Path through Gateway just might lead to profits

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Dear Mr. Berko:

I recently moved my account to a great broker at Merrill Lynch. Here’s my problem. I have 600 shares of Gateway computer. I recall buying 100 or 150 shares on the initial public offering but I can’t figure out my basis on the stock because I now have 600 shares and I don’t recall that I bought more shares. Can you tell me what my basis could be?

Now my new broker wants me to sell my 600 Gateway shares. He thinks the stock is “a sinking ship” and that “there’s nobody at the helm to guide it.” He told my wife and me that he advised all his clients to sell Gateway in November and December of 1999 between $75 and $84 a share. I’ve held this stock for so long I don’t think I should sell it. Please advise.

A.J., Erie, Pa.

Dear A.J.:

Goldman Sachs and PaineWebber took Gateway Inc. (GTW – $5.21) public in 1993 at $15 a share. However, if you adjust that price for a 2-for-1 split in 1997 and another 2-for-1 split in 1999, your cost basis was $3.75. Ergo, your original 150 shares, which cost you $2,250 ($15 times 150 shares), are now 600 shares worth $3,126 (600 times $5.21), so you have an $876 gain. If you sell those shares through your new Merrill Lynch broker, you will pay about $91 in costs, which include mailing expenses, insurance charges and commission expenses. Basically, you’ll be up a bit less than $800 after 11 years of being married to GTW.

But if you were as smart as your new broker, who brilliantly had his clients sell GTW in late 1999 at $84, you’d have about $50,000 after commissions and a taxable profit of $47,750.

I know what you’re thinking: “Darn — I wish I was smart enough to have moved my account to this broker five years ago.” Oh well, that’s life!

However, though this broker’s advice in November 1999 was right on the dime, I believe that his advice today may be wrong at the starting gate.

GTW’s March merger with the tremendously successful eMachines Inc. is bringing on some radical, positive and profitable changes. Wayne Inouye, who successfully turned around eMachines, is the new chief executive officer. Since taking over the GTW helm last March, he has closed 183 Gateway retail stores and announced plans to reduce staff from 11,500 to about 4,000 by the end of the year. Inouye’s goal is to lower operating expenses as a percentage of revenues to a single-digit number like 5 percent to 7 percent. At first blush, that might seem impossible, but eMachines did business at that level and Inouye believes he can paint GTW with the same brush.

Huge retailers such as Best Buy and Circuit City have almost zero personal computer options other than Hewlett-Packard. GTW’s established brand name, its extensive product line and excellent reputation should make it easy for Inouye to line up shelf space at many big retailers. Heck, Costco began to carry eMachines laptops at attractive prices and it didn’t take long for those shelves to empty.

Though GTW will maintain the eMachines brand in its low-end product line, Gateway products (including many consumer electronic devices) will still appeal to the mid-range and above consumer. However, in the next few years, the distinction between the two may become a blur.

Gateway closed its retail stores in Europe and Asia to consolidate its revenues in the United States. But eMachines has enjoyed some good successes in the British and Japanese markets and Inouye plans to reintroduce GTW in Britain, Japan and elsewhere in Asia and Europe. Because eMachines currently has facilities in these countries, Inouye can efficiently allocate his foreign resources and still maintain a low cost structure. A smart man, he!

Given the likelihood of signing the likes of Sam’s Club, Wal-Mart, Good Guys, CompUSA, Best Buy, Circuit City and other retailers, the timing might be right to double your GTW position to 1,200 shares. The company still has no debt and still has plenty of working capital. In fact Wall Street reckons that GTW will lose about 44 cents a share this year, but with the new directives in place, GTW should earn 25 cents in 2005 on revenues of $4.6 billion. And by 2008 the Street believes that GTW can ring up over $6 billion in revenues and post a profit of 65 cents to 70 cents a share. At that time, the Street thinks that GTW could be a $15 to $17 stock.

So tell your new broker that you don’t want to sell GTW but rather that you want to buy 600 more shares. It’s a risky play but it’s also a compelling and intriguing stock.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net.