Special Situation Investing

Wednesday, August 23, 2006

Gateway (GTW) Receives Offer for Retail Division

Computer hardware retailer Gateway (GTW) received a $450 million offer from a private investor for it's retail operations today. From the article:

The founder of eMachines Inc. has offered $450 million to acquire the retail business of Gateway Inc., in a bid that intensified speculation about a possible buyout of the long-struggling PC maker.

To put this into perspective, Gateway ended today with a market cap of $725 million and according to the article:

Gateway's retail operations accounted for $592 million, or 64 percent, of its revenue of $919 million in the second quarter.

Gateway was removed from the S&P500 on July 25, an event which can lead to price discrepancies as institutional investors sell.

So is gateway now a buy? Well let's break the numbers down. Gateway has a $450 million purchase offer for it's retail business divided by a market cap of $725 million. That gives a ratio of .62 or 62%. The retail operations acount for 64 percent of revenue so based purely on sales the company is just fairly valued assuming that the sale goes through.

Realistically, we should also look at earnings as it is possible this is an under-performing division. For that you need to look at the quarterly or annual reports, the quartely reports are accessible here.

The following numbers are from the 2nd quarter, 2006 report.

Retail - This is the unit on which the purchase offer was made

Sales : $592 million, a 21% year over year increase.
Segment Contribution : $17.2 million


Professional

Sales : $250 million, an 8% year over year decrease.
Segment Contribution : -$8.3 million


Direct Sales

Sales : $77 million, a 31% year over year decrease.
Segment Contribution : $9.3. million

So if you sum the segment contributions from the remaining 2 divisions you get $1 million. These numbers can swing either way quarter over quarter but I have a hard time believing that the remaining divisions are worth more than their relative proportion of revenues.

Although Gateway qualifies a a special situation due to it's delisting and potential purchase, it seems that at present it is fairly valued. I don't feel comfortable paying fair value. The computer hardware industry is very tough right now with even ultra-efficient Dell (dell) posting large earnings declines. It seems that this is a business where scale matters and Gateway, with $3.6 Billion in annual sales just doesn't stack up to Dell's $55 Billion. This is not to say that Gateway can't make it or that Hui won't purchase the whole company but at current prices I would prefer to remain on the sidelines.

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