On February 13th, BetaKinetix Partners, a student-run research outfit I founded, published an article regarding Palm (PALM). As is well known by now, Palm shares have zoomed 21% since then on rumors of a potential takeout, the shorts have gotten their heads handed to them, and the Treo 750 has officially launched, even while Palm was off busy hiring an investment banker to help it clean house.
We’ve have received dozens and dozens of emails regarding Palm stock over the last few weeks, and we are thrilled the trade (in which we participated by going long the Mar 17.5 calls) worked out.
As part of my duties as VP of Equities in the Kelley School of Business MBA Investment Club, I work and trade everyday alongside fellow student investors who are, like me, quite serious about trading and capitalizing on short term opportunities. On March 20th, I presented to the MBA program’s Investment Club a quick “Top 8 Reasons Why Palm Was a Table Pounding Buy @ $15.” I’d like to share the highlights with SeekingAlpha readers and use this opportunity to both follow up on that first article and distill what I think were the key drivers of Palm’s rapid ascent.
1) Hedge fund buying hits my 13D screener: The Galleon Group, LP buys 6.2% of Palm in late January. Cognizant of the hyperintelligent, rapacious manner in which most hedge funds operate, I immediately start ripping apart Palm’s latest 10K. I’m aghast at Palm’s customer concentration risk and pricing environment, but I turn cheerful once I realize Palm still holds 40% of its market, is trading at a 52 wk low, and is on the cusp of a new product roll-out. After an hour, I chuck the 10K and get to best part of my job: running through hundreds and hundreds of chart setups.
2) Palm’s chart looks amazing, beginning with a double bottom in Jan and Feb: Palms breaks above the $16 ceiling in late February, and on 3/20, with the help of CNBC, Palm gaps up to $19 after Unstrung.com reports Palm is days away from wrapping a deal with either a competitor or a private equity consortium. Count ‘em – 3 different opportunities to buy Palm manifested themselves and an astute chart reader would have recognized that the risk/reward was skewed to the upside. After going thousands of double-bottom setups the night before, my eye has been trained to see that Palm can’t go lower than $14, but could shoot up to as high as $22. 1 down, 7 up: a handsome risk/reward even Ray Charles could see.
3) Call option activity: In Feb, the smart money starts sweeping up the March 17.5 calls, followed by action among the April 17.5 calls. Since aggressive call accumulation (vol < open interest) tends to precede positive stock price reactions, I see this as further evidence that Palm could be on someone’s radar. Implied vol isn’t too high, I find delta I can manage, so I go long the Mar 17.5 with a smirk on my face -- it’s time to trash the Red Bulls and get to bed.
4) Industry and product circumstances: the Treo is hot, but struggling. I begin to assemble a hit list of possible buyers who A) have more cash than Palm and B) could leverage Palm’s brand name and carrier network to instantly capture a robust platform and loyal consumer segment. Interestingly, Nokia (NYSE:NOK) is struggling in the North America Smartphone market, so even while the Symbian network may not be immediately compatible with Palm technology, I do not dismiss the idea of a Finnish invasion on Palm territory.
5) Short interest/squeeze: I want to know why Palm got a black eye in the back half of 06. I see that 15% of PALM is short (7-8 days to cover): what are those bears thinking??? Palm has $500MM in cash and a best in class smartphone. If shorts start unwinding their bearish bets, Palm has nowhere to go but up. Betting against Palm on a “phones are commodities” thesis holds little weight when you’re talking about a firm with a leadership position and trading at a wide discount to its peers (on a p/sales basis).
6) In 2006, Motorola (MOT) bought Good Technology, the push-email service that could be adapted to Palm’s phones and then sold to the enterprise market. I also remember how much Motorola has suffered with its Q phone: could gobbling up Palm be the answer to Moto’s quandary?
7) Motorola and Nokia have cash – and lots of it. I begin my usual cash/market cap ratio assembling and see that MOT has a market cap of $45B while Palm’s market cap is approximately $1.5B (back in February), roughly < 4% of Motorola’s. Moto could eat Palm and barely burp.
8) Valuation: Palm has had some choppy, turbulent years, so I throw away the DCF spreadsheets and settle for a comparables analysis. On a price to sales basis, Palm looks cheap, trading out of line with its peers group. A low/price to book also catches my attention, which signals that Palm is having a difficult time creating value above and beyond investor’s cost of capital (ROIC model). However, the balance sheet is unlevered and it strikes me as odd that Palm is letting a ton of cash sit idly to collect the risk free rate. I begin to wonder if Palm has run out of places to where it can funnel money. If it has hit a roadblock in its trajectory as a public company, perchance, I contemplate the following: is it time for Palm to take the proverbial back door, bid Wall Street adieu, and exit gracefully at $20 bucks a share?
Full disclosure: Dan Jacome is VP in the Kelley School of Business MBA Investment Club and no longer holds a position in Palm.
