Experts: Gateway Is Ideal Takeover Target

Picking a potential merger or acquisition target in any sector is a bold strategy. But International Business Machines Corp.'s $1.25 billion sale of its PC business to China's Lenovo Group Ltd. suggests that more deals may hold the key to further profit growth in this commoditized industry. Experts think 2005 will be a tough year for PC sales.

Gateway is the third-largest PC maker in the United States by units sold and is starting to recover from a rough few years of declining sales and losses. Its brand remains strong -- New York consultant Brand Keys Inc. rates Gateway's customer loyalty in such company as Hewlett-Packard Co. and IBM -- at a time when some Asian PC makers are looking to mesh their manufacturing muscle with tried-and-true U.S. brands.

Detractors say Gateway's stock is too pricey for a takeover now that it's back in the black, but others think a buyer could still find some savings in the business. In short, in a market where there are so many personal computers, Gateway's PCs could become cheaper yet.

Industry experts think the three most likely bidders for Gateway are Taiwan's Acer Inc., Lenovo and South Korea's Samsung Corp.

Lenovo says expansion in the U.S. consumer PC market is part of its long-term strategy while it's focused on integrating the IBM PC business. Acer says it's sticking with internal growth plans in the United States, for now. Both declined to comment on any MandA speculation.

Acer is the world's fifth-largest personal computer retailer and No. 1 notebook company in Europe. It has said it wants to expand in the United States, so Gateway's strong brand might help it. Meanwhile, Lenovo might be interested in picking up some consumer PC business if it can successfully integrate IBM's corporate, government and education PC operations.

Samsung, the world's largest memory-chip maker and a top flat-panel supplier, lacks a brand in the United States or Europe.

Gateway's shares reached a 52-week high of $6.92 on Dec. 1, after it said it will sell its PCs through retailers in Japan. By mid-month, shares were lower as the market reacted to the company's fourth-quarter and 2005 earnings views and its plan to offer $250 million in convertible senior notes.

Gateway's shares finished unchanged at $5.94 Wednesday on the New York Stock Exchange.

The third quarter was the first in several years in which the Irvine, Calif.-based company showed a profit.

For the turnaround, many credit Wayne R. Inouye, the former chief executive of eMachines Inc., who took the reins from Gateway founder Ted Waitt in March when Gateway bought eMachines. Inouye cut costs, outsourced manufacturing and service, developed sales relationships with major retailers and expanded Gateway's geographic reach.

The result is an expected annual profit for 2004, something Gateway hasn't had since 2000 -- when sales were $9.25 billion. This year, Gateway's sales are expected to be $4 billion to $4.25 billion.

Inouye declined to comment on whether Gateway could be a takeover target.

Needham and Co. analyst Charles Wolf doesn't buy the takeover talk, dubbing it ``a greater fool theory.'' He said Gateway is barely profitable and already has low-cost manufacturing.

But IDC industry analyst Roger Kay thinks Gateway should seek ``some exit strategy for the whole company, to sell it to somebody else.'' (Gateway has a financial relationship with IDC). Kay said Gateway's not big enough to get the best component prices, and suitors would like its strong U.S. position and well-run supply chain.

Further evidence of Gateway's recovery will attract Acer, Lenovo or Samsung, Kay predicts: ``If you matched up Acer and Gateway, they would work out.''

Acer is breaking into the United States with a model it found successful in Europe: an emphasis on using resellers and distributors in the small to medium-sized business market. In the United States, however, it has avoided the consumer and retail areas, so far. Gateway's brand could add a strong consumer business to Acer's growing success in the U.S mid-market.

Samsung, says Kay, is flush with money, a big component supplier and has no brand in the United States or Europe, despite being the eighth-largest brand in Asia.

Smith Barney analyst Richard Gardner sees some benefits to an Acer-Gateway deal but thinks notebook sales give Acer ample growth opportunities for now, so he doesn't expect Acer to step up until 2006.

Rob Enderle, principal analyst at Enderle Group of San Jose, Calif., also finds Gateway shares expensive, but anticipates increased pressure to consolidate in 2005 as PC sales fall and consumers put off purchases ahead of Microsoft's new operating system release in 2006.

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