by Jean-Louis Gassée

Who will buy Palm?

If you’re in a hurry: no one.

If you have more time, here is the sad story: in one day, this past Friday March 19th, Palm shares collapsed, -29% in one Nasdaq session, closing at $4. The obvious question is why? But a second query immediately comes up: why $4, why not zero?

For months, the Wall Street “sentiment” — I didn’t know there was such a thing there — let’s say the calculation was this: ‘Sure, Palm’s cooked but one of the Big Players will buy it.’

By “cooked” the haruspices meant Palm had no future as an independent company.

Why?



You’ll recall the sky-high expectations raised by its main investor, Roger McNamee, from Elevation Partners, a private equity firm. (Since October 2007, Elevation Partners has invested $460M, 25% of its $1.9B fund in Palm, for 30% of the company.)
In March 2009, Roger claimed the just announced Palm Pre would cause iPhone users to switch smartphones: "June 29, 2009, is the two-year anniversary of the first shipment of the iPhone. Not one of those people will still be using an iPhone a month later. Think about it — if you bought the first iPhone, you bought it because you wanted the coolest product on the market. Your two-year contract has just expired. Look around. Tell me what they're going to buy."
Palm quickly disowned such statements, but the damage was done, lofty, out-of-reach expectations were set.
Apple said little but announced a new iPhone model and lowered prices to $99 for the older model in June 2009, just one week after the Pre shipped. Worse, Palm’s “savior” and “iPhone killer” smartphone suffered from a lethal combination of self-inflicted problems: ingenious but clunky hardware implementation, promising but buggy software, restricted SDK (software tools for applications developers) availability and sophomoric cat-and-mouse games with Apple over iTunes synchronization, to name but a few.
Most of the saga is documented, or opinionated here at Endgadget, one of the more “animated” high-tech blogs.
Now, Palm’s CEO, Jon Rubinstein (a.k.a. Ruby) offers his own if-only-coulda-shoulda-woulda explanation: according to him, bad luck struck Palm when Verizon launched Motorola’s Droid two months before shipping Palm’s Pre. This type of lame explanation is embarrassing. Jon always knew Verizon to be a better channel than Sprint, 91 million subscribers for Verizon vs. 48 million for Sprint. What very probably happened is this: initially believing his own propaganda, Ruby didn’t want to yield to Verizon’s demands. Palm’s CEO bet a successful launch with Sprint would cause the bigger carrier to come around -- only to take a less advantageous deal later and too late. By then, everyone knew about the Pre’s tepid reception at Sprint, taking any leverage away from Palm in discussions with other carriers.

It gets worse. Behind the scenes, Palm engaged in a classical desperation move: stuffing the channel. The expression means force-feeding your distribution network, shipping more inventory than needed. The hope is distributors will work harder, stimulated by price concessions or other marketing incentives. But, if the channels barf, the desperation move turns lethal.
With this in mind, we turn to Palm’s latest quarterly numbers released March 18th, 2010: 960,000 units shipped but… only 408,000 “sold-through”. The latter terms refers to units actually sold to paying customers, as opposed to the 960,000 shipped to distribution channels such as Verizon and Sprint. That’s what we mean by stuffing the channel.
Unfortunately, the situation turns out to be even worse than suggested by the 552,000 difference between units shipped and sold through. One analyst, Morgan Stanley’s Ehud Geldblum, looked at earlier quarterly numbers and pegs the total unsold inventory at 1.15 million units. That’s half a year of sales - if things go well. If sales tank because consumers lose faith, or because competitors do a good job, or if you need to introduce a new model that obsoletes the aging inventory, the channels backfires. Backfiring, or barfing, those are terms of art, refers to the return clause in many distribution agreements. Said clause gives resellers the right to ship inventory back for credit. This forces the seller, Palm, to deeply discount, to take a loss on the excess inventory in order to clear shelves.
Going back to Palm’s latest numbers we just looked at, on page 8, you might see the approximately $580M of cash (and short-term investments, quasi-cash) Palm often cites as their war chest, as their means to keep working hard and, ultimately, turn the situation around.

This is, to put it politely, a little incomplete.

The company took equity money against from investors such as Elevation Partners as well as widows and orphans (and, soon, their attorneys), this through two 2009 secondary offerings, in March and September 2009. These offerings could come back and haunt Elevation Partners as the fund “unloaded” shares in both cases. They might face the canonical ‘What did you know and when did you know it?’ from unhappy shareholders thinking Elevation knew about Palm’s trouble but forgot to tell investors.

Palm also borrowed. Under various forms, see the same page 8 again, I’m simplifying a bit without distorting the overall picture, the amount of money the company owes is higher than the sum of its cash plus what others (customers) owe it.
(At the risk of becoming even more abstruse, debt often comes with conditions called “covenants”. The lender agrees to repayment in 2012 but… if the company fails to meet conditions such as revenue growth or a safe enough cash position, the debt becomes exigible right away. Why? Because lenders would rather intervene before it’s too late, they’d rather jump in and force repayment, or take the company over, or force liquidation before everything is gone. Something like this could lurk in Palm’s future if lenders get nervous. IMHO, they should.)
If you believe Peter Misek, an analyst at Canaccord Adams, all this says the company is worth $0 per share.
Does this mean the company is bankrupt? No, because some of the debt isn’t “current”, meaning Palm doesn’t have to pay it right this minute. In theory, there is time to raise more money from investors or to sell the company and use the proceeds to repay the lenders.


Which gets us back to today’s question: who would buy Palm?

Or, more to the point: why, what for?

The cash versus debt situation isn’t new. Wall Street spreadsheet jockeys have known about those numbers for several quarters; their research also told them what the sell-through situation was. Still, Palm’s market cap (the total value of its shares on the Nasdaq) stayed around $1B. Today, after the 29% fall, Palm still seems “worth” about $670M.
Why?


Because someone might buy Palm for more than its “book value”, the accounting number. That’s the speculators‘ bet.
I think that theory will be disproved. (And I’ll quickly add I don’t play the stock market, I don’t own stock or options closely or even remotely related to Palm or its competitors.)


The most commonly cited asset is “the brand”. Smartphones no longer are the next big thing, they are today’s BFD. As a result, a late entrant into the market might want to dress a lesser known product with a brand consumers could relate to.
But isn’t this what the Elevation Partners team bet on? They took control of Palm, brought in new money, ditched the old management and the old product, the Treo, put in new team and new technology in play. And ended up with today’s situation: no money and a shot brand.


The other asset would be the product. Much has been said of Palm’s rebirth through its new operating system, the WebOS. The problem with that line of thinking is the market has spoken, the product hasn’t done well against its competition: Android, free and rising, muscular players such as RIM (Blackberry), Nokia, Microsoft, perhaps, and Apple. Who, in their right mind, would want to buy into the smartphone OS race now?


I’m afraid Palm will be twisting in the wind for a short while and then call it a day. A sad ending for the company that once led the Personal Digital Assistant (PDA) world and then made substantial inroads into the nascent smartphone industry with its Treo.

JLG@mondaynote.com

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