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Gateway May Still Be in Play

The advent of the Acer merger means more focus on the battle for the No. 3 PC spot and Lenovo.

SAN FRANCISCO -- Executives at

Gateway

(GTW)

and

Acer

carried on about the many benefits of teaming up to sell PCs in the U.S., after announcing their $710 million merger Monday.

But for the real significance of the deal, investors may be better off looking to Asia, where Taiwan's Acer and China's

Lenovo

are engaged in a fierce battle for the No. 3 spot in the worldwide PC market.

This rivalry is likely to become even more heated as a result of Monday's deal and may hint that Acer's offer to acquire Gateway is not the end of the story.

According to one person close to the situation, the merger agreement between Gateway and Acer has a superior offer clause, which would allow a third party to swoop in and top Acer's $1.90 a share cash offer.

A likely candidate to make such a move is Lenovo, which has seen its market share increasingly placed under siege by Acer and will be bumped down into fourth place in the PC market if the deal goes through.

A competing bid from Lenovo is "well within the realm of possibilities," according to the source.

A spokesman for Gateway said he could not comment on whether a superior offer clause was part of the deal's terms, as the agreement is not yet public.

Shares of Gateway were up 49.6%, or 60 cents, at $1.81 in midday trading Monday.

Though many investors view the PC market as a competition between heavyweights

Dell

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and

Hewlett-Packard

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, which control more than 35% of the worldwide market between them, there's an equally intense contest for third place underway.

According to market research firm IDC, Lenovo had 8.3% of the worldwide PC market in the second quarter, vs. Acer's 7.2%. While Lenovo's unit shipments jumped 22% in the quarter, Acer's shipments surged by 55%.

Monday's deal appears to be the latest in an ongoing chess match between the two companies.

As a side note to Acer's tender offer to purchase Gateway, the companies also announced that Gateway plans to exercise its first right of refusal to purchase

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Packard Bell

, a European PC maker.

That must have left Lenovo smarting, given that the company revealed only a few weeks ago that it was in talks to buy a stake in Packard Bell.

"That is a huge loss of face for Lenovo, who as of last night thought they were going to be

the No.3

player in the PC market for a long time," says the person close to the situation.

"So you have a Chinese company and a Taiwanese company that hate each other, trumping one another," the source added.

Gateway's right of first refusal for Packard Bell comes courtesy of Lap Shun "John" Hui, who sold his eMachines PC company to Gateway in 2004. When Hui went on to purchase Packard Bell last year, he signed a noncompete agreement with Gateway, giving Gateway the right of first refusal on any subsequent sale of Packard Bell.

Thus, Acer's acquisition of Gateway not only bulks up its presence in the U.S., but gives it the legal weapon to snatch Packard Bell from under Lenovo's nose -- a double coup.

"It does mean that Lenovo has to go back to square one for its European strategy, and they're also facing a much more formidable No. 3 in

the U.S.," says Roger Kay, president of market research firm Endpoint Technologies Associates.

Of course, Lenovo, which had $1.5 billion in cash as of June 30, could respond by stepping up its acquisition activities.

The most likely targets are the handful of Japanese PC makers, such as

Sony

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,

Toshiba

and

Panasonic

, says Kay.

"You look around at the market share, they're the only people that are left," Kay says, although he notes that Lenovo is probably just as likely to focus on growing organically in the wake of losing Packard Bell.

As for Lenovo trying to steal Gateway, and consequently Packard Bell, from Acer with a competing bid, it remains to be seen whether the deal terms would even allow such a move.

Lenovo spokesman Ray Gorman says he cannot speculate on whether the company might make a counteroffer for Gateway.

"We do remain interested in Packard Bell and are reviewing our options. We will have further comment when appropriate," says Gorman.

FTN Midwest analyst Bill Fearnley says he does not expect a competing offer for Gateway to emerge.

"As we said many times before, we believe the clock was running out on Gateway because the Microsoft settlement payments end at the end of FY08, and we believe Gateway's operating margins are negative without those payments," Fearnley wrote in a note to investors Monday.