We’ve had ongoing coverage of the turnaround at Palm, first as a “special situation” back in late 2008 and into 2009. (See Nice short squeeze on PALM! which we posted back then.)

Back then we estimated the intrinsic value (IV) for Palm to be about $11. But the nature of computing IV for a turnaround story is tricky because it’s hard to forecast long-term operating margins of the reinvigorated business in the technology industry and that creates a fairly wide variation in probable scenarios. The range we provided at the time was $6 to $16.

The current situation was detailed more completely here last March when we posted PALM: Worries become more tangible and noted that take up rates and ultimately margins were very uncertain given the current landscape.

One point we made in the note was that for Palm to break out we needed to see other companies license the Palm WebOS. So far that hasn’t happened.

Despite our notes of caution the market and many sell-side analysts jumped on the Palm bandwagon and pushed the stock all the way to $15 which factored in what we saw as a best-case scenario. It’s not that Palm didn’t have a good device and a strong software offering, it was that in a massive, highly rivalrous industry, they were not going to be able to generate high margins at their size.

In the past year though the iPhone has only gotten stronger, Android has erupted on the scene and devices like the Motorola Droid have joined the ranks of “must have” that carriers are scrambling to add to their lineups.

Even Research In Motion is reinvigorated and has a slew of new models and OS upgrades coming this year.

So what can Palm do now? It’s actually not too late to change to a more successful plan. It was pretty clear before that Palm simply lacked the scale and resources to go head-to-head with what has become a very high stakes game in the Mobile Internet.

The key for Palm has to be WebOS and the potential for it in alternative mobile devices. Palm needs to be more than “a better iPhone” for carriers to care. The tablet space could be more open for Palm, especially thanks to WiFi and other broadband networks. We think areas like the connected car are going to be big and drive millions of units per year. That’s a space that Palm could compete in.

At the same time Palm needs to do it with parters and stop trying to go it alone. For example what about partnering with a company like Garmin for automobile cockpits that have both navigation, web and entertainment software?

Maybe they should buy Jolicloud? There’s also a huge set of opportunities in web-connected devices in the home, PalmOS could be a good choice for many of them.  We think the user interface on Jolicloud makes it a potential winner for consumer devices.

In short the company needs a total restart. They have quite a few resources and a decent product. Perhaps they got the dose of humility they needed to move to a new level of leadership. We are rooting for them.

Other Related Posts:

Is there any hope for Nokia? October 2009.

[Disclosure: None.]

Palm is keeping things interesting.  For starters they have filed an offering to resell a chunk of what Elevation Partners put in just a little while ago.  It will help the company raise some cash and start to clean up the capitalization of the company a bit.

The funny part is that Roger McNamee was recently on Bloomberg making all kinds of incendiary statements.  Since the offering is being done the company had to respond with a filing as a free writing prospectus and at the same time had to withdraw some of the more outlandish comments.  Rather than print the whole interview and the whole filing we will just quote the last few “Clarifications and Corrections” from the filing and let readers fill in the rest:

1. With respect to the statements in the tenth paragraph of the transcript that the Palm Pre is “going to be a million times – well, not a million times – several times faster” than Apple, Inc.’s iPhone products and is “going to run rings around them on the web,” the Palm Pre is still under development and it is premature to state the speed at which the device accesses the web or the relative speed of the Palm Pre compared to the smartphone products of competitors.
   
2. With respect to the statements in the twelfth paragraph of the transcript that “there are aspects of the Pre that are unlike any phone you’ve every seen before,” “the Pre is the first one that is the next generation” and “the result is it does a lot of things the others guys don’t do,” the Palm Pre is designed to be the first phone based on the Palm webOS™ platform and as a result will have different operating characteristics and features than other phones, however; the Palm Pre is still under development and it is premature to compare its full functionality with that of other phones.
   
3. The statements in the fourteenth paragraph of the transcript regarding the relative development and stability of Sprint’s, Verizon’s and AT&T’s 3G networks are generalizations regarding wireless cellular network performance that may or may not be true depending on a variety of factors specific to geographic regions.
   
4. The statement in the second paragraph of the article that “not one” person who bought an Apple, Inc. iPhone on the first shipment date “will still be using an iPhone a month” after the two-year anniversary of that day is an exaggerated prediction of consumer behavior pattern and is withdrawn.
   
5. With respect to the statements in the second to last paragraph of the article that “the underlying technology for Research In Motion Ltd.’s BlackBerry is about 13 years old, while the technology behind the iPhone goes back almost nine years,” estimating one specific age for the many technology components underlying any mobile phone is inherently imprecise and these statements are withdrawn.
   
6. With respect to the implications in the second to last and last paragraphs of the article that Palm’s new operating system will give it an edge over competitors that “are going to run out of gas way before” Palm, estimations of the relative useful lifespan of smartphone operating systems are conjecture, unverifiable at this time, and age is not necessarily predictive of their relative long-term success.

We think it’s too bad these statements had to be addressed.  In fact they are bold enough that anyone would recognize it to be showmanship rather than serious commentary.  Anyway the Palm situation and the launch of the Pre will be an interesting show to watch in the next few months.

