Gateway-Acer Does Not Compute

The troubled PC vendor denies it's in talks with Acer, disappointing investors who had bid up the stock on rumors of a deal

For those investors who have been buying Gateway shares on speculation that the computer maker would soon be bought by Taiwan-based Acer, Gateway had a clear message on Mar. 20: Don't get your hopes up.

Shares in Gateway (GTW), the third-largest U.S. PC vendor, have surged 12% since Mar. 13, when Acer Chief Executive JT Wang was quoted as saying he planned to make an acquisition in the PC industry this year. The comments fueled speculation that Gateway is a target. At the Mar. 20 closing share price of $2.38, Gateway would be a bargain for Acer. And Gateway would give Acer a beachhead in U.S. retail. "Acer dominates the notebook market in Europe but has had a hard time in the U.S.," says Roger Kay, president of Endpoint Technologies Associates. "Gateway is widely known and a fairly well-liked brand that has a good national standing in the U.S, but no presence to speak of outside the U.S. And Acer has been lusting for an acquisition target for some time."

Acer may need to direct its lust elsewhere—at least for now. "While it is company policy not to comment on rumor and speculation, in light of continued reports surrounding Acer's plans for an acquisition in 2007, I can confirm that Gateway is not in negotiations with Acer," said Gateway spokesman David Hallisey. "Instead, we remain focused on the business at hand and continuing to deliver high-quality products and superior service and support to our customers worldwide."

Cash and Burn

Based on Gateway's recent performance, Acer may want to keep its distance. Gateway, which reported $9.6 million profit on sales of $3.9 billion for fiscal 2006, has struggled with a near constant state of turnaround since its acquisition of the privately held eMachines in 2004. Having shuttered its Gateway Country stores and focused primarily on retail sales through vendors such as Best Buy (BBY), Circuit City (CC), Wal-Mart (WMT), and CompUSA, the company has sputtered against more successful giants Dell (DELL) and Hewlett-Packard (HPQ).

Gateway has some $416 million in cash, which would be enough to meet expenses for a year or so, but it has been burning through cash at a troubling rate. It exited the 2004 fiscal year with $643.5 million in cash, and finished 2005 with $585.7 million, despite having slashed its selling, general, and administrative expenses by more than $630 million during the same period, from $909 million in 2004 to $274 million in 2006. And more cuts are coming: CEO Ed Coleman said in a conference call on Feb. 8 that another $25 million in SG&A expenses will be squeezed out of Gateway's operational expenses in 2007.

Time to Sell?

But cutting operating expenses doesn't buy growth, and there Gateway's options are limited. Hence the enthusiasm by shareholders for an acquisition. Analyst David Bailey of Goldman Sachs (GS) said that the current quarter will be a mixed bag, marked in part by some sales pickups related to the release of Microsoft's (MSFT) Vista operating system, but offset by stalled sales during January, prior to the Vista launch. "Gateway remains in turnaround mode and will need to show sustained improvement in profitability and top-line growth to break out of its $1.50 to $2.50 trading range," Bailey wrote in recent research note.

Gateway is unlikely to be a willing seller near these prices, says Matt Kather, an analyst at W.R. Hambrecht. "Near term I'd be surprised if anything happens, given how depressed the stock has been," says Kather. "What's really wrong with Gateway is that it (has) too much costs and too large a head count for a PC company in the retail business."

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