Legg Mason's Miller Was Cowed by Gateway, and Got His Bell Rung

This story was updated at 11:45 a.m.

Fresh off a painful profit warning, Gateway(GTW Quote) shares are tumbling and -- wherever he is -- Bill Miller is probably mumbling a blue streak.

The File

Operations

Business: Developer and manufacturer of desktop and portable PCs

1999 Revenue: $8.6 billion

1999 Earnings per Share: $1.36

2000 Estimated Earnings Growth: 36%

Stock Snapshot

52-Week Range: $22.25-$81.5

Percentage Change From Jan. 1: -55.3%

Market Cap: $10 billion

P/E Multiple: 18.7

Shares Outstanding: 323.3 million

Source: Thomson Financial/Baseline.

Miller's (LMVTX Quote)Legg Mason Value Trust is the only fund out there that's topped the S&P 500 in each of the last nine years. Gateway, which warned investors on Wednesday that sagging holiday sales and investment income would keep its fourth-quarter earnings and revenue far short of estimates, was the fund's third-largest holding with a 5.3% position on Sept. 30 -- the most recent portfolio information available on Legg Mason's Web site.

Thanks to its warning, not to mention more bad news from chipmaker Altera(ALTR Quote), Gateway shares were off more than 30% in after-hours trading. Because Miller's fund was down 8% and narrowly ahead of the S&P 500 through Tuesday's close, his index-beating streak might be in jeopardy. Gateway is only 0.1% of the S&P 500, so the fund could lose a lot of ground against the index if it still holds the stock -- Legg Mason didn't return a call for comment on Miller's holdings or current state of aggravation.

It's pretty clear that Miller and his colleagues are believers in Gateway. Of the 10 stock funds with the biggest bets on Gateway in their most recent portfolio reports, five are Legg Mason funds, including Legg Mason Value and (LMASX Quote)Legg Mason Special Investment, a fund Miller co-manages with Lisa Rapuano. And Miller's (LMOPX Quote)Legg Mason Opportunity fund had 5.5% of its assets as of Sept. 30 sunk into Gateway shares, according to a shareholder report filed with regulators this week.

Funds With the Biggest Stake in Gateway
Fund	Percentage of Assets in Gateway	1-Week Return	YTD Return
(FOCTX Quote)Legg Mason Focus	7.5%	-1.2%	-20.9%
(LMASX Quote)Legg Mason Special Investment Prim	6.3	-2.1	-12.5
(LMVTX Quote)Legg Mason Value Prim	5.4	-1.4	-8
(BLUEX Quote)Brandywine Blue	4	-1.4	4.7
(PWKAX Quote)PaineWebber Strategy A	3.6	-0.8	-29.5
(LMALX Quote)Legg Mason American Leading Co Prim	3.3	-0.9	-1.8
(BNLCX Quote)Brinson U.S. Large Cap Equity	3.1	-0.4	-1.5
(TVPAX Quote)Touchstone Value Plus A	2.8	-0.2	-0.9
(NGUAX Quote)Neuberger Berman Guardian	2.8	-0.9	-4.4
(LMTRX Quote)Legg Mason Total Return Prim	2.4	-1.5	-3.7
Source: Morningstar. Performance through Nov. 29.

For his part, Miller downplayed the current pain. "Although we do not typically comment on current portfolio activity, we would note that Gateway is trading at prices last seen in October of l998, a period of great pessimism about the outlook for earnings growth generally. The stock subsequently quadrupled."

While Miller and his colleagues appear to be at the epicenter of Gateway's explosion, they're hardly alone. Nearly 300 stock funds own the stock, according to Morningstar, and in sum, mutual funds own 22% of the company.

It's easy to see why Miller and others were excited about the company, known for customizing PCs for technology-phobes and delivering them in boxes mottled with black splotches to make them resemble cows. Over the past five years Gateway shares have averaged a 35.8% gain, compared to 19.5% for the S&P 500, according to Morningstar.

Big Ups and Downs Gateway's performance has exceeded the S&P 500, on the upside and downside, in recent years
	YTD Returns	3-Year Annualized Returns	5-Year Annualized Returns
Gateway	-57%	30.2%	35.8%
S&P 500	-7.3	13.8	19.5
Source: Morningstar. Performance through Nov. 29.

Slowing PC sales had already hit the stock hard this year, which lost 57% between Jan. 1 and Wednesday. And the company's reliance on consumers in a sluggish economy contributed to this shortfall. After weak sales during the Thanksgiving weekend, the firm made its bleak announcement.

"This combination of a slowing economy and a slowing PC market was really a double-whammy for Gateway," says Joseph Beaulieu, the stock analyst who covers Gateway at Morningstar. "I wouldn't be jumping into Gateway even with the beating it's taking. I'm uncomfortable with the PC market in general right now. That said, Dell(DELL Quote) might be worth a look if it falls far in sympathy, since they're well positioned to get into more lucrative areas like servers and storage."

Because investors haven't needed much reason to sell tech stocks this year -- since Jan. 1 the Nasdaq Composite is down 33.8% and the average tech fund is off more than 29% -- Gateway's troubles will probably hurt most growth funds. Consider that the average big-cap growth fund has more than 43% of its assets invested in tech stocks through this month, according to Morningstar data.

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Though many growth funds have started reducing their stakes in "Old Tech" firms -- those tied to PC sales, as opposed to the Internet -- the PC makers and chipmakers who will fall with Gateway are still a big part of many growth funds. Shareholders of lower-octane value funds that usually avoid tech names might be in for a rude awakening too since many value fund managers have been buying Old Tech stocks this year.

Managers have let fresh cash pile up on the sidelines rather than commit to sagging stocks, but it's hard to see a positive catalyst that will convince them to put that money to work. These stock pickers' apparent reluctance to pick stocks and a flurry of news like this could spell an end to Miller's record, not to mention his and his shareholders' bragging rights.