[Research 2.0 has no position in PALM stock at the time of this writing.]

We published our last full update on PALM on January 12th and provided in the note a "few reasons to stay cool" in terms of buying the stock.   Here is the excerpt from the full note:

1. Pricing is yet to be announced. The end-user price is probably one of the most critical elements to the “take rate” for this phone. The speculation is that it will come in at $199 although Palm management has hinted that it could be higher. Our best guess is that in order to be successful they will have to be at the same price as a comparable iPhone or Blackberry model. Higher price points will cost Palm some critical momentum. If I were advising the company I’d say to figure out a way with Sprint to get the Pre to $99 or even free with a high-end plan. Palm needs to keep the excitement going enough for people to open their wallets. A $249 or higher phone from Sprint isn’t going to get anyone to cross the street.
2. Six months is a long time in the mobile Internet device market. Between now and May we expect more new devices to be announced and possibly shipping. There have been persistent rumors of Apple preparing low-cost models of the iPhone for introduction in 2009. We’d point out that already the 8GB iPhone price is well under $200 in many markets and there are fairly powerful smart phones that are sub-$100 or even free.
3. You can’t expect the big guys to play nice. Right now everyone seems to have a dance partner (Apple-AT&T, Android-T-Mobile, BlackBerry-Verizon and now Palm-Sprint) but as the market develops service provider exclusives will give way to a more open market. Larger players are likely to use terms and allocations to incent carriers to limit additional relationships wherever they can. We all know that it’s not always the best products that win out in the face of commercial realities.
4. We still face a margin mystery. Gross margins have been declining sharply and were only 20% last quarter. Even though the company has taken actions to lower operating expenses the longerterm run rate for gross and net margins is hard to pin down. Management has stated a long-term gross margin goal of 33-36% but it is based on a “great ASP” which is unknown and possibly not sustainable in the market. Long-term gross margins are a huge swing factor in terms of equity value. For example if we use 2013 revenues of $2.2B and operating expenses of $600M and use a gross margin of 36% we get to an intrinsic value of $16; if we use 30% we get to $5.

The other obvious reason to be careful with the stock was the fact that the company was already suffering from weak fundamentals in the business and the potential to be "saved" by the Pre would require two more quarters of acute weakness before investors could start to see a return of positive momentum.

Estimates for the February quarter settled into the $150M range and with a slightly better expectation for the May quarter of $160M or so the number for the year came in at $880M or so.  With the recent pre-announced result of $80-85M for February we can expect analysts to quickly reset figures.  Revenues for the current year should settle into the $700-750M range. Clearly the loss will widen and may again raise concerns of viability or at least clue investors in to the dilution they suffer from the recent Elevation Partners investment.

So enough about the short-term.  What about Palm post the Pre launch?  Unfortunately most of the unknowns above are still unknown. And since then the economic situation hasn’t brightened.  Looking at current estimates we can expect analysts will lower the bar again for the year ending May of 2010.  Right now estimates call for $1.28B in revenue.  At this point it probably makes sense to start to look at the business without any legacy products or revenues given their rate of decline.  Hence top-line figures come down to mostly a guessing game of how many units can they ship, at what price, at what gross margin and so on.

The major wildcard is whether Palm might be able to license the WebOS to anyone who thinks it can give Android or the iPhone a run.  We think any interested parties (Motorola?) are probably going to wait and see how well it does in the marketplace before making any decisions.  That puts the matter into Q3 or Q4 of this year as a guess.

So what to do with the stock?  PALM still has a sizable short position which helps limit downside unless the worst case scenario materializes.  We will rerun our intrinsic value model later this month but in the meantime expect the figures of $11-12 on a successful path are correct.  However given the unknowns we wouldn’t be aggressive unless share prices reflect real concern that Palm "won’t make it."  Last time that translated to $1.20 a share.  We may not see that again but sub-$5 the risk/reward looks reasonable.  Any price below the last round of $3.25 is compelling.

Some details of the Palm WebOS are emerging and the first book is out there already.  We have to do our own homework on the development model to render an opinion on it versus competition but would encourage any interested investor to do their own work on that too.  Unless an ecosystem forms around WebOS, the value will be limited.

Here is a link to the short report we published in January for those wanting to spend a few dollars to read it.

[UPDATE: S&P cuts Palm debt ratings to CCC from CCC+.  Still on negative watch. - March 5, 2009]

[Disclosure: At this time Research 2.0 has no position in PALM shares.]

I guess it’s pretty clear the shorts were not paying much attention to ongoing developments at Palm in the last month or so.  Going into December there were about 38 million shares short out of a float of about 110 million.

When Palm got a fresh injection from Elevation Partners that started the ball rolling and their stellar display of new technology and strategy at CES yesterday, especially in the absence of other interesting news from the Steve-less Macworld and humdrum CES.

Most fundamental analysis would say the stock is a little ahead of itself right now at $6.50 but the volume so far suggests there are still lots of shares sold short.  Our long-term analysis suggests an intrinsic value of $11 based on a successful execution of the turnaround.  So despite all the near-term momentum there isn’t a strong enough reason to sell shares at these prices, at least not yet.

