Can Gateway Reach Greener Pastures?


By Sarah Lacy When Wayne Inouye stepped in as long-struggling Gateway's CEO in March, investors applauded. The former chief of low-cost computer maker eMachines, which Gateway (GTW) acquired for about $250 million last March, has a reputation for keeping an eye on the bottom line. So it was no surprise when he cut headcount from 8,500 to 2,000.

He also dumped Gateway's 200 retail stores and scaled back a pricey plan to get into the consumer-electronics business. And he got Gateway PCs onto the shelves of nearly every major U.S. chain, including Circuit City (CC), Best Buy (BBY), CompUSA, Office Depot (ODP), and Micro Center.

Now comes the hard part: Satisfying Wall Street's expectations in a competitive market that's only going to become tougher. Investors already appear skeptical that Inouye has a follow-up punch to his cost-cutting. As of Dec. 27, Gateway's share price is up just 13%, to $5.84, since the day he stepped in.

HARD FIGHT. Why the investor skepticism? Many figure Inouye has to string a few profitable quarters together before Gateway can be declared a saved company. He didn't exactly enthuse Wall Street with a Dec. 15 warning that sales in the first quarter of 2005 should be down 15%, from around $1 billion in the fourth quarter -- a bigger post-holiday hangover than in past years.

Gateway's fourth-quarter profit figures are confusing because of a preferred-stock buyback. The outfit should earn $13 million to $15 million in profits, but earnings per share could see a big jump once the PC maker retires shares it's buying back.

It won't be easy to keep that profit up while trying to make headway against Dell (DELL) and Hewlett-Packard (HPQ). The former is the master of direct sales over the Internet, and the latter dominates retail shelf space. Inouye must ensure Gateway squeezes between the two.

COW-PATTERNED EDGE. Furthermore, the PC market is a tough place to turn a profit these days. In November, market researchers at Gartner predicted that 3 of the top 10 PC vendors would exit the market by 2007. On cue, IBM (IBM) sold off its PC division to China's Lenovo (LNVGY) in early December.

Problem is, businesses aren't buying PCs the way they used to. A rather tepid replacement cycle may already be over. And any seasoned PC veteran knows what comes next: Price wars. All this as Gateway homes in on PCs.

Gateway still has a lot going for it. It has a strong brand name and just launched a TV ad campaign that takes advantage of its well-known cow-patterned boxes. It also has $550 million in cash with no debt. And retailers hope Gateway will stick around to keep HP honest and give buyers more options for PCs in the $700 to $1,200 price range, says Stephen Baker, an analyst at NPD Group.

GLOBAL EXPANSION. Certainly, Inouye's cost-cutting at the Irvine (Calif.) company went off better and faster than most had hoped. "In a short time, Gateway has done a tremendous amount to restructure itself so that it's much more likely to survive," says Leslie Fiering, Gartner's vice-president for research. She credits the old eMachine management team that came over with their boss.

Inouye's next move will be to find a way to get his outfit growing again. He's already getting started. The Gateway brand was relaunched on Dec. 2 at a press conference in Tokyo, where eMachines has had a strong presence. It will sell both brands through four Japanese chains.

Likewise, on Nov. 22, Gateway announced it would sell eMachines in Mexico for the first time, where it has retail distribution. Expect more international deals as the year progresses, likely in European countries where eMachines already has PCs in stores.

MEDIA FORAYS. Gateway is also going after American sales, says Ed Fisher, the computer maker's senior vice-president for product planning. It's trying to beef up sales to government and higher education customers while elbowing in on its competitors' corporate business.

A return to consumer electronics isn't out of the question, either. While Gateway has abandoned DVD players, digital cameras, and other products where it didn't have much advantage over competitors, it has kept a toe in the electronics market with its flat-panel TVs and new MP3 player, meant to rival Apple's (AAPL) iPod Mini. It's also selling a so-called media center PC that's specially designed for digital entertainment.

Will all this be enough to increase market share as the PC replacement cycle slows? Inouye's successes at Gateway so far -- while impressive -- are merely a prelude to his real management challenge. In the coming year, investors will know whether the computer maker is on the rebound or just another one-time star, destined to fade into obscurity. Lacy is a reporter for BusinessWeek Online in the Silicon Valley bureau


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