Investor Group Takes 10% Stake in Gateway

An investment group that targets foundering companies revealed Monday that it had taken a 10% stake in Gateway Inc. as the Irvine computer maker struggles to turn a profit and regain some of its lost luster.

The group -- which includes Harbinger Capital Partners and Firebrand Partners -- disclosed in a Securities and Exchange Commission filing that it plans to work with Gateway management to improve margins and recruit a new chief executive.

Once a technology industry mainstay, Gateway has had its market share and margins eroded by rivals Hewlett-Packard Co. and Dell Inc. Its shares have lost 98% of their 1999 value, and a string of executive departures have contributed to the sense that the No. 3 computer maker is in danger of becoming an also-ran.

“The company is grossly undervalued,” said Scott Galloway, a brand strategist and founder of New York-based Firebrand Partners. “It’s a great brand with huge awareness and lots of goodwill.... But it would be hard to find a brand as strong that’s trading as cheap.”

Gateway’s market value is $569 million. Shares rose 8 cents, or 6%, to $1.53 on Monday. They have plunged from a record high of $82.50 in 1999. The company reported a second-quarter loss of $7.7 million, or 2 cents a share, on sales of $919 million.

“We appreciate that Harbinger and Firebrand share our enthusiasm for Gateway and see strength in our brand, heritage of innovation and prospects for future growth,” Gateway spokesman Dave Hallisey said. “We strive to have an open dialogue with our shareholders and have had a productive preliminary conversation with Harbinger and Firebrand already.”

Needham & Co. analyst Charles Wolf said Gateway long ago squandered much of the goodwill of its early days as a quirky computer maker born in an Iowa farmhouse and known for custom-built systems as well as a knowledgeable and friendly staff. Its boxes are adorned with whimsical black-and-white cow spots.

But founder Ted Waitt left as chairman of the company last year. Waitt was followed this year by Chief Executive Wayne Inouye, who came aboard in Gateway’s 2004 acquisition of EMachines Inc.

Its margins have been squeezed as it has been forced to compete on price with giants such as HP, which has been aggressively cutting costs to vie with the world’s largest computer maker, Dell.

That has driven Gateway’s margins on its computers to 1% to 3%, Wolf said.

Any investment group attempting to revive Gateway’s stock would have to start by improving margins.

“They’ve got to have a plan to increase gross margins,” said Wolf. “It doesn’t matter how much they cut operating expenses. It doesn’t matter if they aren’t earning money on the hardware.”

Richard Shim, a PC-industry analyst at market researcher IDC, said Gateway appeared to be returning to the strategies that made it successful in the 1990s -- investing in technical support and beefing up systems to compete in the more lucrative PC-enthusiast market.

“The challenge in the market right now, it’s very competitive,” said Shim. “A lot of the companies are doing the same things. In some sense, they’re going after the same customer.”

In a letter to Gateway’s chairman and interim chief executive, Richard Snyder, the investor group requested a meeting to talk about how to drive business and build value.

“The motivation for our investment in Gateway can be distilled to one simple thesis; there is nothing wrong with Gateway that can’t be fixed with what’s right with Gateway,” Galloway wrote.

In an interview, Galloway used the analogy of mass-market retailers to describe Gateway’s position in the computer market. Even though it’s consistently No. 3 in the U.S. computer market, it’s the struggling Kmart to Dell’s dominant Wal-Mart.

“They’re trying to out-Dell Dell and it’s not working,” he said. “What we think they need to do is be Target. The Gateway brand has potential to have a strong value offering whose brand is infused with a strong sense of style and innovative design.”