Palm Discovers Its Limits

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When Palm (Nasdaq: PALM  ) announced the Pre in January to considerable buzz, this former Treo user was glad that the company had halted its slow fade into irrelevance. But as Palm's latest earnings release shows, there can be a big difference between staying relevant and returning to your former glory.

The numbers for Palm's just-announced first quarter weren't bad. Revenues and earnings both came ahead of estimates, and though Palm didn't break out its Pre unit shipments, overall smartphone shipments of 823,000 suggest that they were decent. But alas, the second quarter looks like a completely different story. The revenue guidance range ($240 million to $270 million) given was a far cry from the $344 million estimated by analysts, and implies a healthy drop in Pre shipments during what's historically been a seasonally strong period.

In fairness to Palm, part of the sequential drop is probably due to inventory issues at Sprint (NYSE: S  ) , the Pre's exclusive U.S. distributor. Sprint likely ordered too many Pre units in the first quarter, leading to the revenue beat, and now they're dialing back. But even if you combine the Q1 and Q2 numbers, you're looking at total revenues that are bound to disappoint many optimists. Not what you'd expect from a device that's supposed to be taking the market by storm.

The Pre is definitely a great product. Its innovative features, such as the previewing of applications with "activity cards" and the presence of a "gesture area", show that it's not a me-too device. Unfortunately, the smartphone market has now matured to the point where having an innovative product isn't enough to guarantee huge success. The enormous base of applications claimed by Apple's (Nasdaq: AAPL  ) iPhones, and to a lesser extent by Research In Motion's (Nasdaq: RIMM  ) Blackberrys, act as a strong competitive barrier. So does the brand power and customer loyalty possessed by Apple and Research In Motion. It also doesn't hurt that, unlike the Pre's webOS operating system, the operating systems behind their products have been widely accepted by corporate IT departments.

It's tough for any new smartphone product, no matter how innovative, to compete with all of that. Throw in ongoing competition from phones running Google's (Nasdaq: GOOG  ) Android platform and Microsoft's (Nasdaq: MSFT  ) Windows Mobile, and it gets even tougher. No wonder Palm and Sprint agreed to slash the subsidized price of the Pre from $199 to $149 recently. Being merely as cheap as the cheapest iPhone 3GS apparently wasn't enough.

And Palm's competitive struggles come at a time when the company needs every last Pre shipment for its financial health: Palm burned through $43 million in cash during in Q1, ending the quarter with only $212 million in cash and equivalents to offset its $393 million in debt. Competing head-on with Apple and Research In Motion off of a much smaller revenue base clearly takes its toll. From that perspective, the 11% dilution that will be caused by Palm's upcoming share sale seems necessary.

Looking beyond Q2, there are still some reasons for Palm bulls to be optimistic. Palm's exclusivity agreement with Sprint for the Pre is expected to end in early 2010, after which Verizon (NYSE: VZ  ) , Sprint's bigger and competitively stronger rival, will start carrying the device. Telefonica SA will start offering the Pre this fall in several European markets, and the Pixi, a cheaper webOS device, will begin to be sold by Sprint. The second half of Palm's fiscal year is easily shaping up to be stronger than its first.

All things considered, Palm looks like it has a good future ahead of it as a niche smartphone vendor offering devices with an innovative software platform. That's a lot more than you could say about it a year ago. But with the company's cost structure being what it is, mere niche status might not be especially profitable. Or, at least, not profitable enough to fulfill the hopes that are now built into Palm's stock price.

Eric Jhonsa has no position in any of the companies mentioned. Google is a Motley Fool Rule Breakers pick. Apple is a Motley Fool Stock Advisor recommendation. Microsoft and Sprint Nextel are Motley Fool Inside Value recommendations. Try any of our Foolish newsletters today, free for 30 days.

Read/Post Comments (7) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 21, 2009, at 4:11 PM, makelvin wrote:

    As far as I can tell, whenever a company decides to lump all the numbers together like Palm did with their smart phones, they have something to hide.

    Let's face it; everyone knows Palm's future is in Pre. Palm even decided to stop selling their Windows Mobile and the old Palm OS smart phones. So if the sales of Pre is really, really good, you will not be able to stop Palm from talking about it; but instead, they lumped the sales number together with their other phones and projected a much lower number for their next quarter. None of these is making investors very comfortable with their actual sales.

  • Report this Comment On September 21, 2009, at 6:12 PM, verizonpre wrote:

    We at <a href="">Verizon Pre</a> love the Pre, and hope to see it soon at Verizon

  • Report this Comment On September 21, 2009, at 7:51 PM, NorthPierCIO wrote:

    $393 mil in debt with some of the best terms on Walls St.! They only pay about 4% on it and only pay interest and 1% of pricipal for another three years.

    Noone ever mentions this sweet deal when they talk numbers. With Palm, their debt is an asset folks. Dig a little deeper.

  • Report this Comment On September 22, 2009, at 8:56 AM, Somagarn wrote:

    Palm rose $1.94 nearly 14% to $15.95?

  • Report this Comment On September 22, 2009, at 12:40 PM, Jamison046 wrote:

    I took a chance and left Verizon for Sprint and the Pre.

    As for Sprint: With free mobile to mobile (every carrier) I now save $40 plus a month for a comparable plan at Verizon (including unlimited text, web, email, navigation etc.); my EVDO is just as fast as wifi nearly everywhere I go; never had a drop call yet; customer service oustanding.

    As for the Pre: THIS PHONE IS AWESOME!! I could go on and on about everything I like. Once you use the "gesture" system with multi-tasking you will never want to go back to the old way of navigating around your phone. I own an Itouch . . . I can't even use it without trying to swipe a gesture command. Heck I wish my PC had the gesture system. Moreover, Palm keeps pushing out software updates making the experience even better. In fact, Palm is set to push out WebOS 1.2 on Thursday!

  • Report this Comment On September 22, 2009, at 1:42 PM, Somagarn wrote:

    I meant to solicitate as to why then Palm rose $1.94 nearly 14% to $15.95 on the 21th of September 2009? Yet again at about 1:30PM of the next day rose $1.16 or 7.27% to 17.12. I just can't wait to get my hand on the GSM version, I have been waiting patiently since January and will continue to wait. I'm not a betting man and I'm betting on Palm.

  • Report this Comment On September 23, 2009, at 12:27 PM, Somagarn wrote:

    "Shares of Palm (PALM) gained more than 3% after the wireless device maker priced a public offering of 20 million shares at $16.25 a share.

    Dow Jones Newswires

    09-23-09 1126ET

    Copyright (c) 2009 Dow Jones & Company, Inc."

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