Palm: A Gift for Value Investors

Includes: BBRY, PALM
by: Richard Shaw

It's pre-Christmas season and electronic gadgets are on the top of many gift shopping lists. Smart Phones are among the interesting gifts for the season, and this writer needs a new phone with mobile email. That made looking into PALM TREO and the BLACKBERRY 8700 series a post-Thanksgiving weekend activity. That personal shopping research led to company comparisons that lead to this article favoring purchase of Palm shares (PALM) over those of Blackberry maker Research in Motion (RIMM).

First, what's a Smart Phone? It's a PDA [personal digital assistant] that also offers voice phone and "push email"; and possibly other features such as a Global Positioning System, software such as Word, Excel, and PowerPoint or similar tools, and now the ubiquitous phone camera. The PDA was originally an organizer with a calendar and contact list and notes. "Push Email" is "always-on" e-mail that is instantly transferred [pushed] to your device as it arrives at the email server. It let's you know it has arrived and you don't have to go get it. It's already there.

By no means has PALM been helpful to long investors for some time. The 1 month, 3 years and 7 years charts of PALM and RIMM stock prices below show good things happening to RIMM holders and bad or no things happening to PALM holders, depending when they bought PALM. And, things may not get better any time soon for PALM.

PALM/RIMM 1-mo comparison chart
PALM RIMM 1 mo chart

This 3-year chart shows emerging market stock the runaway winner, with REITS and EAFE stocks in powerful pursuit. US stocks and bonds still brining up the rear.

PALM/RIMM 3-yr comparison chart

PALM RIMM 3 yr chart

PALM/RIMM 7-yr comparison chart
PALM RIMM 7 yr chart

Nonetheless, we think there are some interesting valuation reasons to consider PALM. By most popular valuation measures, PALM is a better buy than RIMM:

PALM RIMM Comparison

Competition: PALM is RIMM's #1 competitor and has a leading market share - about 30%. The market for Smart Phones is far from saturated, although there are several key competitors coming on stream with Smart Phones [Motorola (MOT), Nokia (NYSE:NOK), Samsung, and Sony (NYSE:SNE)]. Microsoft (NASDAQ:MSFT) and Apple (NASDAQ:AAPL) are occasionally rumored to be thinking about Smart Phones of their own. DELL (NASDAQ:DELL) and Hewlett-Packard (NYSE:HPQ) are possibilities too.

Takeover: We see the advent of many new players as more of a positive for PALM than a negative. When "first movers" such as PALM and RIMM are joined by the large cap "me too" companies, that is proof that a product has reached a level of market adoption and maturity and that it is more than a passing fad. Those large companies tend to have the GE mentality of "be #1 or #2 or don't play". They also tend to favor the "Buy" option when they consider the three key options, Buy, Build, or Affiliate. Those tendencies along with PALM's small size and low valuation metrics make a takeover bid for PALM a reasonable prospect. Any of those companies with either higher valuation multiples or a "strategic" rationale could easily absorb such a small but high profile company to leap frog their own Smart Phone development.

Opinions will be all over the lot on this, but we think Microsoft would make the most likely buyer. They have the most money to do it. They have affiliated with PALM to offer the Windows Mobile Pocket PC operating system. They have been embarrassed by the Apple iPod success and probably fear Apple doing it again with an "iphone". However, a good rationale could be worked up for most of the possible acquirers we've listed here.

With a market capitalization of only $1,6 Billion PALM is digestible, whereas at $26 Billion RIMM is too big for most to place a bet.

Lawsuits: RIMM was sued by NTP for patent infringement that could have shut off the service to their approximate 6 million customers. They believed the suit was non-meritorious, but they settled for about $600 million to avoid the market disruption that a protracted battle would involve. Now NTP is suing PALM [and some predict they will sue the other Smart Phone makers]. PALM says the case is non-meritorious and that examiners at the US Patent Office have said as much. At the moment they are contesting, but they too may settle. PALM's cash position would be wiped out if they settled for an amount similar to RIMM, and that might put pressure on them to think of "strategic alternatives", because they might not have enough cash to invest in market development and research.

Microsoft is promoting the windows based PALM platform to its Exchange Server 2003 corporate client base. Microsoft and Vodaphone (NASDAQ:VOD) are working to promote PALM in Europe too.

Quarterly Results: The fact is that PALM's revenue growth faltered slightly in Q2 of 2006 and then tripped and fell in Q3. RIMM meanwhile continued to grow, but the differences in growth could be attributed to some sputtering in the launch of the new PALM TREO product.

Product Comparison:
As to to the product itself, our review of the websites and our trip to the Verizon phone store cause us to believe that the PALM TREO is a better choice than the Blackberry. We will admit that the larger size of the keys on the Blackberry is more appealing, but we could learn to use either keypad. The key differentiator for us is the Windows Mobile operating system.

We don't like the grip Microsoft has on the world any more than the next guy, but that is beside the point -- the PALM device can "sync" with our PC laptops in a more effective way than the Blackberry by all the accounts we have read. Apple offers connection software for Blackberry to sync to MACs, but a review of the message boards shows dissatisfaction due to unreliable and temperamental sync behavior. MACs have 4% or less of market share and PCs have 96%. There is more room to grow with the sync feature by working with Windows than with MACs.

Note: to avoid the possible and predictable backlash from MAC loyalists -- we own, use and love both MACs and PCs -- each being best for its own particular use in our shop. This is not a "what's better PC or MAC" article. It's a "whose gonna buy more Smart Phones, PC owners or MAC owners" article.

SEC Issues: RIMM has some SEC problems relating to getting its financial reports out on time due to options granting questions. Generally, it is not a good thing for stock prices when financial statements are delayed. PALM does not have such problems at this time.

PALM does have the potential problem that their Chief Technology Officer is involved in another business he founded which could be a negative for further innovation.

Growth Expectations:
We'd rather own a company that has already disappointed and paid the stock market consequences than one that has not yet disappointed and that is trading at generally high multiples under high expectations. The performance burden on PALM to support its price and moderate growth expectations is low, while the burden on RIMM to fulfill high growth expectations is high. The growth expectations risk-reward ratio seems to favor PALM over RIMM, although the stock price trends say just the opposite.

The price of long-term growth [PEG ratio] for each company is roughly the same, but the risk of disappointing is greater for RIMM than for PALM, unless TREO fails in the market place.

We'd rather bet that a key player can grow long-term at 11% (PALM) than that they can grow at 22% (RIMM). The two companies have similar PEG ratios, but are based on very different growth assumptions. We prefer to bet on the tortoise more than the hare in this instance.

One Man's Trash Is Another Man's Treasure: If a company is not fundamentally broken and the product is not obsolete or in decline. The question is when do you buy a stock, when everybody wants it or when nobody wants it?. We want to buy when they are giving things away. PALM seems to be a gift.

Summary: Buying PALM here now is risky in terms of technical analysis, but seems reasonable from a fundamental perspective.

We don't own either PALM or RIMM, but we may well purchase some PALM on the basis that it's a good "value stock" in a growing business that may also be a takeover candidate.