Gateway investors skittish ahead of analyst meeting

3 min read

Wall Street was wary about Gateway's prospects Tuesday ahead of the company's analyst meeting. Shares of the PC maker fell as Merrill Lynch downgraded the stock and said the company would probably cut its outlook.

Shares in Gateway (NYSE: GTW) were off 76 cents a share to $17.05 in early trading Tuesday. Merrill Lynch downgraded the stock to "neutral" from "accumulate." Analysts expect Gateway to lower its 2001 financial targets.

The company will be holding its annual analyst meeting in San Diego, Calif., tonight and Wednesday. The official reason for the meeting is the re-introduction of the "new old" management team. In late January, the company's founder and chairman Ted Waitt stepped back in as CEO to get his floundering company back on track. Gateway also replaced its chief financial officer in the management shakeup.

But analysts are expecting Gateway to lower its 2001 targets as a second-half rebound in the economy increasingly looks like a long shot. Meanwhile, Gateway management has said the company will compete in a PC price war, a move that will pressure profit margins.

"We would consider using any strength in the stock around the analyst meeting as an opportunity to exit the shares," said Merrill Lynch analyst Steven Fortuna.

"We think there is a high likelihood that management significantly lowers its EPS (earnings per share) outlook during its analyst meeting this week, well below the current $1.28 Street consensus," Fortuna said in a research note. Fortuna added that he expects to revise estimates after the analyst meeting.

Fortuna said he downgraded Gateway on the presumption that consumer demand is unlikely to bounce back in the second half of the year. In addition, management will need time to retool Gateway.

The stock is now trading at around 15 times 2001 earnings estimates, but if Gateway cuts its earnings outlook "the stock could easily follow it."

Fortuna also prescribed an antidote to Gateway's problems. He suggested that to "renew hope in the Gateway story," Ted Waitt would need to focus on the following:

  • That Gateway is still a hardware company. It needs to show profitable unit growth and resume its reporting of units sold and its growth rate.

  • The company's "beyond-the-box" strategy should be ancillary to Gateway's hardware-focused core. The previous CEO was moving the company "beyond-the-box" far too quickly.

  • Gateway needs to stop expanding its retail base. It should close most, if not all of its OfficeMax locations.

    Fortuna also argued that Gateway needs to view the world as three concentric circles. The innermost circle would include core server and storage infrastructure building blocks. The next would include desktop and portable client PCs. Only in the outermost circle would we find "beyond the box" products and services.

    Gateway also needs to implement these changes soon because "the window is closing in on them," said Fortuna.

    Fortuna wasn't the only analyst expecting bad news. Salomon Smith Barney analyst Richard Gardner reiterated his "neutral, high risk" rating and predicted the company "is likely to reduce earnings guidance for fiscal 2001 below the current consensus."

    "We remain concerned that a Dell-induced price war and high SG&A (selling, general and administrative expense) relative to the competition implies a tough trade-off between price competitiveness and profitability for Gateway near-term," Gardner added. Dell (Nasdaq: DELL) shares were off 31 cents a share to $22.50.

    UBS Warburg analyst Don Young was more optimistic, maintaining his "strong buy" rating.

    "We are maintaining a positive outlook on the stock as Ted Waitt is returning to re-establish Gateway's value leadership position," Young wrote in a research note.

    Though Young was upbeat on expectations that management will outline a more aggressive strategy to establish pricing leadership, he had already cut his fiscal year earnings estimates. The analyst also said he expects "the stock to be pressured as the Street will likely cut estimates to reflect management's new strategy."