Editor's Note: The Fool has removed a reference to varying price-to-sales ratios since different smartphone companies use differing accounting methods for their sales. The Fool regrets this error.
Last week, Citigroup (NYSE: C ) threw in the towel.
Months of betting against the fortunes of smartphone pioneer Palm (Nasdaq: PALM ) hadn't paid off. Despite middling sell-thru of Pixi and Pre smartphones on Verizon (NYSE: VZ ) plans, strong competition for consumer dollars from everyone from Research In Motion (Nasdaq: RIMM ) to Apple (Nasdaq: AAPL ) to Google (Nasdaq: GOOG ) , Palm just would not die.
Even worse for Citi's sell-thesis, reports were beginning to filter out that the FCC would soon approve the Pre for distribution by AT&T (NYSE: T ) . With more than 45% of Palm's float currently sold short, that set up the nightmare scenario of a short squeeze wiping out all the gains Citi had accumulated from its sell-bet, and adding losses to boot.
Never mind that AT&T cannot possibly salvage Palm's business. (As I argued back in September, AT&T lives and dies by the success of the iPhone. No matter how great Palm's products, AT&T's simply not going to give other phones the kind of support it gives Apple. Ain't gonna happen.) With this much negativity surrounding Palm, any good news whatsoever could panic the shorts, causing a cascade of positions closing, buy orders placing, and Palm stock rising.
Reexamining its assumptions, Citi concluded that there was every risk that the stock would rally past its $10 price target, and little chance that Palm would drop further -- and pulled its sell rating on Palm. Investors, buoyed by Citi's capitulation, rushed to buy Palm, sending the shares up 2%.
That was a mistake. Far from being worth $10 a share, Palm could soon be priced closer to $0.
Palm investors need a slap upside the head
How can I say this? How can a company that millions of investors value at $1.6 billion be nearly valueless in my opinion? The way I look at it, there are two ways to value Palm. You can value the company as a going concern -- a business that makes and sells products, collects revenue, and earns profits. Or if the company proves incapable of earning a profit, you can assume that rational management will exit the business -- either by selling out, or shutting down. Unfortunately, under either scenario I don't see any worth in Palm.
If Palm lives ...
Let's tackle the going concern hypothesis first. Over the last 12 months, Palm has racked up a cumulative $430 million in losses. It's burned through $213 million in free cash flow -- and far from turning its business around, as bulls hope, Palm lost money in three of the last four quarters, while managing to post a slight positive cash flow last quarter amid strong smartphone spending and a new product launch.
This, friends, is no way to run a business. Faced with similar situation in 2005, the folks at Siemens actually had to pay someone to take their money-losing cell phone division off their hands. Motorola faces a similar conundrum with how to spin off its struggling cell phone division. Why Palm insists on continuing to stay in this race, even though it's obviously lagging -- and stomping all over shareholder capital for the privilege -- is beyond me.
If Palm dies ...
But what, you ask, is the alternative? Well, Palm could cash out and sell the business to someone who's got a better idea of how to run it. Logically, any of the major cell phone players should jump at the chance to "take out" a rival and decrease the cutthroat competition in this business. But for this exit strategy to make sense to an acquirer, Palm would have to be priced attractively.
But who’s left to purchase Palm at these share levels? Microsoft's all-in move with Windows Phone 7 limits the possibility that it would stake a mobile rebound on scooping up Palm, and in the face of North American struggles, Nokia has been resistant in picking up WebOS. Instead, the company has recommitted to an overhaul of its Symbian operating system.
Shareholders won't like that option, of course -- but it may be their best hope. Consider that Palm lost more than one-quarter of its market share between September and December 2009, falling to a near-industry-low 6.1% share. (And with Google's Android platform right behind them, and doubling its share over the same time period, I'd bet that even as you're reading this, Palm is slipping into dead last place in comScore's rankings.)
Quibble if you will at the methodology of any market-share rankings, but continued evidence suggests that Palm's smartphones aren't being adopted avidly enough to effectively compete with the 800-lb. gorillas of the mobile world. Palm's long said the smartphone market is large enough to accommodate several large players, and it could survive at a sliver the market share of its rivals. However, with the promotional expenses involved with large smartphone rollouts and evidence of downward pricing pressures, investors clinging to relevance at low market share are in for a rude surprise. At this rate, Palm could eventually meet its "BenQ moment" -- and be forced to shut down entirely.
Palm is empty
Now, glass-half-full folks will argue that even this situation doesn't mean a $0 share price. They'll point out that Palm's got $202 million in net cash, so even in a total doomsday scenario, if you divvy that up among the company's 167.6 million shares outstanding, the stock's worth at least a buck-twenty.
Unfortunately, Palm's burning through its cash at a breakneck pace. Cash-burn reached $213 million over the last 12 months; unless something changes soon, Palm could be facing more capital raising rounds within the year. Absent a buyout of the company, I think the company's not worth a penny. While its WebOS is surely worth more than that to some company out there, and we'd shouldn't realistically see that zero value event come to fruition, I'm not buying at today's prices or anywhere near them.
You can do the math, Palm's not up to its current value, and without a turnaround I don't see on the horizon should sink even lower. But that's just how I see it; feel free to disagree in the comments section below.