Gateway Stalked by Dell in Bid to Sell Electronics

POWAY, Calif. — Gateway Inc. Chief Executive Ted Waitt’s latest strategy for turning the struggling computer company around is coming up against a formidable obstacle: industry powerhouse Dell Inc.

Nearly eight months ago, Waitt said he intended to lead Gateway out of its deep losses by diving into the crowded consumer electronics business. The idea was to trade in the 3%-to-5% profit margins of personal computers for the much cushier margins -- as high as 40% -- of video cameras, digital music players and DVD players.

Waitt was looking for a way to reverse Gateway’s money-losing run, which includes 11 of the last 12 quarters and has cost the company $1.8 billion during that period. Gateway began selling plasma television sets last December, and the company said customer response was strong enough that a full-fledged plunge into consumer electronics seemed a sensible move.

Then, in September, Dell said it too would begin selling such electronic devices -- an ominous sign given Dell’s habit of jumping into a market and underpricing competitors.

“Dell is a black hole. Whatever Dell enters, they suck all the profits from everybody else,” said Frank Gens, senior vice president of technology market researcher IDC.

Hewlett-Packard Co. also is mulling over a move into consumer electronics as a way of leveraging its expertise in PC displays. Analysts such as Robert Cihra of Fulcrum Global Partners in New York expect the Palo Alto PC maker to begin selling flat-panel TVs in the coming months.

Even before Dell joined the fray, some analysts were questioning the wisdom of Gateway’s foray into consumer electronics.

“Their competitors have better cost structures and are willing and able to enter any market where Gateway has been able to make money,” said Jason Maxwell, an analyst at TCW Group in Los Angeles, which manages $80 billion and owns 28 million Dell shares.

With Dell in the picture, “I don’t see light at the end of the tunnel,” said Rod Bare, a computer analyst with the equities research firm Morningstar Inc. in Chicago. “If I had to bet my money, I would bet it on Dell, that they come in and squeeze Gateway out of this space.”

It has happened before. Dell vastly reduces overhead costs by keeping virtually no inventory, and its direct sales over the Internet and by phone cut out expensive middlemen. Both enable the Round Rock, Texas-based company to sell computers more cheaply than its competitors.

At Gateway, Waitt insists the company has ample opportunities in consumer electronics, even if it has to compete against Dell.

Dell’s entry “validates our strategy,” he said in his simple office at Gateway’s headquarters in Poway, a relatively affluent suburb about 20 miles north of San Diego. “We knew we wouldn’t have the space for ourselves forever.”

The 50-year-old ponytailed entrepreneur, who founded the company in an Iowa farmhouse 18 years ago, likes to think of the PC as the device to link an array of digital entertainment devices in the home, so offering them in his company’s stores is as natural as selling traditional computer peripherals such as printers and scanners.

So far, Dell’s inroads into consumer electronics have been small. The company sells a 17-inch liquid crystal display TV for $699 and a 30-incher for $2,999, the same prices as Gateway’s models. Dell’s 20-gigabyte MP3 music player is selling for $279, $20 more than Gateway’s comparable model, though the latter includes an integrated FM radio.

Michael Dell downplays his company’s moves into electronic gadgets. They account for only a tiny fraction of the company’s business, which is dominated by computer sales to corporations, universities and government clients.

“Give us some more time,” Dell said in an interview.

Gateway could be feeling pressure from Dell about a year from now, said Chuck Jones, a technology analyst with San Francisco-based Stein Roe Investment Counsel, which manages $8 billion in assets and owns Dell shares.

“My feeling is they’ll eat away at Gateway,” he said.

But Nick Nilarp, an analyst with Fitch Ratings in Chicago, said Gateway was smart to get a jump on electronic gadgets and be first among the computer vendors to develop a new and fast-growing revenue stream.

Gateway got 28% of its $883 million in third-quarter revenue from consumer electronics and other non-PC items, such as installation service, warranties and training. Waitt hopes to boost non-PC sales to 32% of revenue for all of 2004 and to 40% in 2005.

“They have to do it to try and remain a viable company,” Jones said.

Gateway’s 190 retail stores could help. They offer something Dell cannot: the chance to see and feel products before plunking down thousands of dollars for them.

Waitt is betting that Gateway’s sales staff can close deals by demonstrating a flat-panel TV or explaining how a computer and a DVD player can communicate without wires. The company says 70% of its TV buyers have visited one of its stores.

John Sapiente was impressed by the setup when he stopped by a Gateway store this holiday season in Santa Rosa, Calif., to check out the big-screen TVs. Sapiente, a 45-year-old tile setter in nearby Windsor, had visited Best Buy and Good Guys, but he said he felt more confident walking into Gateway’s store.

“You’d tend to think that because they’re a computer company, they’d know the technology better,” said Sapiente, who was prepared to spend $3,000 to $4,000 for a 50-inch TV to watch football and movies.

Investors have rewarded Waitt’s electronics strategy and some tough restructuring moves announced this year, including eliminating 3,200 jobs and closing 82 underperforming stores. The company’s stock has shot up more than 50% since early May, when Gateway plunged into the consumer electronics business. Gateway shares rose 6 cents to $4.54 on Friday on the New York Stock Exchange.

Some experts are optimistic that the share price will continue to climb.

“We believe that the company is an attractive play going into the seasonally strong holiday selling period,” Michelle Gutierrez, an analyst with SoundView Technology Group in San Francisco, wrote in a recent research report to investors. Even after the company reported a $139-million third-quarter loss last month, she upgraded Gateway’s shares to “outperform” and predicted they would rise to $6 within a year.

In any event, Waitt said he was too busy planning other products -- including a music download service similar to one introduced by Apple Computer Inc. -- to lose sleep over what Dell was doing.

“They’re a tough competitor, but we’ve got our own strengths,” he said. “You can’t be too paranoid.”