| 2010 | 2011 | ||||||
| Price: | 12.43 | EPS | na | na | |||
| Shares Out. (in M): | 168 | P/E | na | na | |||
| Market Cap (in $M): | 2,083 | P/FCF | na | na | |||
| Net Debt (in $M): | 90 | EBIT | 0 | 0 | |||
| TEV (in $M): | 2,173 | TEV/EBIT | na | na | |||
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Palm (PALM US): An ANTI-consensus long idea...
Investment Thesis
"Podfather" Jon Rubinstein, inventor of the Ipod, came out of early retirement from Apple to lead Palm in resurrecting itself as a market-leading vertically-integrated smartphone provider. With a blank slate as a starting point, Rubinstein has designed a new suite of products that critics acknowledge intelligently addresses many of the shortcomings of the competition. We believe that the renewed product innovation driven by Rubinstein and his newly assembled best-in-class team, will allow Palm to disproportionately benefit from the large scale secular global penetration dynamic of smartphones over the coming 2-3 years, which should drive 3x upside in the shares over that time period. The market clearly disagrees, as more than 2/3 of the sell-side suggests investors hold or sell the shares, and most recent reported short interest represented ~40% of the float.
As of mid-2009, annual handset sales approximated 1.2Bn globally and smartphone penetration was 14%. In the last 5 years, smartphone growth has been in excess of 75% annually, as penetration has increased five-fold since 2004. We expect that over the next 3-4 years, smartphone penetration will exceed 30% penetration, implying 350mm of annual device sales. Palm's CEO believes that Apple and Palm will benefit from sustainable competitive advantages due to innovative hardware/software offerings that are unmatched by competitors. Palm is in the very early stages of selling smartphones and recently announced a number of new partnerships detailed below. If Palm generates unit sales of 15mm+ in 3-4 years (by comparison, RIMM sells 30mm/yr and AAPL sells 20 mm/yr with smartphone penetration in its infancy stage), the Company will generate north of $2/share in earnings which suggests the stock is a triple from here. Other penetration stories with innovation-driven competitive advantages (AAPL, AMZN, PCLN, NFLX, etc) command 20x+ multiples on out year earnings. RIMM, Nokia, Motorola and HTC are probably not great comps due to significantly lower growth profiles. RIMM trades on a mid-teens multiple on what are likely overly aggressive earnings estimates due to margin pressure from its strategic decision to focus more on personal consumer products. HTC, Nokia and Motorola are not pure-play smartphone providers given significant exposure to "dumb phones" and the inevitable cannibalization. In fact, given Nokia and Motorola's lack of proprietary software and balance sheet capacity, it would not be crazy to envision either player buying PALM in the reasonably near future given proof of technology and ability to win over the largest carriers.
Management Quality
Jon Rubinstein was the head of hardware engineering at Apple from 1997 to 2006 and his team was responsible for the engineering behind the iMac and the iPod which laid the foundation for the Iphone, one of the world's most successful product launches in history. As a reference point, sales were up 5x at AAPL under Rubinstein's reign. Since joining Palm, Rubinstein has replaced over 40% of the employee base, largely with new talent from Apple, Microsoft and other reputable technology firms. Under Rubinstein's leadership, PALM has started out strong with the development of the new WebOS, which differentiates Palm's smartphones. Rubinstein owns ~3m shares in options/RSUs that vest over the next few years and don't fully vest until the stock exceeds $25 meaning the share price needs to double from here in order for him to cash-in on all of his options. Additionally, media-focused private equity firm Elevation Partners invested in PALM in 2007 and has helped to completely revamp the company. Elevation has invested approximately one third of its capital base in Palm and is therefore highly-incentivized to provide incremental liquidity to the extent Palm's operations require it.
Market Dislocation
Boasting a 40%+ short interest, Palm is one of the most hated stocks in the United States. Bears are focused on Palm's current negative free cash flow profile as well as increasing competition on the horizon from Google's new products. Additionally, because Palm's smartphone market share declined from 12% to 4% (before the introduction of the Pre/Pixi), bears linearly projected that Palm share would decline to zero or that the Company would run out of liquidity first. With Palm's recent equity offering, the Company's debt has been reduced and liquidity is in much better shape. Management expects to reach cash break-even in 4-5 months.
The market fails to appreciate the following:
The Simple Math
Palm currently has a $2bn market cap. By mid-2010, Palm will have access to 335mm wireless subs (detailed below), which will generate at least 160mm in annual unit sales. If Palm captures 10-12% of its partners' unit sales (by comparison, RIMM currently claims ~30% of Verizon's unit sales) and earns $25-30 in EBIT per phone (by comparison, RIMM currently earns EBIT of $100/phone), net income will approximate $300mm which creates Palm for less than 7x earnings. HTC sells 12mm units per year and boasts a $7.5bn enterprise value. The continued growth in smartphone penetration combined with the support Palm has received from global carriers (and continued support we expect from new carriers), we expect Palm to exceed that number materially over the long-term. With 40% of the float sold short, the investment case requires minimal evidence of fundamental success to attract a number of marginal buyers.
Agreements already inked:
Beyond the agreements already in place, there are widespread rumors of a China Telecom agreement, which would add roughly ~50mm. Finally, Telefonica Latin America and Vodafone, with whom Palm already has relationships in Europe and the US respectively, could offer an additional 400mm wireless subscribers if their agreements become global. That would clearly offer tremendous upside to these numbers.
We clearly understand the bear argument for Palm (articulated eruditely in April 2009 by 'bubs'). Bears argue that Palm's product success has been mediocre to date. This is difficult to dispute, but we don't view Sprint as a barometer for Palm's success as the typical Sprint customer is far less tech-savvy than an AT&T or Verizon customer (if Palm's products were that bad, would all of the above-mentioned carriers signed up to sell their products?). Bears also argue that the market is competitive and margins will be competed away. While we agree that intense competition will ensue to battle for share in the fast-growing smartphone market, we think little faith is required to see Palm as a top 7 player, especially given a) the CEO is one of the most well-respected innovators in the industry and b) Palm's proprietary WebOS operating system gets fantastic reviews from both consumer and enterprise customers. Additionally, the level of user interactivity and the smartphone producer's control of software and content, suggest that this is a much better business than "dumb phones," plasma televisions or many other consumer electronics. Looking forward, the global smartphone market could exceed 500mm units trough developing world adoption and increased penetration in Europe and North America. Will the 5th, 6th or 7th ranked player in a 500mm+ global smartphone market boast a $2bn market capitalization? We think it is likely a multiple of that. Now imagine if Palm can take real share and earn the 3rd spot....
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