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HP's Palm Purchase Isn't About Smartphones

Pat Dorsey, CFA

Pat Dorsey: Hi I'm Pat Dorsey, Director of Equity Research at Morningstar. Well, ending months of speculation, HP finally put Palm out of its misery. Well, not really with a gun to its head but with a $1.2 billion all cash deal value in Palm at about $5.70 a share. A good ways above its recent low of two or three bucks, but a long ways below the $15 [laughs] price that Palm was at earlier in the year.

I'm here with Senior Equity Analyst Michael Holt to talk about the Palm acquisition, what it means for HP, and more importantly what it means for both the smartphone and PC markets. Thanks for joining me, Michael.

Michael Holt: Thanks for having me.

Dorsey: So the chatter out there is all about the smartphone business, and now there's this much more viable competitor to Android and RIM and Apple. But you don't think this is a smartphone play.

Holt: Part of this certainly is a smartphone play because they're getting a smartphone business with the webOS. The question is, that's the most valuable asset--the webOS operating system. Right now, it's for phones but how else can it be repurposed, I think is the key question.

So I don't think HP is going into this just to take on Android, Apple, Symbian, and Microsoft, all these entrenched players in the smartphone market. They haven't been a player for a while, and I don't think this would be a big move just to go after hat market.

Dorsey: Especially given that that is a market that really is based on network economics, and Apple's got this poll position lead with all the apps and the apps store. I think the number of Android apps is growing reasonably quickly.

Holt: Definitely.

Dorsey: RIM is fairly entrenched in the enterprise, so you've kind of got a three-player market there. It doesn't seem that likely that webOS would be able to kind of elbow its way in for meaningful market share.

Holt: I absolutely agree. It's a very competitive market. There's lots of players coming into it. Every PC maker is trying to make a move there, but the odds of success are pretty low.

Dorsey: But a few years out what you're thinking is, moving away from the smartphone market, you look at the netbook tablet mobile computing device market. You know, the form factor that's in between smartphone and desktop. There maybe we have three players? We have an Apple OS, a Windows OS, and now possibly webOS as a viable third?

Holt: Absolutely, and I think this is really the main strategic driver behind this deal for HP. My speculation is they have learned their lesson in the PC market, where it's very difficult to differentiate your product when you don't control the IP or the operating system behind it or the chips. So in the PCs...

Dorsey: At the end of the day in PCs, HP is a box maker. They get the intellectual property from Intel on the chips. They get intellectual property from Microsoft on the OS. They put it in a beige box and send it to Best Buy.

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Holt: Right, and they're the world's largest so they understand that problem better than anybody, I think. Wen they look at this smartphone market, they see that they're a little late to the game. They had some stuff from the Compaq acquisition, but it never really went anywhere. They're not really a player today.

I don't think they see that as as green of a pasture as this new middle ground that's kind of emerging. They want to be on the forefront of that and not be late to the game. But they don't want to come out with a product that Dell can replicate in two months.

Dorsey: Right. So what you're saying is we could see a netbook from HP in a year or two running Palm's webOS.

Holt: Absolutely. The first device I think we'll see is what they call "the slate" but what we call the "tablet form factor." I think that lends itself to the touchscreen interface that the webOS is really based on. But I think it also lends itself to the netbooks and any device that's in between, bigger than a phone but smaller than a traditional mobile laptop.

Dorsey: So who is most threatened by this? As we talked about earlier, it's not RIM, it's not Apple because, as you point out, the smartphone market has developed so quickly, webOS is very late to the party there. But who in this sort of emerging middle ground market, what player should be most worried by the fact that Palm is not going to be dismembered, but is now in the hands of a viable, financially healthy competitor?

Holt: The other competitors who want to go after that middle ground or the tablet space, Apple's going to do fine. They've got their own proprietary system. But it's the Acers and the Dells who are likely going to come out with a tablet based on Android or Windows, and they're going to keep copying each other's functionalities. This might be the thing that gives HP the ability to differentiate themselves from those guys.

Dorsey: Yeah, not that Dell has really been burning up the tracks anyways.

Holt: Absolutely not.

Dorsey: So the lesson here being that if you don't own the software, if the software is not something that you can differentiate your product with, you're pretty much out of the game in whatever device market we're talking about.

Holt: Right. I think it's easy to have your hardware features copied. But, I would add that it's still going to be difficult for HP. I don't think this is a slam-dunk by any means, that they're going to take off and be a dominant player or the dominant player in this market. Because what we're seeing now is more of the data consumers use is kept in the cloud or kept on the Internet.

You have your email stored on Gmail or Hotmail. You keep your photos online. You might be streaming your music online. As that happens you become less reliant on the underlying operating system. So I think this gives them some advantage to differentiate their product, but at the end of the day it may not be enough.

Dorsey: But bottom line is what we need to watch is this middle ground market, not so much the smartphone market, to see whether Palm actually pays off for HP.

Holt: Absolutely.

Dorsey: Thanks so much, Michael.

Holt: Thanks for having me.

Dorsey: I'm Pat Dorsey, and thanks for watching.