The IPO of PalmBetween January 1997 and August 1999, when the market
rose sharply, 3Com’s stock declined in value. In August
1999, about half of the analysts following 3Com were
bearish on its stock and expressed widely divergent views
about the firm’s mixture of businesses. At the time, 3Com had three businesses: modems and
adaptor cards, networking equipment, and personal digital
assistants (PDAs). CEO Eric Benhamou and CFO Chris
Paisley considered whether their firm had become unfocused.
In September 1999 3Com announced its intention to spin out its PDA Palm division,
making it an independent
publicly traded company, and refocusing on networking
equipment. In March 2000, 3Com began to separate its handheld
organizer division by selling 6 percent of Palm’s outstanding
shares, mostly in an initial public offering (IPO). As
part of the IPO, 3Com sold the shares to an investment
banking syndicate, which in turn placed the shares with
institutional investors at a price agreed upon by the investment
banks and 3Com. (The lead underwriters were
Goldman Sachs and Morgan Stanley.) Between August 1999 and March 10, 2000, the Nasdaq
composite index virtually doubled, and peaked at 5132 on
March 10. Palm went public on March 2, 2000.
Palm’s offer price was $38 per share. At the pricing
meeting that established the offer price, 3Com executives
realized that there would be severe initial underpricing.
However, an offer price higher than $38 would have required
refiling with the Securities and Exchange Commission
and that would have resulted in a delay.
On March 2, Palm stock opened at $165 and closed the
day at $95. When Palm went public, it had fewer than 700
employees. At $165 per share, Palm’s valuation was
$92.7 billion, placing it in the company of some of the
largest firms in the United States, such as Disney and
Boeing whose market capitalizations that day were
$71.4 billion and $33.5 billion, respectively.
At the close of its first day of trading, Palm was worth
$53.4 billion, more than 3Com’s value of $28 billion. And
3Com still held 94 percent of Palm.24 Why did the market
permit Palm’s stock to trade as high as it did early on, especially
in March of 2000? Was there not a clear profit opportunity
there? Indeed there was. However, investors who
thought that Palm was highly overvalued at that time
could not find shares to borrow in order to short the stock.
Therefore the beliefs of excessively optimistic investors
set the price of Palm.
In October 2000, The Wall Street Journal ran an article
describing growing consumer demand for Palm PDAs. At
the time, Palm’s shareswere trading at a forward P/E ratio of
350 and a price-to-sales ratio of about 20. Paul Sagawa, a
wireless telecommunications analyst at Sanford Bernstein,
rated Palm’s shares as “outperform,” called it his favorite
stock, and described it as cheap because of its enormous
upside potential. The Wall Street Journal article mentioned
that Sagawa’s enthusiasm for the stock increased after he
purchased a Palm for his wife and watched her use it to keep
track of her phone numbers and social appointments. Eleven months after Palm’s IPO, its stock was trading
at $21. At that time, 3Com executives concluded that Palm
was overvalued. For their part, Palm’s executives acknowledged
being uncertain how to compute Palm’s fair value.
And they did rely on P/E and price-to-sales in order to
assess Palm’s intrinsic value, comparing Palm’s ratios
to the ratios for other comparable firms. However, they
were well aware about hot and cold issue markets. Eleven
months after Palm’s IPO, the firm’s CFO indicated that
Palm would not have wanted to raise equity in the conditions
prevailing at the time, with Palm’s stock down 45 percent
from its offer price and the Nasdaq composite down by
about the same amount.
The price of Palm’s stock went from its all-time high of
$165 on March 2, 2000, to $0.60 in August 2002.
The general evidence in respect to fundamental value
is that the executives of many Internet firms did not
believe their firms were overvalued at the time of their
IPOs. Some years after Palm’s IPO, former 3Com
executives were asked whether in retrospect 3Com had
sold overvalued shares to the public. They responded
saying that they viewed Palm’s shares as being overvalued
relative to fundamentals, but undervalued at a $38 offer
price relative to what the market was willing to pay in the
aftermarket.
As to being overvalued relative to fundamentals, 3Com
executives stated that they had the responsibility of maximizing
value for their current shareholders at the time,
and that it would be irresponsible not to do so, despite the
likelihood that the return on Palm stock would be low in
the long term.
Case Analysis Questions- Discuss whether any of the three IPO phenomena
apply in regard to the Palm IPO.
- Is the Palm IPO an extreme case?
- Discuss whether Palm and 3Com were efficiently
priced on Palm’s first day of trading.
- Analyze the assessment of Palm made by analyst Paul
Sagawa.
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