From Dow Jones:
IN THE MONEY: Palm-3Com Value Gap Persists, And Widens
By MICHAEL RAPOPORT
A Dow Jones Newswires Column
NEW YORK -- If you're waiting for reality to return to the 3Com Corp. (COMS)-Palm Inc. (PALM) situation, pull up a chair. We may be here awhile.
As was duly noted last week by this and other news organizations, somehow investors consider 3Com's 95% stake in its newly public Palm unit to be worth far more than 3Com itself. When Palm's explosive first day of trading ended last Thursday, 3Com's stake in Palm had a value of $50.6 billion, while the market capitalization of 3Com itself was only $28 billion.
Meaning that if you follow this logic - and I guess it's as logical as anything else in the "new economy," in which companies with tiny revenues, big losses and no guarantee of ever making money have 11-digit market caps - 3Com's money-making non-Palm businesses are worth negative $22.6 billion. (Palm is also profitable.)
Over the next few days, that bizarre gap narrowed a bit, as Palm stock started coming back to earth. As of Wednesday, 3Com's stake in Palm was valued at "only" $10.3 billion more than all of 3Com. Markets generally correct themselves when something like this gets out of whack, as arbitrageurs and other traders buy one stock and sell or short the other to profit from the disconnect. It looked like we were on our way to such a correction.
Nope. On Thursday, the 3Com-Palm value gap widened once again, to $13.6 billion. This, despite the fact that you would expect some investors to start selling or shorting Palm and narrowing that gap, now that the Palm IPO trades have been settled and investors actually have the shares in their hands.
Arbs and other observers have several explanations for this peculiar, persistent state of affairs. Investor fervor for Palm stock continues to bolster the company's stock price, they note. And it's hard right now for them to borrowing Palm shares to short because of Palm's small public float and institutional investors' agreements with the IPO's underwriters.
Reasonable notions. But that doesn't change the fact that we are seeing something that should not be happening. This time, even more so than some of the other nutty things we have seen in this market, we are Alice gone through the looking glass, where the Queen believes as many as six impossible things before breakfast. And so far, there's no sign that investors are about to wake from this dream and nudge these valuations back toward reality.
"I think we're talking about a real inefficiency in the marketplace," said one arbitrageur who is trying to play the situation and didn't want to be identified. "The value gap continues to be mind-boggling."
Part of the reason for Thursday's widening of that gap may be a Wall Street Journal story that took a dim view of 3Com's non-Palm computer-networking businesses and speculated that the company could become a takeover target. That sent 3Com stock lower Thursday, as Palm stock was rising. 3Com closed at 68 5/64, down 2 23/64, while Palm ended at 69 3/8, up 4 43/64.
"Palm is making the balance of 3Com look more like a low-tech company," another arb said. Investors perceive Palm as having more "panache," he said, and continue to throw money into the stock, keeping its momentum going. "There's just kind of a runaway train aspect of these things."
But even if the non-Palm businesses are sagging, surely they're worth SOMETHING. Those businesses had operating income of about $750 million over the 18 months ended in November, the most recent period for which 3Com has reported earnings. Even in a market that seems to have disregarded profits, that means something.
Let's look at it another way. Palm shares and 3Com shares are currently trading for about equal amounts. If you buy 3Com, you stand to get about 1.5 Palm shares for each 3Com share once 3Com spins off its Palm stake to its shareholders later this year, although 3Com hasn't yet announced the actual ratio. If Palm and 3Com continue to trade at comparable prices, that could mean shareholders would make a quick and easy profit of about 50%.
"That's a pretty spectacular return in the world of arbitrage," the first arb said.
Yes, it is. Spectacular, irrational, crazy. How much longer can this go on?
-Michael Rapoport, Dow Jones Newswires, 201-938-5976,
michael.rapoport@dowjones.com |
