direct competition," said Menlow. "A lot of companies are nipping at Palm's heels."

In regulatory filings, Palm said it has to keep pumping out new products and technology to stay ahead of the pack. "The life cycle of our handheld devices is generally 12 to 18 months or less," the company said.

The company said it primarily competes with Casio, Compaq (NYSE: CPQ), Hewlett-Packard (NYSE: HWP), Psion, Sharp and Palm platform licensees such as TRG and Handspring. On the operating system side of the business, Palm competes with Microsoft Corp.'s (Nasdaq: MSFT) CE software. The operating system could become one of Palm's biggest revenue streams as it licenses its software to others.

Other competitors for Palm fly under the radar. These devices include keyboard-based devices, sub-notebook computers, smart phones and two-way pagers, the company said. Palm said licensees such as Nokia (NYSE: NOK), Sony (NYSE: SNE) or Qualcomm (Nasdaq: QCOM) use its platform in devices such as mobile phones or other similar products that can compete indirectly with its handheld devices.

If smart phones supplant the Palm, the company's revenue could suffer. And European wireless service providers are already planning to give a free smart phone away with all the Palm functionality included.

Palm said it is working to diversify its revenue stream through licensing and expansion of its Web sites, but 99 percent of Palm's revenue comes from handheld sales.

With competition looming, Palm is forging some big alliances. America Online (NYSE: AOL), Motorola (NYSE: MOT) and Nokia will buy Palm shares in a private placement that will occur concurrently with the IPO.

After the IPO, 3Com will own about 93 percent of Palm. 3Com plans to distribute its Palm shares to 3Com shareholders within six months.

3Com Palm distribution: No guarantees

Here's an interesting tidbit buried in the Palm regulatory filings: 3Com isn't obligated to give its shareholders Palm shares.

3Com plans to distribute shares after its board approves the move and the Internal Revenue Service rules the distribution will be tax-free.

"This distribution may not occur by that time or at all," said Palm. "At the time of this offering, we will not know what the ruling from the Internal Revenue Service regarding the tax treatment of the separation and the distribution will be. If 3Com does not receive a favorable tax ruling, it is not likely to make the distribution in the expected time frame or at all."