The deal comes against the backdrop of dwindling demand for handheld devices. Both companies posted losses in the latest quarter and are projecting mounting losses in the current quarter.

Global shipments of handheld devices fell 21 percent in the first quarter, according to research firm International Data Corp., reflecting the decline in technology spending by corporations.

Alex Slawsby, an analyst for market research firm IDC, said of the Palm-Handspring deal, "It's something that has been rumored. It's one of the hottest things to speculate on and it has been that way for years now.

"It finally got to the point where Handspring was making progress in the direction of telephony and data -- what we call converged devices. I think those really fit in with Palm's goals of improving its telephony presence."

The acquisition of Handspring will bring Donna Dubinsky and Jeff Hawkins back to Palm. The pair were Palm co-founders in 1992 but left in 1997 to form Handspring, making products that competed head to head with Palm.

Palm's board also approved the spin-off of its PalmSource unit, which makes the operating software for Palm's handhelds. Following the spin-off, Palm will swap 0.09 share of its common stock for each Handspring share.

Palm plans to issue 13.9 million common shares to Handspring holders. Based on Palm's Tuesday closing price of $12.15 on the Nasdaq stock market, the deal would be worth about $169 million.

It was unclear how Palm shares would be valued after the spin-off of PalmSource.

The combined company is expected to cut 125 jobs and expects $25 million in annual cost savings.

Eric Benhamou, current chairman and chief executive of Palm, will be chairman of both PalmSource and the combined company. Dubinsky, Handspring's CEO, will be a director of the combined company.

Todd Bradley, president and CEO of Palm's solutions group, which makes the handheld devices, will become president and CEO of the combined company. Hawkins, Handspring's chairman and chief product officer, will become the chief technology officer of the new company.