PC Makers Look a Day Late, Dollar Short in Web-Services Push

Gateway's (GTW Quote) 25% stock surge last week pointed to just how highly investors value the direct seller's PC services strategy. Too bad so many other boxmakers have had such a hard time articulating one.

PC companies are falling over themselves to construct services-related businesses in Web hosting and wireless to offset across-the-board declines in PC profit margins. But the services field is a bit more complicated than the box world. Application service providers such as SilverStream (SSSW Quote) and USinternetworking (USIX Quote) already have a head start in this area and are forging ties with "the same companies PC makers have been selling PCs to for years," says Kim Scott, an analyst at Waddell & Reed who doesn't rate stocks.

As Dell (DELL Quote), Gateway, Hewlett-Packard (HWP Quote) and Compaq (CPQ Quote) now rush headlong into these supposedly high-growth hot spots, there are some who question whether the PC industry may be entering the game too late to be a factor.

"This is a fast-moving, Internet-like space that PC companies such as Compaq aren't fast enough for," says Patrick Manning, a hedge fund manager with Perry Capital, who has no current PC positions.

The Song Doesn't Remain the Same

PC companies really had no choice. After a decade-long run of profit margins in the 30%-plus range, the maturing industry has been showing its age of late. Even Dell, that paragon of efficiency, has missed earnings expectations over the last two quarters. This industry-wide push into PC services is therefore seen as the clearest path to growth. Although it's still early, there are companies that are clearly benefiting from their early move into PC-related services (e.g. Gateway) -- and there are those (H-P, MicronPC.com (MUEI Quote)) that are merely talking a good game.

"I have not been able to get a good grip on H-P's e-services strategy," says Scott. "It is the most nebulous part of H-P's business." Waddell & Reed is long H-P.

H-P still hasn't figured out how to make its e-services strategy profitable a year after former CEO Lew Platt launched it with much fanfare. E-services, which the company says will partner H-P with such next-generation leaders as Qwest (Q Quote) and Loudcloud and position itself as a computer services company, doesn't necessarily put H-P out in front on the next technological wave.

In fact, many of the problems H-P incurred from 1997 to 1999 were because the company partnered with too many of its potential competitors. H-P's server strategy, for example, involved selling everyone else's product -- Sun's (SUNW Quote) Unix servers, Microsoft's (MSFT Quote) NT servers and Linux servers. Yes, the 30%-plus jump in H-P's stock this year has been impressive, but it has much more to do with its anticipated summer spinoff of Agilent Technologies (A Quote) than anything else, says Lenny Schuster, a hedge fund manager with Gemina Capital. His firm is long H-P.

H-P officials say investors need to look at its strong partnerships with application service providers, which provide Web hosting-like services to companies. This Web-hosting model gives H-P a recurring revenue stream through a pay-per-use model and opportunities to expand a company's infrastructure, says Nick Earle, chief marketing officer for H-P's enterprise computing division. Since H-P doesn't break out this e-services business, investors can't determine whether this recurring model is accretive.

The PC Services Blueprint

In Gateway's case, the Street has a much better grasp of its non-PC business, which is expected to make up 40% of the company's revenue by the end of 2000. "Gateway's attitude from the start is that the PC sale will allow it to acquire the customer, which is the biggest cost for any tech company," says Andy Neff, an analyst at Bear Stearns, who upgraded Gateway to a buy last week. His firm has done no underwriting for Gateway.

Gateway CFO John Todd tells TheStreet.com its non-PC deals with companies such as America Online (AOL Quote), which took over Gateway's ISP business, and Sun will give the company substantial revenue this year and in the future. Unlike other companies that talk a good PC service game, Todd says 10% of Gateway's pretax profits this year will come from the AOL deal.

Companies that haven't yet managed to crystalize their PC services initiatives -- Compaq, H-P and Dell come to mind -- may have trouble catching up. "For these companies now, the goal is to get as large a share of a company's IT spending as possible. It's going to be a dogfight," concludes Bear Stearns' Neff.