Thursday, February 25, 2010

Palm (NASDAQ:PALM):Downgrading as Lack of VZ Support Sidelines Plan A - Morgan Stanley

Morgan Stanley is downgrading Palm (NASDAQ:PALM) to Equal-Weight from Overweight as their basic tenet of our original OW thesis - that Verizon would open up new distribution channels driving subscriber growth which would then drive ecosystem development – appears not to be playing out as Verizon has puzzlingly refrained from providing the marketing muscle behind the products that we had expected them to.

Morgan Stanley continues to believe webOS is a leading OS platform and a valuable asset and ultimately plays a key part in the development of the mobile web OS environment - especially as they expect Android’s fragmenting versions to limit the ultimate success of applications on that platform – they just find it increasingly unlikely that Palm can achieve success on its own by driving strong unit shipments, at least for now and through the Verizon channel.

They continue to believe Verizon is unlikely to launch iPhone this year, but as opposed to their original thesis wherein they expected Verizon to promote Palm’s products as a primary alternative to iPhone, it now appears evident that Verizon has decided to position Android phones in that position while segmenting Palm exclusively for the dubiously sized “Moms” category. While the firm would not be surprised to see Verizon yet pull an about face and begin to more actively promote the Palm products, potentially later in the year when They expect Palm to release new models and form factors, they have no reason to believe that increased marketing push happens in time to rescue unit shipments over the next 3-6 months.

With plan A of a strong Verizon marketing campaign driving material user adoption apparently failing significantly faster than Morgan Stanley had expected it could, and the potential for licensing and partnering adoptions still 9-12 months out, the stock has little valuation support at its current level and they believe could move closer to their original Bear case valuation of $4 as the odds of their Bear thesis playing out have been greatly enhanced.

While Morgan Stanley continues to believe Palm begins selling at AT&T in the calendar 2nd quarter, they suspect that without the momentum they had expected Verizon to create in driving an embedded base of Palm users, that AT&T may tread lighter in pushing Palm’s webOS products themselves.

In addition, their thesis that the potential for partnering or licensing providing a floor for the stock, while still intact, is less of a near-term possibility given Microsoft’s launch of its Windows Phone 7 OS and Nokia’s recent partnership with Intel to create the MeeGo OS while focusing on Symbian versions 3 and 4 for the remainder of 2010 leaving the playing field of licensing suitors relatively thin in the next 6-9 months. Therefore while the opportunity for Palm to seek value from either of these players remains a distinct possibility in 2011 and beyond, the more immediate opportunities are more muted than they were at the beginning of the year, creating less cushion in the meantime while the company navigates its way through re-establishing its own brand. With that as the new backdrop, the firm believes the most important issue is understanding what Palm management decides to do next to monetize its asset, i.e. plan B.

At this point, MSCO believes PALM has 3 options:

1) Spend like crazy on brand advertising to drive brand awareness and consumer adoption, resulting in quarterly cash burn of $100M for each of the next four quarters and a balance of $170 million by the Nov-Q. Depending on the size of the marketing campaign and its resulting success, this strategy may raise near-term balance sheet concerns and the firm calculates leaves the company with less than two quarters of cash at the same burn rate. The appeal of this scenario from Palm’s perspective is without full support from Verizon, time is no longer on Palm’s side and 2010 may end up being the company’s big opportunity to achieve smartphone relevance. The risks to this strategy could be onerous, however, if the strategy does not drive sufficient subscriber adoption and funding sources that were available to them previously dry up. While the bull case outcome of this strategy has the potential of driving the subscriber adoption Palm needs to attain smartphone relevance and thereby regain a $13-16 stock price, the odds of this go-it-alone strategy fully working are, they believe, at best 50/50, placing the option value of this alternative in the mid-to-high single digit range for the stock.

2) A moderation of option #1, matching Morgan's current model, where PALM ramps opex significantly but less aggressively than in the first scenario and relies on negotiations with Verizon and other carriers to result in a more aggressive marketing push from the carrier than it is currently getting. They believe this is the most likely path for Palm to take, although they believe it is unlikely to grow quarterly unit volume above 1M until very late 2010 as carriers generally take time to change course. This scenario drives PALM's cash position to $279 million in the Nov-Q.

3) Change course and license webOS out to other vendors, particularly on the smartbook/notebook side. This would include managing the business for breakeven, sell lower unit volumes themselves just to support customers, and work aggressively to license the OS to multiple OEM's that are either feeling the pinch from Android or struggling with their own internal OS. Morgan Stanley calculates that if PALM licensed its OS for $7 per device and garnered 5-7% of the smartphone market in F2013, this could likely yield ~$0.40-0.50 in EPS in F2013. However, as previously described, they believe most of the potential licensees are likely to remain preoccupied with either new or soon-to-be-upgraded operating systems.

Firm could actively look to revisit our stance on the stock if the company decided to pursue either of plans 2 or 3 outlined above and actually got traction - i.e. Verizon decided to suddenly broadly and aggressively promote Palm and/or the company successively began to pursue a webOS licensing strategy - although at this point, they believe it could be several quarters before either would have thepotential of panning out.


Mason Verger: I guess now you wish you would've fed the rest of me to the dogs.
Hannibal Lecter: No, Mason, I much prefer you the way you are.

Same goes to Merrill Lynch for downgrading PALM to Underperform from Buy yesterday morning after pumping the name all the way down from its $18 highs.

Last man standing seems to be RBC Capital analyst Mike Abramsky, who by the way, lowered his target on PALM to $18 (prev. $25) yesterday while reiterating Outperform.

I just suggest you wait til Mike throws in the towel (not sure when this will happen, though) & buy the stock. Zero expectations coupled with a 70% short interest.

Okey-dokey. Here we go.

PS: The early squeeze you are seeing right now is due to trading desk chatter Palm has cancelled out of GSCO conf. Sometimes (and I mean sometimes!) this means there is news on the way but today I think it's more weather related. Seeing other companies cancel out of meetings as well here, so I'm not reading too much into the Palm cxl.

So you know.

PPS: and it warns! Lol.


Jon said...

Ha, PALM halted and is cutting guidance.. ouch for all those desks that got caught long

notablecalls said...

yeah, clusterfuck