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NVTL, PALM: When the Music Stops, the Ponzi Impact of Sell In Revenue Recognition

We, as analysts, can learn a lesson from Novatel’s (NVTL) financial report that applies to PALM as well.  Novatel, facing deteriorating financial results from a dated product line, released a new product (Mifi) that created overly optimistic expectations and dramatically disappointed shareholders. 

 NVTL released Mifi, a device that combines a 3G data access with a wifi hub in the June quarter.  Consumer response has been strong, reviews have been good and in its first full quarter shipping, accounted for 40% of revenue.  This success has led to nosebleed high earnings growth rates for 2010.  However, these expectations were based on continued revenue contribution based on sell in. 

 The company has been seeing increasing sell through each month since launch.  This success has attracted many additional carriers leading to 11 new customers for Mifi in C3Q09.  However, this success does not mean sell through has kept up with sell in.  The company owned up to this issue and guided C4Q09 results below consensus leaving shareholders with a 20+% overnight decline.  From our perspective, management should be commended for providing conservative guidance rather than aggressively anticipating new relationships to make up for a longer sales cycle which may lead to disappointing financial results.  Despite today’s sell off, if there are indications that sell through picks up as we enter the Christmas season, the stock will likely begin to recover quickly.

 Not all companies take this approach to financial visibility however.  PALM launched the Pre in June and has led people to believe the discrepancy between sell in and sell through are negligible.  We have a contrary opinion and believe that the gap is much more substantial than PALM’s “devices sold” metric would indicate.  The belief that additional products, sold through additional carriers will cushion the blow of lower than expected sales, is a pipe dream based on ponzi like distribution.  We believe that holders of PALM into the November quarter financial results risk a negative surprise similar to what holders of NVTL are experiencing today. Consider the comparison of the two companies:

 Product launch - NVTL launched with Verizon and Sprint in May and June, PALM launched with Sprint in June

 Follow on customers - NVTL signed 11 additional customers since the initial launch, PALM signed 5 additional carriers

 Sell through - NVTL has seen increasing sell through in every month since launch, PALM has seen slowing sell through (based upon our channel contacts) since the initial launch.

 Customer concentration - NVTL had 3 customers that accounted for 70% of revenue in the quarter, PALM had 1 customer that accounted for 85% of revenue

 Valuation - NVTL is trading at 1.5x book value, PALM is trading at -5x book value per share

 We highlighted Mifi as one of the most important products to come out of  this spring’s CTIA and are in the process of determining the natural level of sell through.  If we find that sell through is accelerating and sustainable, we will be publishing an investment opinion on NVTL in the near future.  Currently we have an Unfavorable Opinion on PALM.

 For a broader discussion on either NVTL or PALM, please contact us. Also, feel free to offer your thoughts at our blog: http://blog.townhallresearch.com/ .

 David Eller has no positions in either PALM or NVTL.