Gateway soars on AOL pact

Shares of Gateway Inc. (NYSE: GTW) surged 16 percent Thursday as investors and analysts cheered its distribution pact with America Online (NYSE: AOL).

In early trading Gateway, which topped estimates in the third quarter, jumped 8 1/4 to 58.

AOL-Gateway: Win, win?

The two companies announced a distribution pact where AOL will run Gateway.net under the Gateway brand and invest $800 million in cash and stock in the PC vendor. AOL gets "aggressive marketing" for its service on Gateway PCs and the pair will share revenue.

AOL, which also topped estimates Wednesday, grows it's AOL everywhere strategy. The two companies will also work on home networking devices.

Good move for AOL, Gateway

Wall Street, which has been wary of Gateway's move to be an ISP, rallied behind the AOL deal. Teaming up with AOL sure beats Gateway buying an ISP, analysts said.

"We see Gateway to be an intelligent fit to AOL since Gateway sells PCs directly to the consumer," said James Preissler, an AOL analyst with PaineWebber. "In addition, Gateway has a strong consumer-focused approach and brand, similar to AOL, which targets the mass market audience."

Gateway.net will remain as a separate standalone brand, but will include personalized content, features and functionality from AOL. Gateway also offloaded expenses related to Gateway.net.

Henry Blodget, an analyst at Merrill Lynch, said AOL effectively eliminated a potential competitor in Gateway.net, which was sending traffic directly to Yahoo! (Nasdaq: YHOO).

"We think the revenue share between the two companies shows a strong commitment to the partnership between AOL and Gateway, which is reinforced by the stock and cash swaps," said Preissler, referring to the usual AOL bounty deals. "Both companies plan on sharing the revenue from subscriber fees, advertising, e-commerce, the co-branded online software store sales, and training revenue."

Bah humbug

Not everyone was so enamored with the AOL deal. USB Piper Jaffray analyst Ashok Kumar pointed out that Gateway is still predominately a PC maker and the revenue split is favored toward AOL.

"The company's partnership with AOL is an important step in participating the increasingly back-end loaded revenue stream in the PC market," wrote Kumar in a report.

But ...

"The exact bounties and profit split ratios of the agreement are opaque," said Kumar. "While Gateway would still like to own its customers, it will be able to partake in only a minuscule portion of the $5.73/sub/month that AOL generates in advertising and e-commerce revenue."

Kumar also said AOL could cannibalize Gateway.net by making it just another one of its brands. He added that the AOL relationship could strain Gateway's partnership with Microsoft (Nasdaq: MSFT).