Between 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.