Get Sold: The Prescription for Unlocking Gateway's Value

This was written on April 12th, and was my first original activist idea. I have recently read that distinguished value investors have taken an interest in the stock, and have also argued that the company should get sold.It is my belief that Gateway Inc. (GTW) should be sold to a strategic acquirer as soon as possible as the company has failed to create value for shareholders, which is evidenced by the company’s depressed stock price. Gateway already got in touch with Goldman Sachs (GS) regarding an acquisition back on August 23rd, 2006 to be acquired by entrepreneur Lap Shun John Hui, but the deal has failed to materialize. Rumors also suggest that Taiwanese computer maker Acer may be interested, although Gateway had denied this link.Gateway has significantly lagged the S&P 500 and the Dow Jones Computer Hardware Index, has had poor returns on assets and equity, has not realized any value creation through the acquisition of eMachines, and will struggle to compete against more heavily capitalized, efficient competitors. Gateway’s management does not look shareholder friendly, either. Nonetheless, Gateway has 3 key assets that should make it attractive to a strategic buyer if the company was sold.Destruction of ValueGateway’s share performance and financial performance has been abysmal, and making matters worse, a single customer, Best Buy, accounts for 39% of Gateway’s sales. Gateway traded as high as $23.69 in 2001, before declining to a low of $1.30. The shares currently trade at $2.18 on the NYSE. This represents a 90% destruction in Gateway’s stock price between 2001 to present. The S&P 500 index has risen approximately 18% during this time period, while the Dow Jones Computer Index has returned approximately 12% during the same time period.Gateway’s financials reflect the erosion of value in their stock price. Management has failed to create value by investing in profitable projects. Return on assets from 2001-2006 was, in chronological order, -1.44%, -8.79%, -16.21%, -17.28%, and -11.33%. Return on invested capital has also been terrible, and from 2001-2006 returned -23.89%, -34.37%, -32.55%, -15.16%, -0.44%. Further, competitors have been eating Gateway alive. Sales growth has declined rapidly since 2001, showing the following growth rates in chronological order from 2001-2006: 20.74%, -33.72%, -54.44%, -57.78%, -59.86%, and -34.52%.Gateway’s board of directors and management team also doesn’t seem very intent on creating value for shareholders. After generating net income of 9.64 million dollars, representing a -11.33% return on assets, Gateway’s brilliant board of directors decided to award its start management team with $4.5 million dollars in compensation. New CEO, J. Edward Coleman was paid a 2.7 million dollar signing bonus, while the departing CEO, Wayne R. Inouye was paid a total of $877,977 during the year, which included severance pay equal to 12 months of base salary of $720,000. Meanwhile, the Associated Press reports that in February 2007, Gateway announced plans to cut $20 million to $25 million in expenses and lay off employees. Earlier in 2006, the company announced cuts of $30 million to $35 million and nearly 100 jobs amid declining revenue and flat PC sales. Once again we have a situation where the people most responsible for the company’s poor performance get to stick around in their cushy jobs and make life even worse for shareholders.Attractive AssetsGateway’s 10-k suggests the following three positive developments inside the company that may make the business attractive to a strategic buyer: (1) Award-winning North America-based Tech Support— in 2006, Gateway transitioned all of its customer care operations and support for customers in the U.S. and Canada to North America. As evidenced by the company’s improved performance in a number of third-party service-related studies, this move is paying off. In fact, in the two most recent Technology Business Research [TBR] Corporate IT Buying Behavior and Customer Satisfaction Studies for both desktop and notebook PCs, Gateway earned the number one designation and our “North America-based” approach to customer care was cited as a key factor in both studies. (2) Notebook and Display Sales Growth —in 2006, we continued to experience sales momentum with our notebook products and flat panel displays. Notebook unit sales were up 48% in 2006 compared with 2005 and display sales were up 13% over 2005 sales. (3) New Products —Gateway introduced a number of new products during 2006, including its flagship Gateway FX530 desktop PC line for digital enthusiasts, which has been widely acclaimed for delivering maximum performance and setting new standards for value in this high-end category. With this platform, Gateway became the first major PC OEM to offer warranty support for factory over-clocked processors. Gateway also built on the success of its award-winning 21-inch wide LCD display with a complete line of wide displays at 19-, 22- and 24-inches. Gateway also introduced a number of new notebook products for all sales channels featuring the latest mobile technology. For Professional customers, Gateway’s server line-up was redesigned, offering a new industrial design, enhanced serviceability and remote system management. The company also introduced a new storage area network (SAN) product, which provides enterprise-class storage at an entry-level price without sacrificing performance or reliability. Value CreationGateway operates in the extremely competitive hardware industry, and will continue to struggle to create a competitive advantage and enhance value for shareholders. According to Gateway’s SEC filings, the company aims to compete by being the low-cost producer, although this is hard to justify in reality. In an industry where products are easy to replicate, more heavily capitalized competitors, such as Hewlett-Packard (HPQ) and Dell (DELL), are more capable of competing on cost as they are able to achieve economies of scale, something that Gateway does not enjoy. Gateway will continue to struggle against these larger competitors, and continue its descent that began in 2001. Still, the 3 key assets mentioned in the above section definitely have value, and I believe the best way to realize this value for shareholders is to have Gateway sold to a strategic acquirer.