Palm, one of the first companies to make handheld devices, sometimes called personal digital assistants (PDAs), had licensed its software to Handspring, which became a strong rival in the market.

"These two bold moves will serve as a powerful catalyst to transform the landscape of the handheld industry," said Eric Benhamou, chairman and chief executive of Palm Inc., based in Milpitas, California.

Benhamou said the deal "will help grow the Palm Economy," a reference to the battle to maintain the Palm software operating system's leadership in response to a challenge by Microsoft, which makes the software for rival PocketPC devices.

The move to spin off PalmSource will create separate companies for hardware and software in an increasingly competitive market.

While Palm and its Palm Pilot PDA once dominated the market in both areas, the company now faces competition from Microsoft in the software area and from hardware makers like Compaq, Dell and Sharp.

In the acquisition, Palm will get Handspring's popular new Treo, which combines a PDA with a mobile phone.

"This is a merger of leaders -- the world's leading maker of handheld computers and a global leader of Palm OS-based smart phones," said Todd Bradley, Palm Solutions Group president and chief executive officer.

The firms expect to realize some 25 million dollars in cost savings annually. The merged company will cut 125 jobs, consolidate manufacturing and move operations to Palm Solutions headquarters in Milpitas.

Under the proposed terms of the transaction, and following the spinoff of PalmSource, Handspring's shareholders will receive 0.09 Palm shares -- and no shares of PalmSource -- for each share of Handspring common stock owned.

The deal brings back to Palm Inc. Jeff Hawkins and Donna Dubinsky, who founded the company in 1992 and then left in 1998 to create Handspring.

"Palm and Handspring share a vision that handheld computers and smartphones have the potential to redefine the landscape of personal computing," said Dubinsky, chief executive officer of Handspring.

Palm was bought in 1995 by US Robotics, which was subsequently acquired by networking firm 3Com. In 2000, Palm became independent again in a highly sought-after spinoff during the height of the technology boom.

The company never achieved the spectacular success some predicted at the time, amid a shrinking market for PDAs and increasing competition. When it went public in 2000 at 38 dollars a share, Palm has a market value of 21.3 billion dollars, with investors anticipating an explosion in the market.

Based on its current share price, Palm is worth some 400 million dollars,

But markets applauded the deal, sending prices of both shares higher. In midday trade, Palm was up 1.73 or 14 percent at 13.88 while Handspring rose 16 cents or 14.4 percent at 1.27.

SG Cowen analyst Rob Stone said the deal by underscores the difficulty faced by smaller tech firms to establish profitable business models, adding that the combined company will "benefit from Handspring's focus on convergence of mobile phones and hand-held devices."

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