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Gateway: No plans to buy ISP

The PC maker's plan to acquire EarthLink or another Internet service provider appear to have faded, but its growing reliance on Net revenues is not in jeopardy, the company says.

Gateway's plans to acquire EarthLink or another Internet service provider appear to have faded, but its growing reliance on Internet revenues is not in jeopardy, the company asserts.

Rather, experts say Gateway will likely partner with a large, established ISP to promote "subsidized" PCs or a wider variety of Internet services. Whatever the structure of these deals, expect Gateway to delve further into the Net.

Executives confirmed that the long-rumored acquisition of EarthLink is off.

"We are in no discussions for acquisition of an ISP at this time," said Gateway chief financial officer John Todd in an interview with CNET yesterday. "We're going to continue to execute our strategy which will include expanding capabilities in the commerce area, expanding in the ISP, Web capabilities," and other e-commerce initiatives.

The PC maker, which sells its computers directly to customers, yesterday reported second-quarter earnings of 56 cents per share, beating expectations.

The company attributed its quarterly results to its strategy of building on its higher-profit Internet businesses, namely its Internet service, rather than relying solely upon the PC business, which seems to become less profitable by the day.

Consumers are purchasing PCs mainly for Internet access these days, and Gateway's designs to exploit that trend appear to be paying off. Although the average price of a Gateway PC dropped by 1.7 percent last quarter, Gateway added an average of $200 to the price of each PC sold by pushing add-ons like warranties and Internet access, noted Richard Gardner, a Solomon Smith Barney analyst in a report today.

"We believe that Gateway will...pair up with one of the major ISPs," he said, pointing to MSN and America Online, which recently partnered with Hewlett-Packard and Compaq Computer to offer $400 rebates on PCs to customers who sign up for its CompuServe Internet service.

Gateway is looking at similar subsidy programs, Todd said. "We could partner with someone to offer subsidies. We're evaluating the best alternatives to make sure we're giving true value," he said. "A lot of these programs are gimmicks, with lots of strings attached."

Another option would be to bolster subscriptions to its own branded Internet service, offered through network provider UUNet.

Gateway added about 200,000 users to its service last quarter, effectively doubling its subscription base. These service contracts now account for about ten percent of non-PC revenues per customer. ISP services, however, carry margins of over 50 percent, according to Ashok Kumar, of Piper Jaffray.

But if Gateway is looking to launch a program similar to the subsidies Compaq and HP are now offering, the company is probably better off partnering, rather than acquiring an ISP, Kumar said in a report today. With companies like Emachines growing in popularity and market share by focusing on sub-$500 systems, so-called first-tier manufacturers like Gateway will soon have no choice but to begin rebate partnerships which will match these prices, he said. But financing such contracts can be problematic.

"Only the largest ISPs have the infrastructure and scale to break even with this model," Kumar said.

Other PC makers echo this sentiment. Michael Dell, whose company Dell Computer will begin offering Internet service to the U.S. in the next year, has said publicly that PC companies do not need to acquire to provide these services.

"At this point, it doesn't seem like it's absolutely necessary for a PC manufacturer to own an ISP," said David Rosenfield, an analyst with ValueLine Securities. "There's plenty of affiliate relationships and joint marketing deals that can be made."

"It all comes down to core competencies--how much an ISP will scale, and what value it will add, how much will it cost for you to operate," Rosenfield said.