(FORTUNE Magazine) – In the summer of 2001, FORTUNE recommended that rival PDA makers Palm and Handspring set aside their differences and get hitched to split R&D costs and to avoid a price war. More than two years later, after a brief engagement, they finally took our advice. On Oct. 28 not only did the two companies complete their corporate marriage, but they also produced offspring.

That gives adventurous investors two new ways to play Palm. The union of the money-losing handheld-device makers, called PalmOne (PLMO, $16), will continue to focus on hardware. And the Palm division that licenses its operating system has been spun off as a separate software company named PalmSource (PSRC, $35). So which stock should investors bet on?

Either one presents a high risk. After going public and reaching bubble-driven market valuations in 2000, Palm and Handspring spent most of the past few years hemorrhaging money and watching their shares plummet. Palm's stock did bounce back 124% this year after the June announcement of the merger. And shares of PalmSource jumped 39% on its first day of trading. But the key to long-term success depends on whether each can break new ground in the rapidly growing market for "converged" devices that combine the functions of phones and computers.

Industry analysts and executives at both companies agree that the future lies in smart phones. According to Kevin Burden at research group IDC, the handheld-device market--which PalmOne still dominates, with a 38% market share--will shrink by a tenth this year. But the market for smart phones is just beginning to heat up. In 2002 only 3.6 million were sold, but Burden estimates that the number will top 13 million this year and hit 45 million worldwide by 2005.

The early response to PalmSource shares reflects the company's potential for licensing software to PalmOne's rivals in this growing market. As PalmSource CEO David Nagel boasts, "We're the only pure-play investment in the sector." He's right. But PalmSource is facing a roster of competitors that have a habit of trouncing others. That list begins with Microsoft, which has licensed its OS to consumer-electronics makers like Sony, Samsung, and Dell. PalmSource also counts Sony and Samsung as customers, but it does not have Microsoft's deep pockets.

Overseas the competition might be even stiffer. The most popular OS in Europe, which boasts the world's highest concentration of cellphone users, is from Symbian, the company jointly owned by mobile-phone giants Nokia, Ericsson, Psion, and Samsung, among others. Until PalmSource strikes a major international deal, its prospects for profitability remain murky.

PalmOne, meanwhile, is off to a decent start in the smart-phone market. The Treo 600, which was released in October to rave reviews, combines the capabilities of a PDA, a digital camera, an MP3 player, and a cellphone all in one. But is one stellar product enough? "We're fairly optimistic about the Treo 600, but it's in a highly competitive market," says Bear Stearns analyst Andy Neff, who downgraded PalmOne right after the merger was completed. Neff argues that PalmOne is overvalued, since it's trading at a price-to-sales ratio similar to those of Apple and HP, which are profitable and have more stable balance sheets. Nobody said marriage was easy.