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Never Bet Against
Michael Dell
When Dell's stock slipped for two weeks in February, some analysts talked up Gateway. Then Dell announced his next moves.
Amy Kover
When Michael Dell stopped by FORTUNE in late February, it seemed as if his company's days as the darling of the PC world were ending. For the past two years investors had gotten used to around 50% annual revenue growth from Dell Computer, and its stock price had boomed 1,214%, to a high of $108.63. But on Feb. 12, BancBoston Robertson Stephens analyst Daniel Niles slashed his fourth-quarter revenue estimates from the consensus $5.5 billion to $5.2 billion--a mere 38% or so jump from fourth-quarter 1997--citing "flattening component costs and increased direct competition." Richard Gardner of Salomon Smith Barney chimed in with similar concerns.
Niles turned out to be eerily correct: Four days later Dell reported fourth-quarter revenues of $5.173 billion. By Feb. 19 the stock price had been battered down 26%, to $80. So some analysts began looking past Dell and casting eyes at former consumer-PC outcast Gateway 2000. Despite a spotty earnings record and a reputation for poor service, the company had developed a three-pronged marketing strategy that some experts believed would characterize the future of the PC industry--and maybe even propel Gateway past Dell.
Dream on. By early March, Dell had confounded its doubters by announcing two major developments in rapid-fire succession, and its stock recouped some of the losses. (For that matter, even its "disappointing" 38% increase in revenue would be a fantasy come true for most companies.)
First, Dell launched an e-commerce Website, Gigabuys.com, through which it will sell more than 30,000 outside products such as software, printers, and even games (adding to its $14 million in daily sales involving the Web). It's a great way for the company to squeeze more revenue from its consumer base. And as Michael Kwatinetz of Credit Suisse First Boston puts it, "Through Gigabuys, Dell can build a stronger, longer-lasting relationship with customers than by simply selling them a box."
Also exciting, Dell cut a seven-year, $16 billion pact with IBM for components used mostly in the very large computers that it sells to major companies. Because IBM's technology is considered top quality, the deal could strengthen Dell's position in that business. To produce components itself, Dell would have to get into a whole new line of business. "Essentially it's a marriage of one company that has terrific technology to one with great marketing," says Walter Winnitzki of Hambrecht & Quist. And analyst Phil Rueppel of BT Alex. Brown predicts that there could be more Dell-IBM deals to come. For instance: "It would make sense for Dell to produce PCs for IBM." Sums up Mark Specker of the research firm SoundView: "Once again Dell continues to prove how fiercely competitive it is, and it won't be left behind when it comes to execution."
Dell's snappy comeback emphasizes that it and Gateway are playing in very different leagues. Gateway focuses mainly on consumers and small companies, whereas Dell deals with bigger businesses and on a much larger scale.
So why did analysts get so excited about Gateway in the first place? The buzz started with Ashok Kumar, tech analyst for U.S. Bancorp Piper Jaffray. Kumar had actually downgraded Dell back in November and was peeved that Niles' Feb. 12 downgrade had overshadowed his. Taking another bold leap, on Feb. 22 he upgraded Gateway from a "buy" to "strong buy." He also announced a ridiculously inflated estimate for fourth-quarter earnings--90 cents per share, vs. the consensus 60 cents.
Annoyed Gateway officials told analysts at a recent conference to stick with the consensus. But Kumar's call caught on. Within two days, Gateway's stock had soared by over $10, to a 52-week high of $83. (It has dropped back since then.) And NB Montgomery upgraded its rating to "buy" from "hold."
The Gateway boomlet was based on more than just one analyst's estimate. At its root is the general assumption that the entire PC industry will be facing slower revenue growth and increased price competition as consumer demand for high-priced computers eases: With PC ownership expanding to lower-income groups, fewer new buyers can afford expensive models. In that sort of world, the only way to make money is to persuade people to buy components and, someday, another computer. And Gateway has a plan to capture such a recurring revenue stream by making itself accessible.
For instance, it is populating America's strip malls with what it calls Country Stores--storefronts designed to lure Sunday drivers and small-business owners as well as provide a service center for veteran users. It's also learning to use the Internet, booking $10 million per day in Web-related sales. In addition, Gateway actually beat Dell to the punch in e-commerce by buying a portion of online retailer NECX a week before Dell launched Gigabuys.
A brilliant strategy isn't enough, however. Gateway also has to execute it. So CEO Ted Waitt has brought in a new management team, which he hopes will solve the company's periodic problems of poor service and delivery. But there are anecdotal signs, at least, that things have yet to improve. Money.com, for example, recently received a note complaining, "Since Jan. 18 (Gateway's internet) service has been extremely poor to nonexistent."
Nevertheless, something clearly has changed: Dell's late-February slide gave Gateway an opportunity to make new friends, even if they're back in love with Dell now. "Gateway showed that it's a trendsetter," H&Q's Winnitzki says. So there still might be room for Gateway to flourish--albeit in Dell's shadow. |
