Palm: Showing Up the Analysts 9 comments
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In recent months it would have been difficult to find a stock that Wall Street analysts were more pessimistic about than struggling smart-phone maker Palm (PALM). According to Thomson/First Call, 23 analysts follow the stock, 10 have sell ratings, and only 2 have buy ratings (the rest were neutral). In a world where brokerage firms make money by getting people to buy stocks, such negative sentiment is rare.
As a contrarian, I had actually been accumulating shares of Palm throughout 2008 in some client accounts, as hints of a possible recovery in the company’s business began to appear. Most notably, the combination of a sizable equity investment from private equity firm Elevation Partners (run by Roger McNamee, a man I have great respect for) and the hiring a former research and development star from Apple (Jon Rubenstein).
In recent months Palm had explained to investors that they were revamping their software platform and with the help of Rubenstein and McNamee were set to launch a new set of innovative products in 2009. Given how short-sighted Wall Street is, Palm shares struggled as the iPhone and new Blackberry products came to market. Wall Street analysts were negative on Palm because they claimed Apple and Research in Motion were way ahead of them in terms of products and market share. The stock actually reached a low of $1.14 per share in December, down from $4.00 just a month earlier.
The reason I was interested in the stock was not because I disagreed with the analysts’ assumptions (I too expect Apple and RIM to have higher market share than Palm), but rather because they were ignoring the fact that the global cell phone market is over 1.2 billion units. Palm could lag Apple and RIM and still collect 5% or 10% of the worldwide market, which would translate into tens of millions of units and perhaps several billion dollars of revenue. The idea that Palm had to beat out Apple and RIM to stay in business (some analysts are projecting Palm will file bankruptcy) seemed off the mark to me.
Sell side analysts generally recommend stocks based on what is known, not what could happen in the future. Even though the public knew a successful R&D guy from Apple was now heading up Palm and was slated to introduce a brand new operating system and product lineup in 2009, since the facts at the time were that Apple and RIM were crushing Palm, practically nobody on the Street liked the stock. At a buck or two though, Wall Street was pricing Palm shares based on the worst case scenario, so the risk-reward trade-off highly favored going long the stock, not betting against it.
Last month Elevation Partners increased their equity investment in Palm from $325 million to $425 million, obviously approving of the company’s plan. Yesterday at the Consumer Electronics Show (CES) in Las Vegas Palm unveiled its new operating system and a model of the Palm Pre, the first of its next generation smart-phone products schedule to be released by Sprint in the U.S. sometime during the first half of this year. Palm stock soared 35% on Thursday and is up another 30% today to about $6, bringing its total gain since the December low of $1.14 to more than 400%.
Today analysts are more optimistic (I even saw at least one upgrade) based on the promise of the new operating system and Palm Pre product. Once again, the sell side has waited until the news is out and already priced into the stock (it’s already gone from $1 to $6 in the last month) to become more optimistic on Palm’s prospects. Therein lies the inherent flaw in most brokerage firm research; they base their recommendations on announcements that the market adjusts for immediately, thereby ensuring what they have to say has little or no added value by the time clients read it.
Now, you may insist that an analyst should not blindly assume that a new product being worked on will turn out to be good, so recommending Palm before knowing what the Pre phone looks like would not have been wise. I cannot argue with that, so maintaining a hold rating until seeing the new products is completely understandable if you did not want to put your neck out.
What I cannot understand is a sell rating on a company whose stock price is implying bankruptcy even though the company is getting private equity investments and you know that a highly respected former Apple exec has been leading a new R&D team for over a year. Are we supposed to act surprised that the Palm Pre looks promising? You may not have wanted to bet on it sight unseen, which is fine, but you can’t say that what Palm introduced yesterday was surprising given what we already knew was happening over there.
As usual, Wall Street hated the stock at $1, $2, or $3 but likes it a lot more at $6. Now you know why I like to be a contrarian.
Disclosure: Peridot was long Palm shares at the time of writing but positions may change at any time
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This article has 9 comments:
Hard to be a contrarion in this type of market, many who have tried have been wiped clean (i.e. housing has bottomed! financials can't go lower!) :)
Do your dd before investing as always.
I don't think it's going to last at $6. Maybe $2. Maybe $3. Maybe $4. But not $6 -- especially when there are much safer bets out there in the market that are priced much less aggressively.
They still have a lot of catch up to do but at least they're moving in the right direction. Good job to the guys following the cash infusion but at $6 I think the risk and reward is equally balanced right now. Like so many other articles touting a great success, I would have loved to have seen this article before the fact.
Maybe he posted Palm buys before maybe not. If so, I regret missing it.
I agree with Huneycutt..... Short candidate.. I can see it filling its gap back down to $4.40 pretty quickly. Particularly if the market turns back down.
Not knocking PALM .. Always liked the devices, they just fell behind the herd and don't seem to have anything new to offer unlike SNDK which is coming out with a couple of intriguing products.. A thumbdive harddisk backup device and a preloaded MP3 stick with bulit in jukebox... Don;t have any need for teh jukebox, but sure could have used the other when my harddrive crashed two weeks ago...
jegan
Limiting the Pre to Sprint, especially initially, seems like a really bad move. If it's CDMA why not put it on VZW? Or why not release the rumored GSM Pre on AT&T or T-Mo at the same time?
On the west coast I haven't heard many positive things about Sprint, and my experience with Nextel has really been nothing but negative so that means based on the network I'd never even consider looking at this device.
As as far as shipping 10s of millions of units, BoyGenius had a report saying the device would have a $400 price point. If that's true, good luck moving that.
The iPhone moved those kinds of units because it was the first phone of its kind. This one will be another also-ran.
As pointed out this is a very large market. Palm doesn't need to be #1 or even #2 or #3 for the stock to appreciate. There's too many moving parts to take valuation work seriously but we peg value now on a successful turnaround of $11-12.
With the shares up sharply to $6 it's almost certainly ahead of itself. Thing is last I looked there were 38 million shares already sold short (out of a 110 million float) so there might be more risk in that strategy than meets the eye.