Shorts will certainly point to there still be "lots for Palm to prove" and the next couple of quarters are going to be ugly based on reported results.  However if investors are willing to "look through" the negative short-term data points the shorts may not get the relief they are hoping for.

We agree that there are still plenty of risks for Palm and have included more detail in our published note scheduled for release on Monday.

Stream of consciousness from the Palm call….full transcript is available here.

[This GAAP/non-GAAP thing is a huge useless pain for everyone.  Takes tons of time an does nothing but obfuscate.]

Smartphone business not too bad.  Handhelds obviously down the drain but now pretty small.

Gross margins down 6pts sequentially! No expansion likely in Q3.

Operating expenses are coming down nicely, should hit low-mid $90M range soon.

Non-GAAP loss of $80M and Adjusted EBITDA loss of $55M.  (What large NOL carryforwards you have grandma!)

Cash at $224M, inventory, and A/R all okay.

Sounds like this is close to the bottom for the company with the February quarter offering the most likley bottom IF the new product strategy works starting in fiscal Q4.

It’s tough out there. Maturing product line, consumer spending tough, spending on new products adding to expenses but not yet ramping.  Translates into a "few rough months ahead."

New platform is nearing completion and first phone will launch in the first half of 09 as planned. Believes it will "stand out" in the marketplace. 

For now Treo Pro continues to do okay, rolling out to new markets.  Thinks their ability to control software and hardware will help them long-term in the market.  Claims carriers are excited. [Could be an interesting alternative for carriers.]

Smartphones will continue to be gaining share as it is still early days here.  [We agree.]

Q&A starts…

Sell in and sell through mostly balanced.  Some inventory write-downs should put component WIP in line.  Cash burn will be UP in the next quarter.

Some discussion of it being "too late" for a new phone platform.  [We agree with management that is still early in the game.]

Treo Pro still plugs away in the current quarter and will roll out at a major US carrier this Q as well. All in front of the new product launch.

Company has auction rate securities but there is zero liquidity in the market right now.

[Conference call drinking game for the holidays? -  "challenged environment" or "challenging environment."]

[Pretty good live coverage by the major Street analysts on the call. Clearly they are interested in catching a potential turn at Palm if one materializes.  That's a plus.]

They are going to be aggressive at marketing and promotion for the new products and be heavily discounting older products so margins will be under pressure.  So Centros are going to be getting very cheap while the Treo Pro ramps and they work on the new platform.

Management states they will return to profitability in 2010 but mum on when exactly. Long term gross margin goal is between 33% and 36%. 

Won’t get into what features might differentiate the new Palm offering.  Is it graphics, keyboards, applications? No light shed on it.  Maintains goal of having "the most compelling platform and product on the market."  Hard to believe but they are aiming high anyway.

By Q4 of F09 their OpEx goal is mid-to-low 90M run rate.  Company has $224M in cash and will manage all cash expenses very carefully in the Q.  Claims they could raise additional cash if they needed to but that would only be to further drive initiatives rather than dig a deeper hole.

One last comment that Windows Mobile will continue to be their platform of choice for enteprise applications is interesting.  Does it imply that all the new stuff coming will be consumer only and that they will need to continue to invest heavily in Windows Mobile?  Will a Palm device work on both platforms or are we talking full separation here.

It’s going to be a volatile story the next few months.  Clearly the new platform is a major turning point and with the number of moving parts the stock may not appeal to most.  But with a market cap of $240M, $224M in cash and $400M in run rate revenues it’s an interesting stock.  With listed options the stock can be used like a non-expiring call option to implement some strategies.

[Disclosure: We have a small position in PALM at the time of this writing.]

Sramana Mitra has an excellent post out looking at the failure of Palm to grasp any of the seemingly obvious opportunities to expand their business and value over the last few years.  It’s certainly true of Palm that other than slightly better hardware devices the software and web functionality is little changed in many years.

While LinkedIn and Plaxo are not huge successes on their own such services if launched back in times of greater Palm enthusiasm might have been big.  Even today why not embrace Google backend technologies and make the Palm serve as the missing link for synchronized off-line access?  Ideas abound but maybe they will come too late to make Palm interesting again in an iPhone, Blackberry world.

Another great aspect of this post is it brings up a facet of company analysis that should be more common in our and everyone else’s work.  That is to examine what things a company could or should have done in and around their core markets.  This is more than armchair quarterbacking or simply citing the innovators dilemma as to why companies fail to grasp opportunties in their markets.

Looking at this aspect for a company helps investors understand their culture and attitude around innovation and growing their value-add.  Yahoo is another example that seems to get blindsided by every new innovation Google rolls out, even when it is in an area that Yahoo dominates like Maps a year ago.

We have done some of that type of work in looking at Logitech in our as yet unpublished report on them.  Although the company is successful we’re surprised by the continued reliance on mice and webcams.  Although they have made some acquisitions of companies like Slim Devices there have been fairly major trends that they have not capitalized on; most notably digital photography, Apple and the iPod.

– Kris Tuttle

Tags: PALM, Company Analysis, Logitech

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