Acer Buys Gateway, and Maybe Packard Bell, Too

Published: August 29, 2007

by Timothy Prickett Morgan

The consolidation in the IT industry may be slowed somewhat from the financial jitters the world's economies are suffering from, but that doesn't mean that companies are giving up on acquiring rivals to extend their reach and future potential to wring profits from customer bases. Taiwanese PC maker Acer has made no secret about the fact that it wants to be a dominant player in the PC racket. Which is why the company is going to shell out $710 million to buy American PC maker and the original direct PC suppler, Gateway.

The tender offer, announced on Monday this week, for $1.90 per share will be in place within 10 days, and will be in effect for 20 business days, subject to extensions if Acer feels compelled to do so. If the company gets 90 percent of the shares this way, it is a done deal; if it gets over 50 percent, the process gets a little more complicated and takes time. Acer is hoping to have the Gateway acquisition done by December 2007. The Gateway board of directors has approved the deal, but it is unclear if the institutional investors and Ted Waitt, Gateway's founder and one-time chairman who owns more than 12 percent of the shares, are behind the Acer deal.

On a conference call with analysts, Gianfranco Lanci, Acer's president, explained that the main reason for acquiring Gateway was to expand the Gateway brand outside of the United States and to get more market share in the United States PC market than Acer by itself currently has. According to JT Wang, Acer's chairman and chief executive officer, the companies have been in discussion for about a month and a half. In March of this year, after Wang had been musing about making acquisitions, Gateway was quick to deny that it was in talks with Acer.

And, as part of the bargain, since Gateway claims to have first refusal on a deal involving the sale of French PC maker Packard Bell, Acer could also beat out Chinese PC maker Lenovo to acquiring Packard Bell. Lap Shun Hui, the Chinese entrepreneur who started a PC company called eMachines, which Gateway acquired in 2004 for $30 million in cash and 50 million shares (valued at $236 million at the time), acquired Packard Bell from NEC in October 2006 for an undisclosed sum. Before he did that, Hui offered $450 million to acquire Gateway's retail operations; Gateway turned the offer down.

Earlier this month, Lenovo admitted it was in discussions to buy Packard Bell in an effort to take on Hewlett-Packard and Dell in the PC business, and to put some water between itself and its Taiwanese rival, Acer.

With the acquisition of Gateway, Acer climbs past Lenovo to become the number three supplier of PCs worldwide, with $15 billion in revenues (2006 calendar) and with more than 20 million PC shipments a year (estimated for 2007). Lenovo moved into the number three spot in PC sales by shelling out $1.25 billion for IBM's PC business in December 2004.

If Acer is able to get its hands on Packard Bell through Gateway, it can boost PC shipments to 25 million a year, according to Lanci. "We think this will be closed very, very soon," explained Lanci, referring to Gateway's ability to take over Packard Bell. If, for some reason, Gateway cannot acquire Packard Bell, Lanci said that Acer would continue its acquisition of Gateway. Further complicating the deal, Ed Coleman, Gateway's chief executive officer, said that Gateway will continue with talks with yet another third party that is interested in acquiring Gateway's professional business for an undisclosed sum. The Acer takeover is also not contingent on that sale, since neither Gateway nor Acer are interested in corporate sales at this point, but rather want to focus on consumers.

According to Wang, Acer intends to maintain the three PC brands the combined companies have--Gateway, Acer, and eMachines. This is the first time Acer has carried multiple brands. And it is debatable whether or not this strategy can last over the long haul, regardless of brand recognition value. It is hard to imagine Acer behind able to differentiate three different lines in one retail outlet and getting shelf space for all three. It is far easier to imagine a single set of machines with different brands in different retail outlets in different geographies--all basically the same boxes.

Over the past three years, Gateway has been able to grow a little, nearly hitting $4 billion in sales in 2006. But the company has been losing money, or living on razor-thin margins if you want to be generous and not count restructuring charges or the income tax refunds the company received in 2006. Prior to the announcement of the Acer deal, Gateway's market capitalization was hovering around $315 million, making the Acer offer reasonably generous. As the market closed on Monday, Gateway's shares were trading at $1.81 a share, giving it a value of $452 million. Between mid-2003 and early 2005, Gateway's shares were trading close to $7 a share, giving the company a market cap of around $1.7 billion. And don't even remind any Gateway shareholder about the time when the company's shares were in the $80 range in the late 1990s. The recession early in this decade hurt Gateway disproportionately compared to its rivals in the PC space.

According to Lanci, the Gateway acquisition will be accretive to Acer's earnings, and after initial due diligence, the two companies have identified $150 million in cost savings, mostly due to lower component costs because Acer becomes a bigger player and because of other unspecified supply chain optimizations.

If Acer had already owned Gateway in the second quarter of this year, it would have had 8.8 percent of worldwide PC market shipments, and a PC unit shipment growth rate of 36.1 percent, according to data from Gartner. Lenovo had 7.9 percent of shipments, with 22.3 percent shipment growth in the quarter, giving it the number four slot in this hypothetical ranking. In notebooks, Acer plus Gateway had 15.7 percent share, compared to 8.3 percent for Lenovo, and even ahead of Dell's 14.6 percent share of notebook shipments. Acer is still far behind Dell in overall PC shipments, since Dell accounted for 14.8 percent of shipments, but Dell actually shrank by 5.5 percent, thanks in no small part by images of exploding laptops on the Internet. HP is, of course, the shipment leader in PCs, with 18 percent of shipments in the second quarter, up 36.9 percent, and 20.9 percent share of the notebook space.

Gateway did about 92 percent of its $4 billion in sales in North America, while Acer does a little more than half in Europe with the remaining two quarters split between North America and Asia. When you combine the 2006 financials for the two companies, you get a $15.2 billion company with 43 percent of sales in North America, 39 percent in Europe, and 18 percent in Asia.

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