Duncan Martel

SAN FRANCISCO: Gateway Inc., looking to reverse three years of losses driven by tough pricing in the personal computer market, said it would buy profitable rival eMachines Inc. for $266 million, sending its shares up 15 percent.

Gateway said the deal would double its flagging share of the PC market to 7 percent and forecast that it would return to sustained profitability in 2005 as a result of the acquisition.

The deal would also give Gateway, which currently sells its products at its own stores, over the phone and through the Internet, a distribution line into major retailers such as Best Buy Co., which carries eMachines PCs.

Privately held eMachines has carved out a niche in the low-end PC market, where machines cost $500 or less, an area where Gateway has struggled. The deal could also allow Gateway to shut down many if not all of its own money-losing retail stores, analysts said.

Gateway said that with the eMachines acquisition, it would move back into international markets, particularly England and Japan, where eMachines is strong.

After the deal closes, Gateway founder Ted Waitt will cede the title of chief executive to eMachines CEO Wayne Inouye. Waitt will remain chairman and focus on long-term strategy. Roderick Sherwood will remain Gateway's chief financial officer, the company said.

"This gives Gateway a tremendous increase in their retail presence with a national brand that's already recognized," said Peter Kastner of market research firm Aberdeen Group.

Poway, California-based Gateway, which reported the latest in a string of sales declines on Thursday, said it would buy eMachines for 50 million Gateway shares plus $30 million cash. Based on Gateway's closing stock price on Friday, the stock portion of the deal is worth $236 million.

Irvine, California-based eMachines has 138 employees and reported revenue of $1.1 billion for 2003.

"Gateway always had it in mind to grow its low-priced PC business," said Martin Reynolds of market research firm Gartner Group. "It keeps the factories running, it generates cash flow and even if it's low profit, it can help its overall business model."

Gateway has been recasting itself as a purveyor of a range of consumer electronics devices, such as plasma and LCD televisions, digital cameras, hand-held computers, and media personal computers.

"Gateway is creating its own opportunities. We think this was a good move," said Kastner. Gateway is not a client of Aberdeen Group.

In the PC market, Gateway has been squeezed by Dell Inc., the No. 2 PC maker worldwide, which has used its direct-to-customer sales to undercut competitors.

"Dell has largely vanquished Gateway in the online business, which is where Gateway started," Kastner said. "With a declining online presence and not enough store space, Gateway's been boxed in."

In the fourth quarter, Gateway was the No. 5 U.S. PC maker, right behind eMachines. It has lost market share and withdrawn from international markets as it tries to stem losses.

But Waitt told Reuters that Gateway would be able to cut costs as a larger player. "The more we can adopt of that low-cost operating model ... the more we can be competitive with both HP and Dell," he said.

Some analysts remained skeptical.

"While Gateway argues that the move will double its share in the U.S. and propel it into the No. 3 spot (past IBM), this is likely to barely make a dent in competitive dynamics, given the already overwhelmingly disparate competitive share reality in the market place," SG Cowen analyst Richard Chu wrote in a note to clients.

Analysts said Gateway was likely to close most, if not all, of its roughly 190 retail stores over the next few years.

"As the leases come up and it makes sense to close them, I would expect many of the stores to close over the next two years," Kastner said.

Shares of Gateway, which expects to close the eMachines deal in six to eight weeks, rose 63 cents to close at 4.72 on the New York Stock Exchange, where it was the second highest percentage gainer.

(Additional reporting by Caroline Humer in New York)

© Reuters