Why Palm Shorts Will Be Disappointed

Includes: AAPL, PALM
by: The Alchemist

The shorts are sure to be disappointed. Palm (PALM) is a company that has lost money for eight quarters straight, whose quarterly sales could not even match the iPhone's opening weekend sales, has practiced intentional deception about the definition of sell through and lacks a clear picture on sales figures. So why has Palm held up for so long?

There are many reasons, and I will discuss the technical issues first.

First of all, overpriced as Palm may be, it isn't the most overpriced stock out there given the current frenzy. In order for Palm to crash, all these other stocks should crash as well, and that is not possible under the current circumstances (since it would mean another market crash). The last time Palm went from 16 to 13, if you noticed, it declined along with just about every stock that has outperformed the broader market. Why? Because of macroeconomic trends. Looking back at the BDI, which is widely considered a measure of the economy (will discuss the BDI in another note), it has deteriorated during this period as well, dragging down the high fliers. Is this a coincidence? You decide. Is Palm overpriced? I think so, but for that to hold true it means so are many other stocks, and that the economy is tanking. Regardless of the nature of the economy, it is the market's perception of the market that matters. The market currently believes that there's a 50/50 chance of a V shaped recovery, and the stocks are priced accordingly. Unless that changes, as in, unless the stock market crashes again, Palm will continue to fly high along with the rest of them.

Second of all, we have insider activity. I suppose a word of caution should be placed on insider activities; after all, insiders only know about their own company and have no control over the broader market or consumer preferences (they can of course try to match it). A good example of this would be back in February (and into the next few months) when insiders were selling heavily because most did not believe such a recovery was possible. This was "a bear market rally," which it still could be, but that just goes to show how wrong the insiders could be, especially in this environment. However, there is something to be said about leadership. When the leaders are charging in front, it is only natural for people to follow, and numerous battles in history were won this way, though of course numerous battles were also lost this way.

Third of all, there's a sort of a self fulfilling prophecy going on here. Palm's beta has been relatively stable for the last few months. Stability is a rare and beautiful thing in chaos, and it is only human nature to seek stability. Many institutions have established methodologies in selecting investments, and one would be insane to believe a low beta but high potential (discussed below) stock would not interest anyone.

Next, let's talk about the fundamentals. It isn't so much that Palm's sales were low that got investors turned on, but rather the fact that it is perceived (perhaps even rightly so) as the only true "clone" strong enough to take on the original smart phone. A 123% increase would also get people's imagination going, even though it is anyone's guess whether the sales trend will continue. It is also obvious that they will focus on the platform and not any given phone, which alleviates concerns that any given model will bomb. If at first you don't succeed, then try and try and try again. WIth a huge war chest in tow, Palm could indeed try and try and try again for that big break. For the iPhone, it'll be like fighting an enemy that will not die, resurrecting itself even if the iPhone crushes the Pre, or the Pixi, etc. After all, the company is filled with ex-Apple engineers, it'll be like fighting yourself, and as the saying goes, we are our worst enemy.

So why don't I like Palm? I'm going to skip the part everyone already knows about, the hacking and the foggy sales numbers and sales through definition. Ok fine, I didn't skip it, I condensed it, but chances are everyone is already aware of those issues so why talk about it? I had to check my old blogs to see why I don't like it, because much like the broader market my memory sucks and can't seem to remember beyond even a week or two.

There are two major reasons why I would not buy Palm. One: I'm wondering about which stage the smartphone evolution is currently in. People assume it is in the growth stage, which it is. The real question is, is it at the early growth stage, or the late growth stage? The pioneer stage is characterized with a small user base but huge premium, followed by expansion as the product matures and costs go down. The problem with the growth stage is that profit margin goes down as well, and near maturity margins may be significantly lower. While the evolution brought by the iPhone is only 2 years old and is continuing with full steam, one must wonder just how big the market really is. Will every consumer adopt a smartphone in the next decade? Only if they become just as affordable as regular phones, which of course is how technology is suppose to advance. (Does anyone ever see those huge textless cell phones from the 90's anymore? of course not.) But the problem of course is that superior profit also evaporates. There have been no game changers introduced by the WebOS, and we're not at a new pioneer stage by any means. Sure, it multitasks, but inventing a function on the computer and inventing the computer are two different things.

Two: Like it or not Palm's image is that of a business phone. However Palm's target is now consumers, and image matters when it comes to finicky consumers. Let's assume that Main Street likes them as much as Wall Street (which doesn't get any better), but what does Wall Street see the Pre as? An iPhone competitor, aka iPhone substitute. Why does Palm want iTunes so badly? because Palm wants to be iPalm. It would like nothing less than to have Mr. Mac put on a Palm shirt and Mr. PC put on an Apple shirt.

A main selling point for the Pre was the lower cost in contracts. However, this also means that the iPhone and the Pre do not target the same consumer groups, and yet Wall Street expects the same profit margin (and the price cuts has already demonstrated that it does not offer the same margin). The iPhone went from targeting the affluent mass consumers to including semi-affluent consumers, for whom the shiny Apple logo is a major incentive, even if it is a bit more cumbersome as some would say. Of course if the iPhone does not innovate then it will eventually lose its status, but there's no reason to assume that Apple would just sit there while Palm advances. (Apple should, however, be more cautious about Android, what with Google (NASDAQ:GOOG) being a strong brand as well.) That leaves the consumers who want a smartphone but can't afford Apple choosing between WebOS, Androids and some BlackBerry models. When competition goes up, profit goes down. That isn't to say Apple does not have its own problems, but Palm's problem is that much more difficult to overcome.

I guess what Palm needs to do now is differentiate, because where would Pepsi be without the differentiation?

Disclosure: I own Palm shorts (which will be worthless soon enough though).