Why Google Should Buy Palm (to Battle Apple)

(MoneyWatch)  Palm (PALM) is pretty clearly screwed. Sales never took off when the company finally got Verizon (VZ) to sell its webOS-based handsets. Palm had to lower its guidance because clearly business wasn't picking up. And CEO Jon Rubinstein, in a new interpretation of how to win friends and influence people, blamed Verizon for its current problems. Now a Morgan Stanley analyst Ehud Gelblum thinks that Palm could still keep its rear out of a sling if it killed off its own handsets and licensed webOS to other hardware vendors:

If Palm were to shutter its manufacturing operations and adopt a licensing model for smartphones and other devices, it just might see its business improve. Says Gelbum, "We calculate that if Palm licensed its OS for $7 per device and won 5-7 percent of the smartphone market in F2013, this could yield ~$0.40-0.50 earnings per share in F2013."

Three words for Mr. Gelblum: not a chance. The numbers might work, but Palm faces some factors that make the scenario an impossibility:

• Hardware vendors only license operating systems if they think it will pay off. So far, relatively few people have adopted webOS devices from Palm and the company has little free cash to strongly market and attract people. That would leave the hardware vendors to create all the demand on their own. Why would webOS work any better for them? It might, but it's not a gamble worth taking.
• Palm has significant competition in the smartphone OS market: Android from Google (GOOG) and Symbian. Android is on track to surpass iPhone sales. Symbian is a known quantity with significant adoption. Both are free. Why pay money to Palm?
• Palm has about $500 million in cash, which is a tiny amount compared to what large tech companies have. Apple has filed suits against companies it claims infringe its patents and has made clear in the past that Palm could wind up on that list. With its cash burn rate, Palm doesn't have the money to survive long, let along manage a protracted legal battle, and no hardware vendor will want to foot the lawyers. On the other hand, Google could buy a law firm and not even notice the drop in its bank account.

With Palm's baggage, the potential legal travails tied to using webOS, and the lack of enough consumer interest, I don't see where hardware vendors even bother. I think the company's only hope is an acquisition by someone who wants something in particular that Palm has. But here's where it gets interesting. Palm may not have a big revenue stream. It may not have bright possibilities. But it has has over 400 patents in the mobile and handset spaces that would likely come in handy should a company find itself targeted in a suit by Apple (AAPL).

Apple has made it clear that it wants to burn a number of competitors, particularly those working with Google. So perhaps Google should buy Palm. It would get a massive club for any upcoming legal battle. As of today, Palm's market cap is about $937 million. Google wouldn't need much of a premium, as investors are likely to welcome any chance to jump without a total loss, and gathering that much cash for Google is trivial.

From the point of using IP as a weapon, Google also isn't the only possibility. Microsoft (MSFT) could purchase Palm just to keep it out of Google's hands. Or Apple could buy the company to deny the legal advantage to any of its competitors. It comes down to this: Palm could actually be worth far more as a collection of patent filings than as a going concern.

Image: RGBStock.com user mzacha, site standard license, adapted by Erik Sherman.