Pre Aside, Palm Isn't Quite Out of the Woods

Everyone, it seems, it excited about the Palm Pre. Those who have been granted time to fondle the Pre praise its features, the press is welcoming it with a fanfare worthy of the iPhone, and investors have tripled Palm’s price to $9.42 as of Friday’s close, its highest level in 18 months. But as hungry as investors may be for a feel-good story, they risk getting ahead of themselves. Even if the Pre is a smash hit, the journey from crisis to turnaround to recovery is a long one, and one that produces a lot of baggage. And when it comes to financial baggage, Palm already has more than its share.

Financially speaking, Palm is still a mess. In its most recent quarter, revenue fell 91 percent from the previous year, while gross margin collapsed from 30 percent to less than 5 percent. Cash on hand dropped to $131 million from $263 million.

Even after raising $104 million via a stock offering last month, Palm’s lossesĀ could go deeper still. With the Pre and all other devices powered by WebOS, Palm is counting revenue in a drastically different way. To Palm, Pre customers are buying a two-year subscription to a software that will be updated regularly for free. Instead of recording revenue when a product is sold, it’s recording 1/24 every month for two years. At the same time, other costs — marketing expenses, R&D, interest on loans, taxes and writedowns — won’t be recorded over two years, but as they are incurred.

So Palm’s marketing campaign launching the Pre will be subtracted from revenue right away. But revenue from Pres sold in the second half of this year won’t fully show up until the end of 2011. And a lot can happen between now and the end of 2011.

Want more baggage? Palm says it’sĀ facing impairment charges in future quarters from the decline in the value of its investments in auction rate securities. In the past nine months, these securities have led to $33 million in charges. And it’s saddled with $400 million in long-term loans. The terms of those loans may prevent Palm from raising more capital to stay competitive.

None of this means Palm is necessarily in trouble. But Palm bulls will need to be patient and willing to face uncertainty. Analysts are at a loss to project Pre sales two or three years out when the economic outlook for just the next six months is so unclear. And while the Pre may find itself at the head of the pack at launch, this is a fast-moving pack, full of some very innovative and cash-rich tech companies such as Apple, Google and RIMM pouring resources into it.

Some of these issues might also concern those companies said to be considering a takeover of Palm, such as Dell. Putting an offer price on Palm will be tricky, to say the least. What bid do you make on a company that has in the last 12 months lost $68 million, burned through $105 million and yet seen its market cap rise $700 million on the promise of a product that has not only not been released but whose release date hasn’t even been announced?

On top of that, an acquirer will have to make the bid appealing to a nine-member board that is dominated by Palm officers (two seats) or Elevation Partners, its venture backers (three seats). That could lead to an epic round of Microsoft-Yahoo style haggling over the true value of a company in the midst of an expensive turnaround.

So while consumers may be delighted with the Pre, the future is a lot less certain for Palm investors.

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