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 THE STAT 26Percentage of wireless customers who use their cell phones to take picturesMore Vitals
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NOVEMBER 4, 2003
For Investors, a Gateway to What? [Page 2 of 2] RETAILERS' EDGE? While Gateway has grabbed the No. 1 spot in sales of plasma TVs in the U.S., its success could be short-lived. Dell is expected to release its own line of flat-panel TVs in the fourth quarter. Taiwan manufacturers are moving in as well. And prices of plasma TVs have dropped 30% this year as competition has intensified. What's more, Gateway faces a formidable fight from retailers. Today, Wal-Mart (WMT ), office-supply stores such as Office Depot (ODP ), and even drugstores sell consumer electronics. More significant is the competition from long-time electronics retailers such as Best Buy (BBY ) and CompUSA. They may have an edge over Gateway because they attract more customers under 35, who are the biggest buyers of gadgets, says Tom Edwards, an analyst with market consultancy NPD Group. About 40% of Best Buy's customers are younger than 35, vs. 30% for Gateway, he says. Gateway claims it isn't worried: "Our salespeople are more knowledgeable," says Chief Financial Officer Rod Sherwood. "They can demonstrate how the products fit together," he argues, while most retailers can't. Plus, he figures, Gateway's new stores -- which are fashioned like living rooms, complete with couches and fireplaces (the layout was designed by the same exec who created Starbucks' look) -- allow for better presentation. That's super-important, since 94% of consumer electronics are sold through retail stores. RELUCTANT BUYERS. Gateway won't enjoy this advantage for long, however. Already, retailer Circuit City (CC) is remodeling its stores to better demonstrate consumer electronics. Best Buy is pilot-testing its "digital living stores" in Arizona -- an approach similar to Gateway's. And Gateway's edge is blunted by the fact that only a handful of its 185 stores have been thoroughly remodeled, while the others simply received a facelift, say analysts. The other obstacle is that no company has yet been able to persuade consumers to interconnect their digital devices, says Roger Kay, a vice-president at tech consultancy IDC. Most still have no desire to transfer filmed images from their cameras to their PCs to edit -- even though companies such Apple (AAPL ) have pushed this idea for months. "There needs to be a lot of evangelism," says Kay. And Gateway might not be able to afford that -- or to become a well-known consumer-electronics brand, says Fearnley of FTN Midwest. CFO Sherwood disagrees. "Our research shows that Gateway has a broadly recognizable brand in the PC arena," he says. "And Gateway is quickly becoming associated with new, innovative digital cameras [sales of which grew 500% between August and September]. So this extension into consumer electronics hasn't been a problem, and I think the brand is extending well." DROOPING MARGINS. Even so, Gateway still faces the daunting task of resurrecting its PC business. Even as overall PC shipments in the U.S. rose 19% in this year's third quarter, Gateway's market share fell to 3.4%, from 5.5% in 2002, according to market consultancy Gartner. To stem its losses, it has outsourced manufacturing and streamlined distribution. Still, pricing pressure and rising component prices have reduced Gateway's gross margins on PCs to 3.8%, estimates Charlie Wolf, an analyst with Needham & Co. -- hardly enough to support a sustainable business. In fact, PCs are the one of the key reasons why Gateway's overall gross margin declined from 17% to 14% from this year's second quarter to the third. Another thorn is the ongoing Securities & Exchange Commission investigation into its past accounting practices. The SEC is investigating Gateway's revenue recognition relating to America Online (TWX ) services it bundled with new computers. It has already restated its earnings for 2001, 2000, and 1999. Thus, most of the restructuring charges are behind Gateway, says SoundView's Gutierrez. And Gateway says its shipments of notebook PCs -- its most profitable computer category -- grew 22% in the third quarter vs. the second. Moreover, it expects consumer-electronics sales to double in the fourth quarter vs. the third. If so, that gives Gateway a window of opportunity. The question is whether it can move adroitly enough in the face of stiff competition to take advantage of it. Only investors with an appetite for adventure may want to risk their money finding out.
 By Olga Kharif in Portland, Ore.
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