Bear Hugging Gateway

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The essential elements of a good bear hug letter are (a) an unsolicited and unexpected demand that a board sell all or part of its business and (b) a demand that they respond to letter in an unreasonably short time. The second point is very important because one of the points of sending a bear hug letter is to make the board jump, to shake them out of their routine. It helps if the letter is a little bit passive-aggressive—nice sounding but subtly condescending.
Lap Shun Hui’s letter to Gateway chairman Richard Snyder has it all. A demand that the board respond within twenty-four hours. A proposal to slice up the company. And to drive home the point, Lap Shun chummily refers to the chairman as “Rick.”
After the jump we give you the full text of the letter.


August 21, 2006
Gateway, Inc.
7565 Irvine Center Drive
Irvine, California 92618-2930
Attention: Mr. Richard Snyder
Chairman of the Board
Dear Rick:
I am very disappointed that Gateway has chosen not to
constructively engage in discussions with me and my advisors on the
proposal that I sent to you on August 3, 2006. I believe that
management and the Board need to adopt a sense of urgency to address
Gateway's problems. The landscape of the PC business has continued to
evolve rapidly and Gateway has not reacted. Gateway's stock price has
continued to decline and the failure to name a replacement CEO for
over six months has left Gateway in a position where it is unable to
clearly and credibly articulate its strategic direction to the market.
I strongly believe that separating the Retail business from the
Professional and Direct businesses is the right strategic direction
for Gateway and the only way for Gateway to enhance its shareholder
value. This belief is primarily driven by the following factors:
-- The Retail, Professional and Direct businesses are very
different. They require different sales strategies, have
separate sales channels and a much different sales cycle and
require very different levels of post-sale support. As a
result, the organizations that are needed to support each of
these businesses are different and the businesses themselves
have different margins and business models. The Direct
business is an impediment to the execution of the retail
channel strategy and the large investment in a service support
organization and server business necessary for an effective
Professional business can not be justified with the Gateway's
margins and lack of scale. They should clearly be separated.
-- Gateway's Retail business is subsidizing its Professional and
Direct businesses. The results of the Professional business
and, to a lesser extent the Direct business, have been
disappointing at best. Given the different business models and
the relatively high levels of capital investment in the
Professional business, it appears clear that Gateway's Retail
business has been subsidizing the Professional business. The
full value of the Retail business, which is the dominant
revenue driver at Gateway, is not being achieved due to the
drag of the Professional and Direct businesses.
-- Gateway has high SG&A expenses due to excess overhead
expenses. Despite a number of efforts to reduce overhead
through restructurings over the last five years, Gateway still
has a cost structure that is too high given the narrow margins
in the very competitive PC business. A separation of the
Retail business would permit a focus on the SG&A necessary for
that business alone and allow for a fuller valuation of the
Retail business.
My August 3rd proposal was to purchase the Retail operations (not
including the Direct operations) for $450 million, on a debt free,
cash free basis, subject to completion of due diligence, including the
identification of the specific assets and liabilities to be
transferred, and documentation. Based on the original purchase price
for eMachines of $262 million, which was primarily comprised of stock,
this represents a premium in excess of 70.0%. If the share component
of the eMachines purchase price is valued at the latest 30-day VWAP
for Gateway common stock, this represents a transaction price more
than 3.5x the value of the consideration received in the eMachines
transaction. With 372.2 million shares outstanding, the per share
value of the offer is equivalent to $1.21 per share (before
consideration of the cash and other assets that will remain at
Gateway), or approximately 80% of the VWAP at Friday's close of $1.54.
This will result in an efficient and quick way to achieve the required
separation of the businesses. Alternatively, if Gateway would prefer a
sale of the entire company, I am also willing to explore a purchase of
100% of the outstanding shares of common stock. That way, I would take
responsibility for separating the Professional and Direct businesses
after the closing through a sale or other transaction, or by
discontinuing those business lines.
Obviously, any such transaction will be complicated and my
advisors have expressed our desire to work together with you to
evaluate our proposal and to identify and solve the issues that must
be addressed to more fully flesh out the proposal and to make the
transaction work for both me and Gateway's other shareholders. As I
have stated, I am prepared to move quickly to arrive at a mutually
agreeable transaction. Given my familiarity with eMachines, which
makes up a large part of the Retail business, I believe that due
diligence will move very quickly. In addition, I am confident that
commitments for the necessary financing for either transaction can
also be obtained quickly. If we work together cooperatively to
finalize a transaction structure and to document the transaction, I
believe that the sale could be completed in the fourth quarter of this
year.
In order to move forward with this proposal, which I believe is
very attractive to Gateway and its shareholders, I request that you
schedule further meetings with me and my advisors to discuss the
details of the proposal, to identify issues that must be resolved and
to work in tandem to solve these issues. I also believe that time is
of the essence. Please respond with firm times to meet by the end of
the day on Tuesday, August 22nd. If I do not hear from you with an
acceptable timeframe for substantive discussions by then, I will have
to assume that Gateway and its Board of Directors do not wish to
discuss my proposal further. In that event, I will not have any
alternatives other than to make public my views on the strategic
direction of Gateway and my proposal. Although I believe that we would
both be better served by working towards a transaction without public
disclosure and the attendant press and analyst attention, I also
believe that the other shareholders of Gateway and the financial
community will enthusiastically embrace my proposal.
Please contact either me or any of my advisors to schedule a
meeting. I sincerely hope that we can work together to arrive at a
transaction that will benefit Gateway and its shareholders.
Sincerely,
Lap Shun (John) Hui

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