Update on the Pre and the Fate of Palm

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Includes: AAPL, BB, PALM, S
by: Ockham Research

It is generally accepted that the new Pre handset is a make or break device for Palm (PALM). Just over a month since the release of the Pre, reports vary widely in terms of the sales expectations. Backed by positive reviews of Palm’s new operating system, the Pre sold well initially, with reports of selling out in just minutes at many locations across the country. However, those results were subject to criticism because severe supply constraints limited the amount of phones sold and the stock actually dipped after the launch weekend’s sales were tallied (According to the Market, Palm Pre Fails First Test). In the month since that weekend the stock has risen impressively: Palm is up 19% compared to a 5% decline in the S&P 500 benchmark. Is this run-up justified by the results, or is it more a product of hype?

The release of the Pre was highly anticipated and it was no surprise to see it sell out in its first weekend; the larger question was how would the Pre hold up after the release of the new Apple (NASDAQ:AAPL) iPhone. This is where it gets really interesting, because estimates are all over the place. Analyst Edward Synder of Charter Equity Research has estimated that the Pre has sold 300,000 units already and that Palm will ship 1 million units in the first three months. Those estimates are aggressive to say the least and probably are a best case scenario as the Pre sold about 50,000 units during its launch weekend.

PALM On Monday, Techcrunch.com, a renowned technology news and blog site, published an article about the Pre suggesting a very different outlook for the company. The article quotes a survey run by wireless consulting group iGR that, according to the survey of about 50 participating Sprint (NYSE:S) stores, the demand has slowed considerably in just the first month. Not a single store in the survey reported having inventory shortages of Pre’s and the majority had “plenty” for sale. Over the last few weeks, the number of stores surveyed saying they are sold out has shown a steady decline from 38% in week one, 28% a week later, 8% last week, and finally none in the latest survey. The encouraging signs from the survey was that a significant portion of customers buying the Pre are new to Sprint, but this seems to bode well for Sprint more than for Palm.

Of course, this survey provides only anecdotal evidence as it is not comprehensive of all Sprint stores, but it is a trend that tells you something important. Palm, with its wacky balance sheet which shows negative total equity, will need to justify the stock’s quadrupling year to date with strong and consistent sales of the Pre. The smart phone industry is a crowded market, but it is growing rapidly and Palm is trying to get a significant slice of the pie in order to right the ship. At this point, we are not putting much stock in either of these extreme predictions for how Palm is doing thus far, but we do think that the Pre is facing significant headwinds. The timing of the Pre launch seems to have been sub-optimal as the new iPhone released just days after the Pre stole a lot of its thunder. In the months leading up to the Pre’s launch many Pre supporters welcomed the comparison to the iPhone and many touted it as the first legitimate “iPhone killer”. Considering most estimates have the Pre sales on opening weekend of about 50,000, but the iPhone sold more than 20 times that number the weekend of its release; Palm is facing strong and established competition.

Ockham currently has Palm stock’s valuation as Fairly Valued and nearing Overvalued territory, and we cannot justify recommending a stock that has such a poor quality balance sheet and with nearly all of its hopes laying at the feet of one product, no matter how great it may be. Furthermore, as we stated before, the stock has quadrupled on the hype of the Pre, and even relatively strong sales may not live up to the expectations. From our perspective, the sales estimates are mostly speculation at this point, but what we know is that the Pre faces headwinds that make it a stock that will only really interest momentum seekers at this point, as no value investor can still be interested. We do not short any stock, but if we did this stock would be on our radar. Surely, many shorts have covered as Palm has rebounded from very low levels, but there is still a significant short interest at 28.5% of float.

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