Technology

Palm's New Dough—and New Blood


With onetime Apple bigwigs on board and new funding from Elevation Partners, Palm is poised to compete with the iPhone

Former Apple executive Jon Rubinstein had a knack for keeping the company's product development team on track. "He drove the development of innovative products with rapid product cycles," former Apple Chief Financial Officer Fred Anderson says of Rubinstein. A result of that effort was the iconic, best-selling iPod digital music player.

Rubinstein, who headed the iPod division while at Apple (AAPL), will get a chance to put that set of skills to use again as executive chairman of Palm (PALM). He's one of a handful of new officials assuming key roles at the maker of the Treo smartphone, which on June 4 said it's getting a $325 million cash infusion from Elevation Partners, the private equity fund run by Roger McNamee.

As part of the arrangement, Elevation will purchase a 25% equity stake, or about 25.8 million shares, and Palm will pay $940 million in cash, or about $9 a share, to existing shareholders. The deal values Palm at about $17.50 per share, a premium of more than $1.40 to the company's closing share price June 1.

Palm's New Panel

Equally as important as Palm's new dough is the company's new blood.

Anderson joins Palm's board, as does McNamee. Ed Colligan, long the heart and soul of Palm along with founders Jeff Hawkins and Donna Dubinsky, will remain chief executive officer, a post he's held since the 2005 resignation of Todd Bradley, now the head of Hewlett-Packard's (HPQ) PC division.

The board additions come at a crucial time for Palm, which had been exploring strategic options with the help of securities firm Morgan Stanley (MS) that some had thought would result in a sale. While Palm's revenue has been growing steadily—it reported $1.6 billion in sales in fiscal 2006, from $950 million in 2004—it's been under persistent attack from competitors like Canada's Research In Motion (RIMM), maker of the BlackBerry wireless e-mail device, and Motorola (MOT), maker of the Moto Q smartphone (see BusinessWeek.com, 3/23/07, "Palm's Fortunes, Cloudy Again"). Pressure will only increase with the entry of a new competitor, Apple, whose iPhone device launches June 29.

Who better to help gird Palm for the onslaught than former Apple folks? IDC analyst Randy Giusto says what Palm needs is a round of product upgrades that will appeal to consumers targeted by Apple's iPhone marketing blitz, but also stand up against RIM amid enterprises. When individuals buy a smart handheld for themselves, they tend to buy a Treo, Giusto says. But when the boss is footing the bill, the device is often a BlackBerry. "The biggest thing that Palm needs is some serious innovation across its products lines," Giusto says.

That gives RIM the market share edge. Palm's share of the U.S. smartphone market is about 18%, compared with RIM's 45%. Both have lost several percentage points of share to Motorola and its Q phone device, which debuted in mid-2006 (see BusinessWeek.com, 7/20/06, "Unmasking Motorola's Q"). Palm seems to have borne the brunt of that new competition better than RIM, as Motorola smartphones now count for about 12% of the market, IDC reckons.

The Apple in Palm's Eye

Anderson, who co-founded Elevation Partners with McNamee, stepped in as Apple's finance chief during the computer maker's darkest days in mid-1996. Apple was losing money, strapped for cash, burdened by debt, and its sales were in the doldrums. By 2004, when Anderson stepped down as CFO, Apple had almost $5 billion in cash and sales, and profits were on the rise.

Anderson's history at Apple isn't without an asterisk. The Securities & Exchange Commission filed a civil suit against Anderson related to Apple's improper dating of stock options in 2001; he settled the matter with the SEC by paying a $3.5 million fine. Anderson, who resigned from Apple's board last year as the options matter emerged, blasted Apple in a sharply worded statement laying some of the blame for the matter at the feet of CEO Steve Jobs and the company's board of directors (see BusinessWeek.com, 4/25/07, "Parting Shots at Apple's Jobs").

