Gateway: Picking Fights It Just Might Lose

As it leaks money, it's battling Dell on price and aiming at Apple

No one has suffered from the collapse of Gateway Inc.'s (GTW ) stock more than Ted Waitt, the ponytailed CEO who founded the computer company 17 years ago on his parents' Iowa farm. Just three years ago, Waitt's one-third stake was worth $9 billion. Now, as the company weathers a bruising industry downturn and a nasty price war with Dell Computer Corp. (DELL ), the value of his shares has dwindled to about $400 million. Worse, Gateway's market cap is $1.3 billion--and it has $1 billion in cash on hand. The math is simple and scary: Investors value Gateway at next to nothing.

The slide has left the 39-year-old Waitt battling for share in a down market and pursuing it in the most punishing way. For starters, he's clashing with mighty Dell, among others, in a price war. And on Aug. 26, he launched a nationwide head-to-head TV brand battle against none other than Apple Computer Inc.

Is this guy crazy? No, just desperate. Waitt is fighting like mad to escape a no-man's-land between Dell and Apple (AAPL ). For years he has struggled to establish Gateway as a cult brand, one that could attract hordes of Apple-like devotees. But he's still waiting for Gateway's cows to come home with the cash, leaving him with a mere 5.6% of the U.S. market. To grow, he's making his case to prospective Apple shoppers.

The new ads feature an animated Gateway computer, the Profile 4, doing backflips over an iMac. It touts Gateway as the cheaper alternative, one that's in the PC world. The flat-screened Profile 4 resembles Apple's iMacs, but comes in some $400 cheaper. Analysts say the new Gateway doesn't have enough features to win over Apple loyalists, but it could lure the small niche of PC users contemplating buying Macs.

Even as he targets Apple shoppers, Waitt is slugging it out with Dell in a computer price war. He's inched up in unit sales. But the effect on Gateway's bottom line has been devastating. With year-over-year dollar sales tumbling 33% in a contracting computer market, Gateway's loss in the quarter that ended June 30 nearly tripled to $61 million on revenues of $1 billion. By contrast, Dell is prospering. On Aug. 15, the Austin (Tex.) company beat second-quarter estimates, reporting a profit of $501 million on sales of $8.5 billion, up 11% from last year. "It hasn't been a tough market for us," says Kurt Kirsch, Dell's director of new consumer business. Waitt is hoping that the PC market will recover and rising prices will buoy Gateway before he digs too deep into his cash horde.

The trouble is, Waitt is betting on a recovery that's nowhere in sight. He concedes that to break even, Gateway would need to boost unit sales a mind-numbing 43%--from 651,000 in the second quarter to 933,000--while researcher IDC is projecting a 5% rise in unit sales for the PC industry this year and 10% next year. To turn a profit, Waitt may have no choice but to cut costs further, perhaps by closing many of Gateway's 274 stores. Or he could outsource more Gateway production to offshore manufacturers. "He's at the `Hail Mary' point," says IDC analyst Roger Kay. Waitt, who wouldn't comment directly for this story, denies through a spokesperson that such drastic moves are planned.

As back-to-school sales rev up, Waitt is vowing to keep battling to win market share. But without further cost-cutting, analysts say Gateway could exceed the pretax loss of $200 million to $250 million Waitt is predicting for 2002. "Low pricing is not a sustainable model," says Lehman Brothers Inc. analyst Dan Niles. "Gateway's revenues have been obliterated."

For profits, Waitt is counting on an unlikely source--unprofitable Gateway stores. His strategy has been to use the stores to sell customers a slew of profitable PC add-ons, such as warranties and training courses. Such "beyond-the-box wares" carry gross margins of 38%, vs. 10% on PCs. Trouble is, such sales are actually shrinking, from 19% of revenues a year ago to 17% of smaller revenues in the second quarter.

For now, Waitt is standing by the stores and hoping that his new anti-Apple campaign sparks sales. But every week he puts off radical cost-cutting, he eats deeper into his cash--which is likely to send Gateway's value down even more. And in today's market, Gateway's shrinking pile of cash is practically the only asset investors can appreciate.

By Arlene Weintraub in Los Angeles

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