Speculation is rife that Palm (PALM) is in play. Here is a look at the reasons why Palm is a likely acquisition candidate for several potential strategic buyers.
Palm was an early innovator in the smartphone space. Its line of Treo phones represented the natural evolution of the Palm Pilot created by Jeff Hawkins and company, first at 3com, then Palm, then Handspring, and then coming back full circle to Palm.
Unlike most other smartphones, many Treo users bought their phones because they were an extension of a tool they already used, their Palm Pilots. Palm has a loyal base of users, attested to by their willingness to stick with their Treos despite the company’s rocky history.
Over the last two years, the company has made a string of execution blunders, from having to stop selling phones in Europe to product delays to an inability to produce conservative and accurate financial guidance. In addition, due to its relatively small size, Palm has been unable to keep up with the pace of innovations of competitors.
On the bright side, the company is cash-rich, has a sizable, influential and entrenched set of users, solid technology, and the sort of profile that makes it easy for an acquirer to pay a substantial premium over the company’s current Wall Street doghouse valuation.
Let’s start with the consensus .64c estimate for FY2007, ending May 07. The company is using a 40% pro-forma tax rate, which means the company is projected to earn $1.06/share on a pre-tax basis. (We are being conservative in using the FY07 number, since this number was impacted by several blunders, the most damaging being that the company had to stop new sales in Europe when it was unable to meet EU environmental requirements. By comparison, the company earned .92c in the prior year.)
Once it became clear that the company would miss its annual guidance, it decided it would not matter if it missed by an additional $25 million, and chose to invest that amount in a special advertising campaign. This translates to .25c/share. We assume that there will be substantial cost savings for an acquirer, given the overlap that will result. We assume .25c in R&D synergies, .20c in Sales/Marketing, and.05c in G&A, for a total of .50c in synergies. Further, each of the potential buyers has substantially greater purchasing leverage, and so we estimate .15c in component savings. We end up with:
1.06 FY07 pretax profit
.25 one time extra ad campaign
.15 component savings
1.96 pretax profit
1.31 taxed (assuming a 33% tax rate)
Assuming a p/e of 15, and adding in the company’s $5/share in cash, Palm would be worth abour $25/share to an acquirer. The company also has more than a billion dollars in NOLs, which could potentially mean several hundred million dollars to an acquirer. In addition, we are conservative in estimating no further upside from an acquirer’s marketing and distribution muscle.
While the case can be made for private equity, the situation is simply too compelling for strategic buyers. We focus on these below:
Company takes control of its destiny in terms of Windows platform for smartphones, without having to rely on Motorola or Nokia or Rimm if they were to acquire Palm.
Gives company an instant, proven platform to answer Apple’s Iphone thrust. The Zune drove home the point that designing and building an attractive hardware platform is not easily done.
As smartphones evolve into broader-functioning portable computing devices, the company makes sure that Windows becomes the OS to beat (versus Apple’s plans to make OS X the dominant portable Net platform).
Deal, depending on price, may be marginally accretive.
Management may be distracted by Vista execution. Perhaps a classic case of a company bogged down nurturing old technology (the desktop OS) while competitors walk off with the future (the portable OS).
Deal may not be accretive without being able to take advantage of synergies.
Finally enables the company to break into lucrative North American smartphone market.
Enables company to introduce Symbian OS into N American smartphone market. Palm software could be run as a virtual app on top of Symbian.
Company could potentially align itself with Microsoft to counter Apple’s move.
Palm is only likely candidate to give the company an immediate market presence. Nokia’s efforts to break into the market with homegrown products has been consistently thwarted. Since that is likely to continue, Palm may represent its only hope before ceding the market to the players already established.
Deal likely very accretive given even modest distribution upside.
Nokia has a strong internal culture of “not invented here.”
There is no love lost between Nokia and Microsoft, and the company may balk at embracing anything with Windows.
Research in Motion
Effectively shut down its two most likely near-term competitors, Nokia and Motorola, and further marginalize Windows as a portable OS.
If the company decided to ally with Microsoft, it could turn a traditional foe into a friend, with the intention of together battling Apple.
Deal likely to be extremely accretive, not only due to synergies but also to Rim’s stratospheric stock price (assuming a stock swap).
Not invented here culture at company.
Given Rim’s traditional arrogance, company is likely to conclude that its rich stock price will continue, with no urgency to use it as capital.
CEO Zander has stated the company needs more “feature-rich phones.”
Icahn wants the company to use its cash or return it to shareholders.
Deal would be very accretive.
Ron Garriques, an advocate of “not invented here”, has left the company
Company can position itself as Microsoft’s best bet for taking on Rim (and its proprietary OS) and Apple (and OS X).
Acquisition would greatly enhance the company’s ability to battle Rim in the corporate sphere, while effectively pushing Nokia out of the competition
Complements company’s recent acquisition of Good Technology
Company may divert potential deal focus due to Icahn.
Handset business may be distracted by Garriques departure.
Management may get stuck focusing on how to fix its commodity handset business, neglecting the higher margin smartphone segment.
The bottom line is that Palm is a very attractive acquisition candidate. At what price? The stock currently trades around $16, with a 52-week range of $13 - $24. While a deal is likely to be accretive for an acquirer at a price as high as $25, it is unlikely that it will fetch such a premium given the current price. Yet for Nokia, Rim, and Motorola, acquiring the company will be as much a defensive move as it is an offensive one. In such an auction the players are less likely to be concerned with the size of the premium and more with the importance of acquiring an important strategic asset.
Disclosure: Author is long PALM.
PALM 1-yr chart