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Over the last two years I have gravitated towards Gateway (GTW) many a time trying to figure out if it is a turnaround story or a trap. I first got interested in Gateway back in May 2004 when Gateway had just completed its acquisition of EMachines and appointed EMachines CEO Wayne Inouye as the CEO of the combined company.

The stock was then trading at $4 and it looked like Inouye might just be able to turn Gateway around by getting rid of all the Gateway brick-and-mortar stores, working out better deals with suppliers from the far East and making Gateway a lean operating company like Dell (NASDAQ:DELL).

For a while it looked like the story was going to play out like everyone hoped and the stock moved up through the rest of 2004 to close at a peak of $6.92 on Dec 1st, 2004, an impressive gain of over 70%. When reality set in and Gateway continued to lose market share -- thanks in part to the introduction of $349 PCs by Dell -- the stock began its steep descent, losing almost two-thirds its value to close at $2.44 on Feb 13th, 2006.

Last week I looked at Gateway again, trying to fathom whether the company had reached a bottom. At a Price/Sales ratio of 0.24 and forward looking P/E of 13.56, it certainly appears that way. A closer look at Gateway reveals an interesting picture.

On the positive side:

* After many quarters of negative earnings, Gateway has shown positive operating earnings over the last three quarters.
* Gateway posted a 9% increase in revenue in its latest quarter and a small gain in market share from 6.4% to 6.8%
* High insider ownership with founder Ted Waitt holding more than 20% of the company.
* Gateway currently carries $635 million in cash and short-term investments on its balance sheet when compared to $350 million in short and long–term debt.


On the negative side
:

* Gateway’s CEO Wayne Inouye, who was supposed to turn the company around, resigned last week.
* A large portion of Gateway’s positive earnings are a result of the antitrust lawsuit settlement that Gateway reached with Microsoft (NASDAQ:MSFT) in April 2005 where Microsoft agreed to pay gateway $150 million over four years.
* Gateway faces the same cut-throat competition in its electronics business as it faced in its computer business.
* With Inouye’s departure, the strong relationship Gateway has enjoyed with retailers such as Best Buy could be in jeopardy.

The jury is still out on Gateway, and I would rather stay on the sidelines than get embroiled in the company's turmoil.


GTW 1-yr Chart

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Source: Gateway: Turnaround or Trap? (GTW)