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TMO Analysis - Gateway and Apple: A Tale Of Two Companies

by , 11:00 AM EDT, September 30th, 2002

Gateway and Apple: A Tale Of Two Companies

In the 1970s Apple Computer created the market for personal computers. Cofounders Steve Jobs and Steve Wozniak brought an egalitarian ideal to the high-tech industry – empowering people rather than institutions to effectively store, retrieve and use information via of a personal computer. Apple's ideal and the company's success as the first modern day high-tech IPO have secured the company's place in American history.

A little less than a decade later, a company called Gateway was founded on the innovative idea of selling computers directly to consumers rather than through retailers and distributors. Gateway's goal was to make a profitable business by reducing the costs of computers to consumers through a direct sales model.

Both Gateway and Apple achieved early success, and both companies struggled as their business models failed to keep pace with changing industrial and economic times.

Soon after Apple released its first mass-produced personal computer, the company created an army of independent resellers who sold Apple products to consumers, small businesses and schools. Working through established retailers and start-up resellers was the only practical way for Apple to adequately sell its products. Computers in homes and schools were not common place at the time and the company needed the support of sales people and knowledgeable resellers in order to successfully sell its products.

At the time Gateway was founded, computers could be found in most schools, small businesses and a large percentage of homes. Personal computers were fast becoming part of the American culture and the needs for and benefits of a personal computer no longer required explanation nor the assistance of more highly paid, presumably better-trained sales people to help consumers make a purchase decision. Apple's costly distribution system and minimum pricing requirements for resellers began to wok against the company. Gateway capitalized on the changing American culture by providing consumers with a more cost-effective way to purchase personal computers.

Although Apple and Gateway were both innovative companies, the manner in which the two companies brought innovation to the PC industry are distinctly different, and each reflect changing times in American culture. Apple forged an industry while Gateway capitalized on a shift in purchasing methods used by the American consumer.

This chart compares the performance of Gateway and Apple stock from about the time both companies became publicly traded. It's interesting to note that for the first few years after Gateway became publicly traded, its stock price traveled a path very similar to the stock price of Apple Computer. In the latter part of the 1990's Gateway's stock began to move significantly higher while Apple's stock price began to fall. Gateway's rise in fortune was directly tied to the release of Windows 95 and the climb to market dominance of Microsoft's ubiquitous desktop operating system.

Apple struggled in the latter part of the 1990's due in part to the fact that it no longer had a conspicuously easier to use operating system than its competitors. Further, Apple misplayed the market by offering older technology at premium prices while its competitors took advantage of the new operating system from Microsoft and cut product costs by using more common components.

In the year before the release of Windows 95, Apple released the PowerPC. Unfortunately, Apple failed to make enough of its newer product as management relied on the company's reputation for innovation to sell products with less powerful technology to consumers and schools. By the time Apple came to grips with its mistake, much of its market had migrated to less costly Windows-based PCs, the company was forced to unload hundreds of millions of dollars of unsold inventory and was compelled to recognize a catastrophic loss. Apple continued to lose money and market share as the company struggled to regain its footing in the industry.

Unlike Apple, which brought to market innovative products through the development of proprietary technology, Gateway's innovative approach to direct-to-consumer sales could be matched by a competitor much more quickly and easily. Unfortunately for Gateway, competitors such as Dell Computer found ways to sell computers less expensively and offered more complete solutions to business customers.

As this stock chart indicates, Dell's focus on efficiency outpaced Gateway's efforts to sell direct to consumers while maintaining a folksy marketing charm. Dell's revenue and profits grew at an accelerated rate compared to Gateway. Dell's stock price soared at a rate that seemed to defy the laws of gravity.

While Apple Computer was busy reinventing itself under the renewed direction of cofounder Steve Jobs -- who returned to Apple following the company's purchase of NeXT the enterprise he founded immediately after leaving Apple in the mid-1980s -- Gateway was opening retail stores in suburban locations. The goal of the retail store strategy was to provide customers with more hands-on help while staying with its direct-to-consumer sales model. The retail stores did not carry computer inventory, but were designed to showcase and demonstrate the company's products to consumers. Gateway's management also pursued a strategy called "beyond the box" in an effort to grow revenue and earnings by providing other services to businesses and consumers. The so-called "beyond the box" strategy was an indication that management no longer saw hardware sales as the source for future earnings growth. Dell had bested Gateway on price and manufacturing efficiency, and Gateway was turning to services as a way to maintain growth and profitability.

At the end of the 1990s Apple was experiencing a corporate renaissance. Steve Jobs and Apple's new management team had successfully cut costs, eliminated unprofitable operations, refocused the company's efforts on award-winning product designs and was poised to release a next generation operating system based on technology purchased in the NeXT acquisition. Fred Anderson, Apple's chief financial officer who had previously served as CFO at ADP during an extraordinary time of growth for that payroll management services company, helped to craft a recovery plan that quickly amassed large quantities of cash. Apple skillfully used tax loss carry-forwards from the 1990s string of large losses and quickly amortized or expensed R&D costs and other assets to reduce the company's tax costs from profitable operations. Apple was not only increasing revenue and earnings, the company had seemingly overnight overhauled its balance sheet. Apple's management team had successfully infused the company with billions of dollars in new cash from highly profitable operations.

As much as the return of Steve Jobs and the release of the popular iMac were turnings points for Apple, the tech industry bust of 2000 had a calamitous effect on Gateway.

