HP and Palm: How To Waste a Billion Dollars

HP has come to the rescue of the ailing company with the intention of playing with the big guys in the smart phone arena. However, HP bought Palm for all the wrong reasons and the writing is on the wall: Palm will become the first big casualty in the modern mobile phone battle. My prediction is that Palm will end its life as a write-off in HP’s balance sheet.

I have to admit that I am a big fan of the old PalmOS and Palm itself. I loved the early PDAs and  the Treo smart phones. I always forgave the company for being too slow to recognize trends that we all know could put them out of business, such as the emergence of WiFi, which Palm so vigorously tried to resist in the early 2000s.

Palm was always able to reanimate itself, thanks to a complex company and license structure that no one on the outside really can understood. However, there is an end to almost everything and WebOS as well as the Pre and Pixi phones were really the last hope for Palm to return to the old glory and success of the early Palm Pilots.

Recently, it has been obvious that Palm’s financial situation has become increasingly desperate–so desperate that even HTC reportedly walked away from buying Palm. But how desperate was it? Palm disclosed the other day in an SEC filing a dramatic drop in sales. The company now expects revenue for the May quarter to be in the $90 million to $100 million range, down from a previous, already cautious, guidance of less than $150 million. That, by the way, compares with an average street estimate of about $165 million.

Conceivably, Palm was lucky to find a buyer right now, at a time when its value is still measured in dollars. In a year from now, Palm could have gone for pocketbook change and its products could have been so insignificant that Gizmodo may have walked away from buying a secretly leaked Palm prototype phone.

Don’t get me wrong, there is value in Palm and reasons why Palm may work out for HP and help the company to jumpstart its mobile phone venture. On the upside, Palm can give HP a solid base of patents that will enable the company to relatively quickly compete with some of its rivals. Instead of using Windows 7, it now has its own OS and it is clear that Palm could give HP scale. Indeed, WebOS may be integrated in a variety of other devices, including tablets and perhaps even small desktops. It is clear that it is the Palm experience that HP bought.

HP executives explained that Palm is a “strategic” purchase of a cutting-edge mobile operating system as well as the engineering and management talent to make it bloom. HP pays for that opportunity by purchasing $5.70 for each share of Palm, which is a 23% premium over Palm's price before the deal was announced. The value of the deal is $1.2 billion, including Palm's cash and debt. In that view, Palm is a significant purchase in any case, but HP has deep pockets and a war chest of about $13.6 billion. The acquisition does not put its future at stake, but should be seen more as a shot at the mobile market and the acquisition of a company that was available.

If we drop the marketing bubbles for a moment and look at what the risk HP may have bought, then we get an entirely different picture.

What? Two phones for $1.2 billion?

Yes, I know, the Palm acquisition is not about the Pre and Pixi, even if those devices were originally imagined as the main pillars of Palm’s future business and they become for Palm what the iPhone is for Apple. HP did not purchase market share, but instead it purchased opportunity. Existing devices represent a share of opportunity and it is what makes money for Palm. The bottom line is that Palm is not profitable and its global market share in smart phones dropped from 3.5% in 2005 to 1.5% in 2009, according to IDC. This year, it appears that Palm’s market share will drop below the 1% mark and become insignificant, which means that HP will have to start from scratch. HP cited smart phone sales of 172.4 million units for 2009 and explosive growth of 24% per year. But it will need the right approach to capitalize on this opportunity and consumers will not buy Palm phones now just because HP acquired Palm.

Can a non-existent brand revive a dead brand?

Let’s be realistic. Today’s smart phone market is being divided between Apple and Google, with Nokia and RIM figuring out who will be third. At best, HP is in a battle for third place for now. Even if HP claims the market is still in its infancy, Apple and Google have all the tools in place that make mobile successful today–and HP/Palm do not. The operating system is just one part of the equation. For example, both companies have access to a vast amount of content as well a gigantic developer base that is excited about the future of the iPhone and Android. Both have advertising solutions in place and are several years ahead of Palm.

HP, on the other side, has a past of abandoned iPaq Windows phones and no visible brand presence in the smart phone market. Palm has 14 years of experience, but its brand has been watered down by countless acquisitions and is largely unknown to mainstream consumers today. If Palm had the brand equity in the past and the know-how to build great products, but could not compete in the market place, HP will need much more than $1.2 billion to capitalize on the Palm brand. Realistically, Palm’s brand can only draw from its past, not from its present.   

Palm is not important enough

One of the most stunning announcements made by HP is that Palm will be integrated into its personal computers business unit. Palm CEO and former Apple executive Jon Rubinstein is "expected to remain with the company." Interestingly, the HP PC man in charge is Todd Bradley, who was Palm’s CEO from 2003 and 2005.

So let me get this straight: HP wants to sell lots of smart phones and enter this extremely lucrative market, but it is not important enough to create its own division and instead, put the business under the roof of the PC unit? How innovative can Palm be under the PC division? How can Palm succeed against Apple if it cannot breathe free? I believe that the integration in the PC business sends the wrong signal to Palm employees and prepares Palm for failure.

On a much smaller scale, we have seen such moves by HP before, such as when it bought VoodooPC, a boutique PC maker that was acquired largely in response to Dell’s acquisition of Alienware. While Alienware was pretty much left alone by Dell (well, as much as possible), VoodooPC was folded into HP with the purpose of becoming a Formula 1 team that develops technologies that eventually trickle down into the mainstream. How much do you see from VoodooPC today and how much cutting-edge technologies do you see coming out of HP? Right. It is easy to see that Palm will see a similar fate.

A second, last chance to survive

If there is anything positive to draw from this acquisition and the initial strategy for Palm, it is that Palm gets another chance to survive, which is possibly its last. There is no way to predict how good WebOS can really be and if it can challenge the iPhone and Android, two very well established players in the market that determine what the future will look like at this time. Palm’s and HP’s opportunities will very much depend on whether the two can come up with devices consumers want and it does not take much to see that HP will have to invest billions of dollars in this segment to even have a shot at substantial sales.

The iPhone has become Apple’s main revenue source–more than $5.4 billion in the most recent quarter–and only has to fear Google at this time. And even behind Apple and Google, it is unlikely that Nokia and RIM will watch what HP will do. Also, we should not forget Dell as well as Microsoft, which may also see HP’s acquisition as a threat. The new Palm will make the mobile landscape much more competitive and it will be difficult for HP to steer Palm into a much brighter future. It certainly will not be as easy as HP executives make it sound like at this time.

Conclusion: $1.2 billion? Really?

Some may argue that $1.2 billion was a bargain for Palm, considering its patents and the patent infringement lawsuits HP may avoid as a result. Some also claim that the bidding for Palm possible was heating up and HP had no choice. I believe HP had a choice.

HP had to decide which role it wanted to play in the smart phone place and whether it wants to be another Apple/Nokia/RIM or another HTC. Palm was the wrong choice and it is acquired for all the wrong reasons. Somehow, Palm reminds me of Be, which had a fantastic operating system back in 2000, but could not come up with a device that was appealing enough for consumers. Be was acquired by one of Palm’s many ancestors and is non-existent today. There is a good chance that Palm will go down the same road and end up as a footnote in one of HP’s quarterly earnings reports.

Wolfgang Gruener is a technology journalist and analyst. He was managing editor for the Tom’s Hardware news section from 2003 to 2005, before launching and acquiring TG Daily. Today, Wolfgang works with startups and publishes his thoughts and analysis on critical and emerging technologies and products at Conceivablytech.com.