No matter how well the Pre performs when it launches next month, Palm Inc. (PALM) shareholders are bound to be disappointed.

The palpable demand for the smartphone - on which Palm has pinned much of its hopes - won't be enough to overcome the hype already fed into Palm's share price, up tenfold from its December low. The high expectations are likely to lead to a stock price retreat, mirroring the double-digit percentage sell-offs seen after the releases of other notable new smartphones.

"Palm's current share price implies the company can walk on water," Needham & Co. analyst Charles Wolf said in his downgrade of the stock to underperform from hold. "We don't think it can."

The launch does carry some risks: the Pre likely has a small window to make a splash before other high-profile smartphones debut; supply issues may mean potential new customers could get turned away empty-handed; and Sprint Nextel Corp.'s (S) poor service reputation may be a deterrent.

Regardless, the strength of the Pre and its underlying operating system - which will likely be used to create a line of smartphones for other carriers - is expected to help turn around the company's fundamentals. Analysts see Palm posting a loss for the next two fiscal years with revenue nearly doubling during that period.

Expectations for Pre sales are wide-ranging because few actually have seen it yet. Most people's experiences have been limited to fleeting glimpses at trade shows, blurry spy shots and a cameo in recent Sprint ads.

Macquarie Securities analyst Philip Cusick estimates that Palm and Sprint will sell 1 million devices a quarter and 6 million in fiscal 2011. Needham & Co.'s Wolf said that to justify Palm's valuation, the company will have to sell more than 10 million in 2011.

In comparison, AT&T Inc. (T) said the iPhone sold 2.4 million units its first quarter. Matthew Thornton, an analyst at Avian Securities LLC, estimates that close to a million Blackberry Bold units sold through AT&T in its first full quarter, while Verizon Wireless, jointly owned by Verizon Communications Inc. (VZ) and Vodafone Group PLC (VOD), sold 2 million Blackberry Storms. Both AT&T and Verizon Wireless, however, have a much larger base and are able to sell more phones than Sprint.

Sprint and Palm declined to provide their own internal estimates.

Palm's stock price reflects a healthy dose of optimism - maybe too much for some as the stock already has slid 17% from its peak last week.

Shares are poised to fall further once the Pre is released. In the weeks after the last iPhone was launched last July, Apple Inc.'s (AAPL) stock fell more than 13%. Shares of Research In Motion Ltd. (RIMM), after unveiling the Bold in November, lost about a third of their value in the following month.

Apple remains well off its pre-launch levels, although RIM has rebounded.

While Apple and RIM were able to overcome any launch-related problems - for example, RIM's Storm had shortage issues - that may not be the case with Palm, which is fully dependent on the success of the Pre for its survival. It can ill afford a botched release of the phone.

The Pre also needs a strong start because Apple is expected to release its next iPhone in the summer, RIM is expected to launch several new Blackberrys and new phones using Google Inc.'s (GOOG) Android operating system are slated to show up later in the year.

"The second half of 2009 will prove to be the most competitive smartphone market ever," said Hugues de la Vergne, an analyst at research firm Gartner.

In addition, there are hints that, like with the Storm, supply may be an issue. Sprint Chief Executive Dan Hesse said he expected shortages in the early days of the launch, and speculation is that one of the main retail partners, Best Buy Co. Inc. (BBY), may only get a limited supply of phones.

Sprint and Palm declined to comment on the potential shortages.

Finally, the partnership with Sprint may limit its market. Despite improvements, the carrier still suffers from the perception that its customer service is poor. It has lost more than 6 million contract subscribers in the last year and a half, and is expected to lose another million customers this quarter.

Sprint hopes the Pre will be its halo product, drawing new customers as well as keeping existing subscribers. It's unclear how many people are willing to get past Sprint's reputation to get their hands on a Pre.

"Sprint may have more difficulties in getting new subscribers to switch operators due to customer perception than AT&T and Verizon have had with the iPhone and the Storm," de la Vergne said.

-By Roger Cheng, Dow Jones Newswires; 201-938-2020; roger.cheng@dowjones.com

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