Even in this dreary tech market, some companies look more bedraggled than others. Case in point: computer hardware vendor

Gateway

(GTW)

. The company seems bound to become ever more marginalized, with powerhouse

Dell

(DELL) - Get Dell Technologies Inc Class C Report

threatening to kick sand in its face until it suffocates.

Even after rounds of punishing layoffs that have halved the size of the company, it's still saddled with an operating expense ratio more than twice that of Dell's. The consumer market, from which it draws more than half its sales, remains moribund. And over the past year, Dell has siphoned off precious amounts of its shrinking U.S. market share.

In short, despite the return of CEO and founder Ted Waitt to the helm nearly two years ago, the company hasn't convinced anyone of a turnaround. Gateway has hinted it plans to announce new strategies on the retail front in the coming months.

It had better. Changes are urgently overdue: Gateway hasn't made money since 2001 and Wall Street doesn't see any profits coming from the company for more than a year. At this rate, it's unclear how long the company will survive.

Tell Me a Story Please

Given that outlook, it's no big surprise that the company's shares trade for less than the cash on its books. Analysts say the company has cash of $3.17 per share; Thursday the stock closed at $3.10.

It's lost 70% of its value from its year-to-date peak in January, which was already far below boom-era valuations.

But shares still don't look like a bargain to money managers. "People think of cash value as some sort of theoretical floor value" for a stock, says Mark Schultz, manager of the Vision Large Cap Core fund. "But if a company's going to produce at a loss, it will burn through that cash."

"What I've seen over time is they haven't been able to conceive of, much less execute, an effective competitive response to Dell's challenge," he says. Schultz has no position in Gateway, but his fund owns Dell, he says, because "we look for industry leaders, the people who inflict pain on the likes of Gateway."

There are signs that even Gateway's investors have grown disappointed with the lack of progress. According to August

Securities and Exchange Commission

filings, its largest outside investor, Legg Mason, recently dumped a big portion of its holdings, cutting its stake from about 13% to 6% of the company. Legg Mason declined to comment on the decision.

Other investors have simply stopped paying attention, given Gateway's shrinking market value. "The market cap has kind of fallen underneath our requirements," shrugs John Park, a buy-side analyst at John Hancock, in explaining why he doesn't cover the stock. John Hancock looks for stocks with market caps of at least $2 billion; Gateway's now measures $1 billion.

Gateway did not respond to a request to comment; representatives said its top executives were away attending a retreat.

Rolling Along on Blunder Road

Gateway's troubles aren't just the fault of the economy, but rather reflect its own missteps, says Steve Kleynhans, a vice president at Meta Group. "Dell has growth in the consumer space. There's no reason Gateway shouldn't have done as well."

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When Dell started pushing more aggressively into consumer PC sales about a year ago, it didn't have a strong brand with consumers, he says. But since then, it's managed to steadily gain market share at the same time Gateway has lost it. The No. 4 computer seller, Gateway scratched out a sequential gain of 0.3% in U.S. PC market share in the second quarter -- but at 5.9%, that's still below the 7.2% it claimed for the same period a year ago, according to IDC analyst David Daoud.

Over the same period, Dell grew its share from 22.8% to 27.2%.

Although marketing has been somewhat weak, Gateway gets credit for pricing its computers more competitively since Waitt's return as CEO. The company expects to lift sequential sales and gross margin percentages in the third quarter by keeping prices fairly low. In the second quarter, average selling prices (which include both PCs and higher-margin stuff such as software and Internet service) fell 6% from year-ago levels to $1,414.

But to become profitable again, Gateway will need to boost its gross margins a lot more, while at the same time cutting operating expenses, maintains Needham & Co. analyst Charlie Wolf, who owns shares in the company himself. (He has a hold rating on Gateway; Needham hasn't done banking for the company.) "The blended hardware and beyond-the-box

non-PC gross margins are around 14% or 15%, but it should be more like 17% or 18%," says Wolf.

An Industry Leader -- in Operating Expenses

Meanwhile, Gateway's operating expenses total around 22% of revenue, compared to less than 10% for Dell. "The only way they can become profitable is if those lines cross," Wolf says.

One reason for the relatively high expenses is that Gateway sells some of its computers through a network of 274 stores, in addition to its Web and phone sales. At a time when Dell has reaped big market-share gains on the strength of its direct-sales model, Gateway's retail arm looks anachronistic.

Wolf argues it's not necessarily a misguided strategy, pointing out that it worked when the economy was strong. "To the extent they can consummate

store sales, they have the opportunity to sell other stuff that is far more profitable -- broadband access, software, training, warranties," he says. "To me, they have to stick with the store strategy until death do them part. If they close the stores now, it would be hopeless. Sure, they'd cut expenses, but revenues would implode."

Others contend the retail model simply reflects a flawed strategy. "They carry an overhead that obviously Dell doesn't," says money manager Schultz. "That makes the company difficult to compete

a priori

because they're carrying a much higher cost basis. I think most analysts looking at Gateway ask themselves, 'Why do they persist in this retail strategy?' And the financial results would seem to indicate that the benefits of the upsell are not sufficient to cover the costs of operating the retail network."

Make Up Your Mind

But the retail model is only one of Gateway's weak points. More broadly, analysts condemn management for indecisiveness. Over the past few years, "They flip-flopped in whether to go after market share or to preserve profits," says Megan Graham-Hackett, an equity analyst at Standard & Poor's.

With its renewed focus on value pricing, Gateway now looks bent on the first course. But Graham-Hackett says the company simply can't go head to head with Dell when it comes to price. "They're not going to win that battle. They don't have the cost structure to support that in the long term."

The alternative -- to cut operating expenses further, by cutting more staff -- would likely marginalize the company even more. But at this point, it clearly needs to do something. "Their viability is in question; they need some other strategy," she says.

In better days, rumors circulated that Gateway might be an acquisition target. But nobody expects the company to be bought out of its misery now. The reaction to

H-P's

purchase of Compaq has made clear that investors are very leery of companies increasing their PC exposure.

The signs don't look good. At the end of August, Gateway's CFO said that 2002 revenue would probably come in at the low end of prior guidance of $4.5 billion to $5 billion.

"I think they would have a pretty good shot if the consumer market was at all vibrant, but in my mind it's going to limp along till we get a larger penetration of broadband," says Wolf. "In the meantime, I think the consumer market limps along with zero growth. That obviously puts more pressure on Gateway."