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Tickers in this Article: PALM, AAPL, RIMM, S, VZ, T
Normally, when a company's debt rating is pushed deep into junk bond territory by a rating agency like Moody's, it's bound to hurt share performance. But in the case of smartphone and PDA maker Palm Inc. (Nasdaq:PALM), investors ignored the bad news as they bid up the shares by almost 8% on the day of the Moody's downgrade. (For further reading, check out Junk Bonds: Everything You Need To Know.)

So, is this one day pop just a long overdue technical rebound against a six month long, almost uninterrupted, price slump, or are there solid fundamental reasons for being bullish on Palm's shares at this point? Let's investigate.

Weak Results Prompt Ratings Downgrade
The trigger for Moody's downgrade of Palm's debt from 'B1' to 'B2' was the release of the company's latest results which showed a worse-than-expected drop in sales and earnings.

Revenue for the third fiscal quarter ending February 28 slid by 24% to $312.1 million from $410.5 million in the year-ago quarter, and a net loss of $31.5 million (30 cents per share) was reported for the quarter, compared with a profit of $11.8 million (11 cents per share) a year ago. (Find out how to gauge true performance by reading Earnings: Quality Means Everything.)

While the company continues to have high hopes for its new Centro smartphone, brisk sales for the new product were not enough to offset the continuing slide in the company's legacy handheld PDA business.

Bottom Of The Smartphone Pack
Palm initially made a fortune back in 1996 when it was the first company to come out with what was essentially a small handheld computer, or personal digital assistant (PDA). Twelve years later, the PDA has morphed into the smartphone, a wildly popular gadget that combines basic mobile telephony with internet browsing, emailing, digital photography and wireless communications functionality like Bluetooth and Wi-Fi. It's a huge market that has attracted many players and competition is fierce. Device makers like Palm generally sell their products through mobile service providers like Sprint Nextel (NYSE:S), Verizon Communications (NYSE:VZ) and AT&T (NYSE:T) who discount the price to the consumer after they signup for a long-term service contract.

The problem for Palm is that it didn't react fast enough to this convergence trend, and it has now fallen well behind. In the consumer technology game where innovation is everything, Palm is still struggling with the basics like upgrading its proprietary operating system, while Apple (Nasdaq:AAPL) has stepped in with the launch of its unique iPhone, and market leader Research In Motion (Nasdaq:RIMM) continues to dominant the space with its iconic BlackBerry device.

Since Palm can't be expected to come out with a "wow factor" technodazzle product like the iPhone, it only has the price card to play. And that's what the Centro is all about. At $99, after rebates and a wireless service commitment, the Centro is supposed to win over those basic cellphone consumers that would like to upgrade to a smartphone, but can't afford a high-end product like Palm's own Treo 755. But the low-end of the market has also attracted other bigger players like Research In Motion and Samsung.

The Bottom Line
Margins are thin on the Centro, and could get thinner as competition heats up at the low end of the smartphone market. As the weakest player in the game, its unlikely that Palm would be able to sustain a protracted and intense price war, especially since it appears to have all its eggs in one basket, so to speak. Once investors realize how much of a long-odds play Palm really is, the current rally should quickly run out of steam.

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