IPO Critic: Palm smells money
By Tom Davey
Redherring.com, February 25, 2000
Human culture evolved from loincloths and spears, to togas and swords, to suits and cell phones. The twenty-first century already looks to be the era of baggy pants and Palm Pilots.
Even if you're not a Pilot user, it doesn't hurt to be seen today in the right circles pecking away at one. For instance, my boss, Rafe Needleman, jams with the best of them. He sits in Bucks, the restaurant for Silicon Valley entrepreneurs, and taps out "to do" lists in a machine-gun staccato on his well-trained Pilot. Groupies gape as if witnessing the reincarnation of Jimi Hendrix.
OK, I'm exaggerating, but I'm also envious. I'm a Luddite who lacks the nerdy virility to master a Pilot. I think we'll soon see a lot more of the devices, too. Next week, Palm Computing is expected to launch an initial public offering in hopes of raising an estimated $423 million. If successful, the funds will give Palm the financial resources and independence to put the little devices in a lot more pockets. The shares are expected to be traded on Nasdaq under the symbol PALM.
Palm is doing what big guys like Apple Computer (Nasdaq: AAPL) and Netscape could never dream of doing: it's kicking Microsoft (Nasdaq: MSFT)'s butt. Sales of Microsoft's Windows CE devices lag behind Pilot sales by a wide margin.
HANDHELD HEAVEN
Palm will be spinning off from 3Com (Nasdaq: COMS), which still will own 93 percent of the company. But 3Com says it's committed to entirely severing operations with the little company, turning over its Palm shares to 3Com shareholders within six months, thereby cutting its ties. The fresh capital and newly won independence should go a long way toward furthering Palm's continued domination of the handheld-computing market.
Palm's timing is shrewd. The company introduced its first color model this week, significant because color computing was about the only edge Microsoft held over Palm in terms of product features. The announcement also is important because the Securities And Exchange Commission doesn't let companies with pending IPOs hype their prospects to investors. So instead, Palm introduces a competitive new product and lets newspapers and computer magazines hype its prospects.
Palm already has sold more than five million Pilots. By some estimates, the Palm operating system, which it licenses to third parties, holds two-thirds of the worldwide market for handheld-computing devices. That's nearly the same percentage companies like Microsoft, Intel (Nasdaq: INTC), and Cisco Systems (Nasdaq: CSCO) hold in areas where they excel. This market, while still fledgling, will really grow when Luddites like me can use cell phones with the Palm OS, which many analysts expect in the future.
Despite its success, not all has been smooth inside Palm, especially over the past two years. The brains behind the company -- Jeff Hawkins, who invented the Pilot, and his longtime marketing sidekick, Donna Dubinsky -- left in 1998 to start a company called Handspring, which licenses the Palm OS for its own brand of consumer device. Subsequently, Palm's president left last July for a position at Internet startup Chemdex (Nasdaq: CMDX). In December, after deciding to go public, the company named Carl Yankowski, an executive from Reebok (NYSE: RBK), as Palm's CEO.
EARNINGS UP
But the executive vacancies didn't seem to faze Palm's earnings. For a six-month period ended in November, Palm's revenues were $435 million, up 65 percent from the year earlier period. Whether this growth trajectory can continue is anyone's guess. But Palm is building the right alliances for the future, and it is one of those rare IPO companies with significant earnings. Net income was $22.5 million, up 39 percent from a year earlier.
Here's where the Pilot can really shine: Palm has had very little penetration in the corporate market where two-thirds of all computing dollars are spent. Through recent deals with Oracle (Nasdaq: ORCL) and other partners, however, Palm devices are now able to connect to corporate databases and may soon fill a large, still-untapped market.
Other recently inked partnerships should further spur the popularity of the Palm OS, from which Palm extracts a licensing fee. Nokia (NYSE: NOK) and Motorola (NYSE: MOT) are developing cell phone versions of the OS. Sony is working on developing audio/visual technologies for the OS. And America Online (NYSE: AOL) is developing services to deliver its content to those with wireless Pilots.
These companies are putting their money where there mouths are. Palm's public offering is 26.4 million shares at about $16 a share for $423 million. In a separate deal, AOL, Motorola, and Nokia are committing to buy about 15 million additional Palm shares at the offering price.
BLOCKBUSTER IPO?
By old-school financial metrics, the Palm spin-off is far from a bargain. An aggressive earnings estimate of 10 cents a share for the current fiscal year ending in May would put the IPO price at 160 times earnings.
But the strong, double-digit growth rate and gross margins of 43 percent make the company look like a blockbuster compared with the vast majority of offerings currently spewing from the IPO pipeline. Palm is a technology company that even a Luddite can love.
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