One Year Later, Gateway's Gumption Pays Off

Gateway's efforts to move beyond the PC have come to fruition. Its shares are up 76% year to date.
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Last September,

Gateway

(GTW)

was in the doghouse. Amid declining computer prices, there was concern on Wall Street that the company was wrongly focusing on a retail channel instead of improving its direct-sales model.

Even worse, Gateway was coming off a horrible second quarter when it missed its earnings estimate by 6 cents a share -- 38 cents a share vs. an expected 44 cents -- without giving any warning to the Street. Unhappy about the negative surprise, analysts downgraded the stock en masse and helped send it down 21%.

Institutional investors were concerned about a management that was not communicating with the Street. The stock then was heading toward a 52-week low of 18 1/16.

"We didn't know what Gateway's revenue and

earnings per share numbers were going to be, and I don't think management knew either," says Kurt King, managing director at

Banc of America Securities

, who has a buy rating on Gateway. (King's firm has not performed underwriting services for Gateway.)

Today, shares of Gateway are up 76% year to date, and many credit John Todd, the company's CFO, and Jeff Weitzen, its president and COO, for the turnaround. With its stock hovering around 45, Gateway has succeeded in proving the skeptics wrong and staying on Wall Street's good side. In its latest quarter ended June 1999, Gateway's net income jumped 46% to $89 million from $61 million in the prior-year period. Business sales in the company's Country stores -- three new stores open every week at a cost of around $650,000 per store -- have doubled this year, says Jim Lucas, Gateway's vice president for commercial sales.

Todd, who joined Gateway last October from

AlliedSignal

(ALD)

, and before that

Pepsico

(PEP) - Get Report

, brings a new attitude to Gateway. "I think of the Street as partners," says Todd. Just this past quarter, Todd told analysts a month before earnings were announced that the company's unit sales would meet the consensus estimate or come in slightly below it. "We want to be pretty honest with the Street," he says. "If things aren't going as expected, analysts will want to hear it from us and not

from the shorts."

Not that Todd expects any dark clouds soon. The Street should expect 25%-plus year-over-year earnings growth and 22% gross margins "forever and ever and ever -- quarter in and quarter out," he says. Gateway is generating more than 10% of its profits in nonsystem revenue (for example, Internet service contracts), and Todd expects that portion to rise to 20% by the end of next year.

Gateway's Steady Rise
Shares of Gateway are up 76% year to date.

Moving beyond the PC has been a key goal for Weitzen, who came over from

AT&T

(T) - Get Report

in January 1998. To get the company to think beyond the PC, Weitzen plans to rapidly add personalization services to ensure that consumers will continue buying Gateway's wide assortment of products (computers, ISP service, peripherals) and services (Country stores, e-commerce, financing). One example is to allow customers to set up their own home pages at Country stores, so the PCs customers buy there will be customized when they're delivered, explains Weitzen.

Weitzen has stuck with the Country store concept (along with innovative ideas such as

YourWare

financing program and a Gateway ISP service) through the early criticisms and now feels vindicated for taking the risks. "A face-to-face presence clobbers over the phone service, and we get 250% higher retail margins than the rest of the PC retail industry," he says.

"I never want a Gateway customer to go into a

CompUSA

(CPU)

," he says. Country stores, which now number around 185, are one big reason why gross margins have actually risen to 22% this year from 20.6% last year.

"

Dell

(DELL) - Get Report

is copying us all the way down to the background noise on our television ads," says Weitzen, referring to how Gateway is using

The Who's

"Who Are You" for its TV ad campaign, while Dell has gone with the same group's "Magic Bus." (Dell's CFO Tom Meredith counters by saying the copying goes both ways. "It's not a one-way street, but whether we are copying them or not, who cares?" says Meredith.)

'If things aren't going as expected, analysts will want to hear it from us and not

from the shorts.' -- Gateway CFO John Todd

Looking ahead, Weitzen hints that Gateway may need an additional ISP carrier to

UUNet

, a unit of

MCI WorldCom

(WCOM)

, because Gateway's

Gateway.net

service expects to have 800,000 subscribers by year-end, double the amount it had at the end of June. This frenetic ramp-up, however, could be too much too soon, warns Randy Befumo, an analyst at

Legg Mason Fund Adviser

. "More good businesses get killed for growing too fast rather than too slow," says Befumo, whose firm is the largest institutional shareholder in Gateway.

That's the price of being a trendsetter. Gateway has had great success in the consumer space, and its next step is to bring skills developed there to the business world. Then Gateway might really have something to crow about.