EMachines, or investor milking machine?
By Tom Davey
Redherring.com
September 2, 1999
Emachines' planned public offering should be labeled
as an IMM -- investor milking machine -- rather than
an IPO. That's the conclusion Redherring.com reached
after examining the company's preliminary prospectus.
Emachines, a middleman for
cut-rate-priced personal
computers sold by discount
retailers, is attempting to hoist
itself above the fray of other
cheap PC vendors with a $200
million stock offering. But despite
its leadership at marketing PCs at
$400 to $600 and its relatively
small net losses, Emachines is a high-risk play for
investors.
"This company is a complete sham story," says Ashok
Kumar, an analyst with U.S. Bancorp Piper Jaffray
who wrote a scathing report on Emachines'
next-to-nothing profit margins. "There's no brand
loyalty there. The minute Compaq goes to $499, the
game is over."
Among the land mines potential
shareholders should look out for
is the cozy relationship between
Emachines and its two largest
stockholders, the lack of written
agreements concerning
warranties, and lawsuits by two of
the world's largest personal
computer makers.
The 49-employee company
operates as a virtual screwdriver
shop by "outsourcing" most of its
manufacturing to Trigem
Computer and Korea Data Systems. These two South
Korean concerns also own 57 percent of Emachines'
preoffering stock.
Emachines, which celebrates its first birthday this
month, did not state in its preliminary filing whether the
two manufacturers would still hold a majority interest
after the stock sale. But the company concedes that its
PC purchases from the two vendors "might not be as
favorable to us as arrangements we could negotiate at
arm's length between unrelated parties."
YOU WANT IT IN WRITING?
Investors considering rebooting their portfolios with
Emachines should notice the absence of some critical
written agreements between Emachines and its
owner/suppliers. Despite their stake in Emachines,
neither TriGem nor Korea Data has a written
agreement to honor its warranties on PCs and
monitors.
"If we are unable to continue to operate under these
verbal agreements ... our business would be
significantly harmed," the prospectus states. Although
such business practices are not unusual in parts of
Asia, they should send chills down the spines of many
U.S. investors.
Emachines has an agreement with America Online
(NYSE: AOL) that gives customers rebates on PCs if
they subscribe to AOL's Internet service for a fixed
length of time. In the fourth quarter, Emachines also
plans to begin offering its own Internet service. It views
this service model as a critical source of revenue. The
company states that if it is not able to sell Internet
access to customers, its business "would be
significantly harmed."
Furthermore, Emachines plans to pay up front for
customer Internet service contracts, which it will
outsource to MCI WorldCom (Nasdaq: WCOM).
Emachines is concerned that if Internet prices fall,
customers seeking cheaper access will default on those
contracts.
THE GREAT REBATE
Emachines also offers product rebates but is keeping
its fingers crossed that few consumers will cash them
in. The company notes it would be "significantly
harmed if an unexpectedly large number of our PC
buyers redeemed the product rebates to which they
were entitled."
In the filing, Emachines notes that the TriGem factory,
which builds its Etower PCs, is operating at full
capacity, potentially limiting growth. TriGem is
expanding its manufacturing operations into China by
outsourcing. It plans to build new factories later this
year. That could entail political and currency
ramifications.
Another concern is those pesky lawsuits. In July
Compaq Computer (NYSE: CPQ) filed a suit against
Emachines and its manufacturing owners for allegedly
violating 13 patents regarding technical issues. In
August Apple Computer (Nasdaq: AAPL) filed a suit
alleging that Emachines ripped off the design of its
iMac computer. Emachines acknowledges it could be
"significantly harmed" by the outcome of either of these
suits.
Emachines lost $3.9 million on $351 million in
revenues for the six-month period ended June 30.
Interestingly, the company spent only $2.5 million, or
well under 1 percent of revenues, on customer support
and service, which it outsources to another company.
Cynics in flame-retardant gear wait on the sidelines to
see how quickly Emachines' new-found windfall will
combust. Says Mr. Kumar, "The suckers bring in the
money, and Wall Street brings the matches."
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