PalmSource Aquires Linux Developer China MobileSoftPalmSource Aquires Linux Developer China MobileSoft

PalmSource Inc., which has seen its share of the handheld computer market plummet, said on Wednesday that it has agreed to acquire China MobileSoft Ltd. as a step into the potentially lucrative Chinese mobile-phone market.

By acquiring CMS, PalmSource would get its ongoing development of a version of the Linux operating system for advanced cellular phones, often called "smartphones," and other wireless devices. PalmSource currently sells two proprietary OSes, Palm OS Garnet and Cobalt.

Under the deal, PalmSource, based in Sunnyvale, Calif., would issue 1.57 million shares of common stock in exchange for the outstanding equity and rights to acquire equity in CMS. Based on PalmSource's opening stock price Wednesday of $14.45, the deal is worth about $22.7 million.

The transaction, which is subject to CMS shareholder approval, is expected to close before the end of PalmSource's third fiscal quarter, which ends Feb. 28, 2005.

In a teleconference, David Nagel, PalmSource president and chief executive, said the company would continue to support its current operating systems, while also developing a version of the Palm OS for Linux. The new open-source OS would support all current Palm OS software, as well as its user interface, which analysts have praised as consumer friendly.

The Chinese government has publicly supported Linux over proprietary software for the country, as a key ingredient to building a local high-tech industry through open source technology. PalmSource, therefore, sees CMS as opening the door to a Chinese mobile-phone market that's among the fastest growing in the world.

"We believe this will give us a strong entre into those markets," Nagel said.

While targeting the Chinese market made sense, the move comes at a time when PalmSource is left with few options, Todd Kort, analyst for market researcher Gartner Inc., said. The company has suffered financially from a declining market for handheld computers, called personal digital assistants, which were the original users of the Palm OS.

"PalmSource had to acquire something that enabled them to be a larger player in the smartphone space," Kort said. "(The acquisition) makes a lot of sense, but I would say they are in a desperate situation and had to make a move. They couldn't just stand still."

PalmSource has targeted the smartphone market with Cobalt, while quietly ceding the PDA market to Microsoft. PDAs have fallen out of favor with consumers as advanced cellular phones have incorporated many of the older technology's capabilities, such as calendaring, contact lists and other software for personal information management.

In the third quarter of this year, Microsoft Corp.'s Windows CE surpassed the Palm OS in the handheld computer market for the first time, capturing 48.1 percent of the market while PalmSource trailed with 29.8 percent of the market, according to Gartner. Linux had 0.9 percent of the market.

During the same period in 2003, PalmSource had a 46.9 percent market share versus Microsoft's 41.2 percent and Linux's 1.9 percent.

In addition, PalmSource's biggest customer, hardware maker PalmOne Inc., is expected to use Microsoft's OS in future versions of PalmOne's Treo smartphone. PalmSource also lost a major customer when Sony Corp. announced earlier this year that it would exit the PDA market.

Within China, PalmSource will face its toughest competition from MontaVista Software Inc., which has partnered with Motorola Inc., to sell Linux-based handsets in the country, Kort said.

"Linux and Java will play a larger role as time goes on, and hopefully, for PalmSource's sake, they can become a good alternative to MontaVista," Kort said.

Java, a cross-platform technology developed by an industry consortium led by Sun Microsystems Inc., is used to run software in advanced cellular phones, which is the smallest, but fastest growing, portion of the overall handset market.

Besides developing the Palm OS for Linux, Nagel said PalmSource would continue development of both Garnet and Cobalt, which was met with skepticism by Gartner.

"With the additional level of complexity (in developing a Linux OS), it's likely something might get dropped along the way, and it's my feeling that Cobalt will see some reduction (in development) over the next year," Kort said. "It's hard for a company of that size to be all things to all people."

In its fiscal year ended May 31, PalmSource reported $73.1 million in revenue and a loss of $15.25 million.