Palm Deal: Lifeline, But Oh That Dilution

Some views are starting to trickle in about today’s announcement that private equity firm Elevation Partners is giving $100 million in fresh money to Treo maker Palm (PALM), which seemed on the risk of going out of business in a newly competitive smartphone market. Palm shares are currently up 42 cents, or 17%, at $2.91.

Basically, the bailout gives Palm time to see whether its new “Nova” operating system, and new devices based on it, will be a hit with consumers. Nova is expected to be unveiled during the Consumer Electronics Show in Las Vegas starting January 6. There’s plenty of skepticism about its potential to succeed.

Writes UBS Securities analyst Maynard Um,

We view the OS introduction as critical to how investors view the future of the company and feasibility of fiscal year 2010 profitability. We remain cautious over Palm’s ability to fully leverage its new platform given its greater focus on US after Sales & Marketing restructuring. Assuming Palm launches multiple handsets, the key question is whether an operator will take the entire portfolio at the same time (which we only see as likely if the phones are differentiated from each other). We believe this may be important to drive unit volumes given reduced operating expenses (Sales & Marketing) focus near-term.

Um maintains a “Sell” rating on Palm shares and a price target of $1.35.

Calling the deal “an early Christmas present for Palm,” Morgan Keegan analyst Tavis McCourt writes today that the cash infusion means that Palm’s cash position will probably bottom in the second half of next year at $150 million, thinks McCourt, a better place to be than the $50 million he figured the company would have left by then. But he’s taking a wait and see attitude toward the new Nova operating system: McCourt maintains a Market Perform rating on the stock.

Ah, but what’s it worth to investors?

The agreement to give Elevation preferred shares will dilute common stock holders from 66% ownership of the company to 54%, by his estimate. Elevation increases its stake to 37% of the company, while holders of options are diluted from 11% to 9%. McCourt thinks that despite the dilution, “shareholders will find comfort with a transaction that is not unreasonable and takes any liquidity out of the realm of possibility, at least until 2010 even if the platform rollout does not proceed as well as expected.”

Here’s the rub: McCourt says that with $430 million in secured loans, including a revolving line of credit that may or may not be tapped; $325 million in preferred owned by Elevation on top of today’s $100 million, holders of Palm common stock won’t begin to accrue value until “the market perceives Palm’s assets to be worth more than $855 million.”

Canaccord Adams analyst Peter Misek is less confident of the cash cushion and says the deal sends “mixed messages.” He says that while Palm burned through $23 million last quarter and management last week told investors its cash position is sufficient to navigate a deteriorating economy, “We believe the proposed financing may foreshadow a material cash burn over the next few quarters.” The cash burn rate could rise to $40 million to $50 million per quarter, he writes. Misek has a “Sell” rating on the stock and price target of zero.

Comments

[Peter Lynch:]

I wonder what the EP guys know that these analysts don't.

Who do you believe? The money guy or the analysts....

I am with the guy who actually has skin in the game.

2008 Dec 22 05:22 PM

[Moon Kil Woong:]

I'm with Peter Lynch on this. Clearly the investor sees some positive value in their client base. I doubt if the analyst has shorted the stock or bought puts. It's easy to be a nay sayer. I remember such analysts decrying the doom of Apple in the 90's. Boy were they wrong.

A zero valuation always sounds to me like an analyst that doesn't want to do his homework. It is very hard to say the probablilty of a company's success is 0 in all cases. Especially when it still has millions in cash and fresh infusions without some government mumbo jumbo supporting role with taxpayers money.

I commend Elevation Partners for taking a calculated risk in this market. If only other money managers tried building something rather than just trying to figure out what company will pop up 20% because the government will bail them out tomorrow.

2008 Dec 23 02:39 AM