Tax Rules Could Limit Handspring-Palm Union

Despite speculation that sent shares of hand-held computer makers Palm Inc. and Handspring Inc. soaring Monday, a marriage of the two is unlikely, in part because of tax rules that limit Palm’s ability to merge.

Palm shares gained 13% to close at $3.87 and Handspring closed up 35% at $5.41 after some analysts ruminated that the two struggling outfits would perform better as a single company.

Handspring denied merger talks. “We are not in active discussions about a merger,” spokesman Brian Jaquet said.

A Palm spokeswoman declined to comment.

A merger of the two would be a reunion of sorts. Palm founders Donna Dubinsky and Jeff Hawkins left the company three years ago to start Handspring. Some analysts suggested that a “remarriage” would give the companies more strength to fight off attacks from Microsoft’s increasingly popular Pocket PC platform.

Personal digital assistants sold by Handspring use the Palm operating system.

The speculation that Dubinsky and Hawkins would reunite with the company they founded in 1992 began earlier this month with the resignation of Palm Chief Executive Carl Yankowski.

“These things kind of fuel the fire,” Jaquet said.

But most analysts contacted acknowledged the difficulties of joining Palm and Handspring.

When Palm spun off from 3Com Corp. last year, the Internal Revenue Service allowed the transaction to proceed without taxes as long as no more than 50% of Palm’s equity changes hands until next July.

The condition prevents companies from spinning off units about to be acquired to avoid taxes. The IRS would have to overturn the ruling for another company to acquire Palm or for Palm to merge with a company of an equivalent size without penalty.

“Consequently, our ability to engage in mergers and acquisitions could be limited,” according to the company’s annual report.

“Essentially, most people view it as one of the stumbling blocks to a successful acquisition of Palm,” said Michael Kim, an analyst with Robertson Stephens.

Although unlikely, a merger might prove beneficial to the companies, some analysts said. In its fiscal first quarter that ended in August, Palm reported operating losses of $38.7 million on revenue of $214 million. Handspring lost $32 million on sales of $61.4 million.

Analysts said a merger would eliminate overlapping services and constant price reductions.

To remain competitive, both companies have discounted prices of new products within two months of their release, said Thomas Carpenter, an analyst with Hilliard Lyons.

“I don’t think Palm views Handspring as a direct competitor,” Kim said. “I think the real competition is Microsoft and the Pocket PC.”

Rather than merging with Handspring, it would make more sense for Palm to divide itself into two separate entities: one to concentrate on the software and another to concentrate on the hardware, said Thomas Sepenzis, an analyst with CIBC World Markets.