SAN FRANCISCO (Reuters) - Hewlett-Packard Co's (HPQ.N) $1.2 billion acquisition of struggling smartphone maker Palm Inc PALM.O gives the company a foothold in a market it cannot afford to ignore, but HP will have to spend more to make its bet on the company pay off.
HP, the world's largest technology company by revenue, is already a dominant force in PCs, servers, services and printers. But without a credible smartphone offering, the company risked being left behind in a rising and highly profitable market, one that rivals both at home and in Asia are increasingly moving into.
PC makers Dell DELL.O, Lenovo (0992.HK) and Acer (2353.TW) are all pushing into smartphones, which offer advanced services such as streaming video, email and GPS in addition traditional voice calls. But analysts said Palm gives HP a product that stands apart from rivals offering a slew of devices tied to operating systems by Google (GOOG.O) and Microsoft (MSFT.O).
And it allows HP to begin selling a potentially lucrative array of back-end services for mobile users.
"It would be at their risk to ignore it," said C.L. King & Associates analyst Lawrence Harris. "I would say HP looked around and said, 'we need to be in this space.' Google is here, Apple is here."
Smartphones offer the promise of higher margins, a lure that has tempted other PC makers. HP's gross margin for its most recent quarter was 22.8 percent, just half Research in Motion's RIM.TO 45.7 percent margin, while Apple's (AAPL.O) was 41.7 percent.
Collins Stewart analyst Lou Miscioscia said Palm's price tag meant it was not a terribly risky deal for HP relative to the potential payoff. HP, which is paying cash for Palm, had more than $13 billion in cash and equivalents as of January 31.
"HP has been notably absent in the smartphone category obviously, where the buzz has been dominated by the iPhone," Miscioscia said. "I don't think they wanted to get left out."
Global smartphone shipments are expected to rise 35.5 percent to 247 million units in 2010, according to research group iSuppli.
In Palm, HP acquired a battered but well-known brand whose smartphones have faltered despite good reviews for its webOs platform. In a sea of competing devices from larger rivals, Palm was burning cash as it struggled to find breathing room for its Pre and Pixi smartphones.
Many analysts blamed at least part of Palm's struggles on a poor marketing and sales strategy.
Palm offers HP a combined hardware and software product, something that many smartphones firms can't match. Handset makers Motorola MOT.N, HTC (2498.TW) and Samsung Electronics (005930.KS) have been gravitating towards Google's Android software.
"The two successful companies in this space are Apple and RIM and they have integrated hardware and software," said Hudson Square analyst Daniel Ernst said. "If you are making phones every single day, and you are relying on Microsoft or Google for your next feature set, you are always behind."
HP declined to lay out its plans for Palm's product lineup, and the company faces a serious -- potentially expensive -- challenge in building up the brand in the face of well-established rivals.
According to Gartner, Palm held a 1.2 percent share of the global smartphone market in 2009, compared to Nokia's NOK1V.HE 41.1 percent, RIM's 19.9 percent and Apple's 14.4 percent.
"HP has to put a lot of muscle into this. For them, it's not just going to be the $1 billion they invested," said Ernst.
But HP boasts a impressive balance sheet and massive global scale, and the company made it clear that it planned to spend to resurrect Palm.
"HP will help Palm. What (Palm's) lacking right now is the capital to stay in the game," said Avian Securities analyst Matthew Thornton. "With HP you've got very deep pockets."
HP hopes its investments will spur developers into writing more applications for the webOs platform. As demonstrated by Apple, a robust offering of apps is key to success in the smartphone arena.
Although Palm's App Catalogue currently has more than 2,000 apps, that is dwarfed by Apple's App Store, which has closer to 200,000 apps.
Palm is home to a number of former Apple executives, including Chief Executive Jon Rubinstein, who was credited with helping to invent the iPod while at Apple.
HP expects Rubinstein to remain with the company, and said its has a "significant" retention program in place to keep Palm talent in the fold.
HP said it provides technology infrastructure for most of the top wireless carriers, and planned to leverage Palm's relationships with them in the smartphone space.
Shane Robison, HP's chief strategy and technology officer, said in an interview with Reuters that the company is uniquely well-positioned to take advantage of what Palm has built.
"When you ask why they (Palm) really haven't taken off yet, you've got to remember that the webOs itself is only about a year old and so it's at a point now where we can take that and mature it." (Editing by Edwin Chan and Lincoln Feast)