Buy Palm or Buy 3Com? The Mathematics of the IPO: David Wilson
(Commentary)
Princeton, New Jersey, March 1 (Bloomberg) -- Investors
looking to own a stake in Palm Inc. may want to keep the number
1.55 in mind.
That's the ratio between the number of Palm shares owned by
3Com Corp., which will spin off its stake in the world's largest
maker of electronic organizers within six months, and the number
of 3Com shares outstanding as of Dec. 31.
The number provides a starting point for answering a key
question: For someone who wants to buy into Palm, due to make a
$736 million initial public offering tomorrow and start trading
Thursday, are the unit's shares or 3Com's cheaper?
Here's how to proceed: Once Palm is trading, multiply its
price by 1.55 to figure out the per-share value of 3Com's stake.
Then subtract the total from the stock price of 3Com, the No. 2
maker of computer-networking equipment behind Cisco Systems Inc.
The difference represents the value of 3Com's modem and
networking units and its $2 billion of cash, expressed on a per-
share basis. This number ought to be positive, because it stands
to reason that 3Com is worth more than its 94 percent Palm stake.
One estimate, published Monday by Lehman Brothers, valued the
two units and cash at $23.32 a share. The figure assumes the value
of the businesses equals the firm's estimate of 2000 sales.
Then again, investors don't always behave reasonably,
especially in the wake of IPOs. Consider what happened to Ziff-
Davis Inc., the second-largest publisher of computer magazines,
when it sold a stake in its ZDNet unit.
On the day after last March's sale, Ziff-Davis had a lower
value than ZDNet, an operator of Web sites. That's also the case
now that the company's preparing to sell non-Internet businesses
and to combine its two series of common stock into one.
Reversing Direction
If the Palm vs. 3Com number is negative, anyone who buys
stock in 3Com gets the other businesses and the cash for free.
Based on the evidence of people's enthusiasm for the Palm IPO,
that outcome is a possibility.
3Com's stock has more than tripled since Sept. 13, when the
Santa Clara, California-based company said it would make Palm an
independent company. That included yesterday's rally of 18 15/16,
or 24 percent, to 96 after Palm doubled the sale price to a range
of $30 to $32.
The surge marked a turnaround for the company's shares, which
slumped after the $7.3 billion takeover of U.S. Robotics Corp. --
including Palm, then called Palm Computing Inc. -- in June 1997.
By last April, the stock had fallen more than three-quarters
from a record high set in December 1996. The drop occurred as the
company dealt with slower-than-expected sales, overproduction and
declining prices for U.S. Robotics' products, such as modems. It
surpassed the high last week.
Palm has been the company's bright spot. Sales in the quarter
ended Nov. 26 jumped 76 percent to $259 million, and accounted for
about one-fifth of 3Com's revenue in the period. The parent
company's sales fell 4.3 percent to $1.47 billion.
Going Wireless
More than 5.5 million Palm organizers have been sold since
the first one, known as the PalmPilot, was introduced four years
ago. Some versions of the devices provide wireless access to the
Internet through the company's own service.
The company has licensed the Palm's operating system to two
of the world's three largest makers of cellular phones, Motorola
Inc. and Nokia Oyj, for use in their products. The companies are
also working together with International Business Machines Corp.,
Starfish Software Inc. and Britain's Psion Plc on a standard for
linking the phones and organizers to personal computers.
Nokia and America Online Inc., the world's largest provider
of Internet access, are each buying $80 million of Palm's shares
privately at the IPO price. Motorola is investing $65 million in
the company through the same process.
Palm is selling a 4.1 percent stake in the IPO, the second-
smallest percentage ever for a U.S. company according to CommScan
LLC. The smallest was the 2.6 percent stake sold in 1994 by Arden
Industrial Products, a Minnesota-based industrial fastener maker
that's now a unit of Park-Ohio Holdings Corp.
Revenue = Value
After the sale, Palm will have about 565 million shares
outstanding, including 534 million owned by 3Com. Based on the six-
month schedule, 3Com will spin off its stake by September.
In IPO filings, 3Com said it had 343.2 million shares
outstanding as of Dec. 31. Dividing 565 million by that number
produces a ratio just above 1.55. Using a lower number accounts
for the possibility that the number of shares will rise before the
spinoff, reflecting the exercise of stock options.
3Com refers to its other two units as personal connectivity
and network systems. The former sells modems and network-adapter
cards, used to tie personal computers into networks. The latter
sells products for controlling the flow of information through
networks, such as routers, switches and computer hubs.
The connectivity unit will record $2 billion of sales during
the current calendar year, compared with $2.5 billion for network
systems, according to Monday's report by Lehman. Analyst Timothy
Luke provided the figures in explaining his decision to raise
3Com's rating to ``outperform' from ``neutral.'
The estimates equal $5.67 and $7.15 a share, respectively,
and he used the same numbers to value the units. The $2 billion in
cash added $10.50 a share, bringing the total to $23.32.
As for Palm, Luke wrote that the stock may be worth 20 times
his sales estimate of about $1.4 billion. Putting all the numbers
together resulted in a ``sum-of-the-parts' valuation of $101.25 a
share for 3Com; he sees the stock reaching $100 initially.
Past as Prologue?
Then again, a publicly traded part can sometimes be greater
than the whole, as the Ziff-Davis example shows. Last March, the
company sold ZDNet ``tracking stock,' a security that's tied to
part of a company even though it represents partial ownership of
the entire company.
On the day after the IPO, Ziff-Davis had a market value of
$2.47 billion -- about $1 billion less than ZDNet's value, based
on the unit's stock price and the number of tracking shares that
Ziff-Davis effectively owned.
As of yesterday's close, Ziff-Davis was about $700 million
less valuable. The company received approval from shareholders
yesterday to sell its magazines, including PC Magazine and PC
Week, to Willis Stein & Partners LP for $780 million. The vote
also will allow the company to sell a computer trade-show unit,
and to combine its stock and ZDNet's into one class.
3Com isn't exactly following the lead of Ziff-Davis. For one
thing, Palm isn't a tracking stock. Holders of shares sold in the
IPO have a stake in Palm, not 3Com.
For another, 3Com's spinoff plan is already in place. Ziff-
Davis agreed to sell its publishing business in December, eight
months after the ZDNet stock sale. Softbank Corp. of Japan, its
majority holder, then decided to focus on online businesses and
sell the trade-show unit in January.
Nevertheless, Palm's initial stock sale provides the same
opportunity to compare market values, and to buy what's cheaper.
It all comes down to the math.
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