Unable to stop the loss of market share to rival Dell Computer, Ted Waitt, Gateway's founder, returned to company in early 2001 in order to salvage the operation he founded fifteen years earlier. Both Gateway and Apple were under the careful direction of people who founded the companies. Apple was started in a garage in Silicon Valley, while Gateway was conceived on an Iowa cattle farm, but was now headquartered outside of San Diego, California. The two companies had developed expansive operations that had to pruned, consolidated and redirected.

Mr. Waitt immediately attempted to cut the company's bloated cost structure and decreed that Gateway was jettisoning the "beyond the box" model in order to focus the company's efforts on profitability from hardware sales. As this C|Net News story from March 2001 attests, Mr. Waitt's decision caught most analysts and investors by surprise. The company had close to 300 gateway Country Stores staffed by people trained to push both hardware products and "beyond the box" services. At the time that story was written, Gateway's shares were trading at a value more than six times that of today.

Gateway soon curtailed its international operations and shut money-losing stores in an attempt to cut costs and reduces losses. The liability for the leases on the Gateway Country Stores weighed heavily on the company's books. In an effort to revive sales at its retail locations, Gateway moved inventory into the stores so that shoppers could purchase hardware products on site, rather than over the phone or the Internet and be forced to wait on delivery.

The performance of Gateway and Apple over the past two years reveals a rather compelling story. As this chart indicates, under the direction of Steve Jobs and his management team, Apple was able reduce the impact of a declining market for PCs on the company's share price. Gateway's share price has continued to suffer from the company's challenges.

Although all the major PC makers have seen their share prices decline over the past two-year period, Gateway's inability to compete effectively on price with Dell and the high costs of the retail store operations has put in doubt Gateway's ability to survive. Gateway has a cash position of about US$1 billion and virtually no debt, but US$400 million of the remaining cash is sourced from AOL Time Warner. The Internet services and media conglomerate holds roughly US$400 million in Gateway preferred stock, subordinating the rights of common shareholders to the assets of the company. The market value of Gateway's common stock now stands at about US$960 million. Less than three years ago Gateway's common stock had a market value of over US$25 billion. Currently Apple has cash and equivalents of roughly US$4.3 billion and a market value for its common stock of approximately US$5.3 billion.

A look at the balance sheets of Gateway and Apple illustrate the successful efforts of Apple's management team to return the storied company to industry glory and the challenges Gateway currently faces, as Ted Waitt endeavors to return Gateway to sustainable profitability. The income statements of Gateway and Apple contrast the performance of the two companies as they each strive for newfound success.

During the latter part of the 1990s, Gateway surpassed Apple Computer in unit sales and revenue. Today, Apple ships more units in total than Gateway and is positioned to overtake Gateway in US sales within the next six to twelve months. Apple generated US$1.43 billion in revenue for the three-month period ended in June 2002 versus revenue of roughly US$1 billion for Gateway in the same three-month period. Apple successfully stopped its loss of market share, and through the development of new and innovative products, reversed the company's revenue slide relative to the market.

Soon after Steve Jobs returned to the helm at Apple he restructured the company's reseller network, reduced the number of outlets authorized to sell Apple products and began a direct to consumer sales push through the development of an online Apple Store, utilizing the WebObjects technology developed at NeXT. Unhappy with the presentation of Apple products at conventional retail outlets, Apple put in place a plan to open its own retail stores. Learning a lesson from Gateway's retail problems, Apple chose high-traffic retail locations in upscale malls close to major urban centers for the company's retail stores. Apple has stocked the retail stores with ample amounts of product inventory, a wide selection of software, and staffed the stores with well-trained personnel. Apple has chosen to limit the number of retail stores it opens. At the end of this year Apple will have about 50 retail stores open for business.

Ironically, it may be Gateway's retail strategy that will hasten the company's demise. Gateway's decision to open almost 300 Gateway Country Stores was a curious departure from the company's low cost approach to consumer sales. Until recently the stores did not carry an inventory of PCs and their locations in suburban strip malls were inconvenient for business executives interested in learning more about the company's "beyond the box" products and services. The number of Country Stores and the cost of the leases on so many suburban store locations significantly raised Gateway's costs of doing business. The company's higher cost structure has made it more difficult for Gateway to compete with Dell and other competitors on price.

Looking at Apple's historical stock chart and balance sheet, Steve Jobs and his management team have successfully returned the company to where it stood prior to management's 1995 and 1996 strategic mistakes. The question for Apple: Can the company regain market share through product innovation and a unique mix of retail and online distribution?

Ted Waitt has not been afraid to make tough decisions. He has worked hard to cut Gateway's bloated cost structure, and curtailed the company's international operations in order to focus the company's efforts on the less costly and more lucrative US market. To management's credit the company has no debt, and executives have strived to preserve what remains of the company's cash. The question for Gateway: Does enough time remain to stop the continuing loss of market share and position the company to grow revenue and earnings while competing with Dell and others on price?

Gateway and Apple: A tale of two companies. One company that has successfully turned back the hands of time and one company in a race against time in order to survive.

If you are interested in Apple's stock, join our forum members in the Apple Finance Boards, a moderated forum for Apple Investors and people who are interested in Apple's financial dealings. For other stories regarding Apple's stock activity, visit our updated Apple Stock Watch Special Report.

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