Anderson says Palm is in a very different position from the Apple of a decade ago. "When I joined Apple it was in a weak financial position," Anderson says. "Palm isn't like that. At that time, the PC market was maturing and growth was slowing for everyone, and Apple had to undergo a turnaround in that environment. Here, there's a rapid growth opportunity."

Palm CEO Colligan concurs. Growth of the overall total market for smartphones will leave plenty of room for all concerned to succeed. "When you look at the growth of the total addressable market over five to 10 years, you realize that we don't have to knock the other guys out of the market to be successful," he says.

iPhone Raising the Bar

And that's precisely what attracted McNamee and Elevation Partners. McNamee says that most of the wireless handsets in use today constitute "feature phones" with many sophisticated extras that aren't easy for the average user to maximize. "That suggests that as people's expectations rise, they're going to want something that's a lot more compelling than a device that just makes phone calls." Such a device will call for the tight hardware-software integration that has been a big part of what makes Palm devices so popular among its user base.

Apple's iPhone, if successful, will only underscore the demand for devices whose features are woven together elegantly by software, McNamee says. "It demonstrates the importance of the software platform on the device," he says. "To anyone who says there's no growth left in smartphones, the Treo is exhibit A and the iPhone will be exhibit B that that's not correct."

Other makers of handsets could follow in the footsteps of Apple, which will sell the iPhone exclusively in partnership with AT&T (T). If and when lines start to form outside Apple and AT&T stores after the iPhone launch, other U.S. carriers like Verizon Wireless, owned by Verizon (VZ), and Vodafone (VOD), will be eager for a competing device.

It's not clear whether Palm would fit that bill, but Colligan says Palm is hard at work building a new version of its operating system that will be based around the open-source Linux operating system, and that its business of selling handhelds running Microsoft's Windows Mobile software is taking on an increasingly important role. "It's not a huge part of our business now, because we've only had it for a little more than a year, but with this next generation of devices, I'd say the split between Palm OS and Windows Mobile will be more like 50-50," he says.

Decade of Innovation

The Elevation deal marks the latest in a long history of sweeping changes at Palm. The company's debut product, the Palm Pilot, was launched in 1996 and defined the category of handheld computing throughout the late 1990s. If you had a handheld organizer, you bought a Palm Pilot, or later a Palm V. Born as an independent company, Palm was acquired by USRobotics in 1995, which was in turn acquired by 3COM (COMS) in 1997, only to be spun out as an independent company in 2000 when it clocked its first billion-dollar year in sales.

That same year, founders Colligan, Hawkins, and Dubinsky struck out on their own to start Handspring, which launched a consumer-oriented line of PDAs running Palm's operating system software, dubbed the Visor. Competitive with Palm's products, and priced to move, the Visor ate into Palm's consumer handheld business, and Handspring reported sales of $370 million in its fiscal 2001. Then came the Treo, which for the first time successfully combined a Palm-based PDA with a wireless phone. Palm tried its own phone-PDA combo in 2003, but it fell short of the Treo, which in turn prompted a merger of the two in 2003.

Along the way, Palm had split off its operating-system business into a separate company called PalmSource, whose mission was to license the software to other manufacturers. Sony (SNE) and Garmin (GRMN) and a few others took out licenses, but ran into a declining market for standalone PDAs. PalmSource ended up in the hands of Access, a Japanese software maker.

Meanwhile, sales of standalone PDAs have tanked in favor of smartphones. Palm is still the top seller of those devices, but IDC estimates sales of its non-phone PDAs dipped below 300,000 in the first quarter of 2007. HP saw its unit sales dip below 200,000 while Dell (DELL) dropped below 100,000 and exited the business.

Anderson compares the current chapter of Palm's story to the Apple saga, just after the introduction of the iPod. "It's like joining Apple in 2002," the year before iPod sales really took off, he says.

That's the way he and Rubinstein and their Elevation cohorts would prefer the story plays out. Better that than entering the digital media player business as an Apple competitor in 2002.


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