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Gateway's chip shortages could hurt earnings

Intel chip shortages hit the computer maker at the worst possible time: the holiday buying season.

Computer maker Gateway is being hurt by Intel chip shortages at the worst possible time: the holiday buying season.

The San Diego, Calif.-based company, which custom builds and ships its PC products, has been hit disproportionately hard by Intel's struggle to manufacture enough of its newest and fastest Pentium III processors, according to several industry research reports. Unfortunately for Gateway--reliant on Intel after a flirtation with competing chipmaker AMD--its highest-volume products run on the hardest-to-find chips, according to the reports.

Although analysts following Gateway's stock generally express optimism about the company's long-term strategy, some predict that fourth-quarter sales, which encompass the all-important holiday buying season, will be disappointing because of the company's inability to deliver its most popular products.

"Though Gateway appears to have DRAM [memory chip] pricing and LCD [screen] availability under control, the company is being impacted significantly by continued problems in getting the required supply of Intel processors, most notably the Pentium III 450 MHz, and to a lesser extent, the Celeron 400 MHz," Merrill Lynch vice president Steven Fortuna said in a report.

Gateway acknowledged having trouble with its component supply, but said earnings should be unscathed, according to a company spokesman.

Fortuna this week lowered his fourth-quarter sales estimate by $117 million to $2.65 billion, blaming Intel's issues with processor availability for Gateway's holiday problems.

A recent Piper Jaffray report predicted Gateway will likely not be able to ship more than 1.5 million units this quarter.

Although component shortage issues are common in the PC industry, especially among direct sellers like Gateway and Dell, which have much shorter lead times on component inventory than traditional manufacturers, these processor shortages pose some unique issues for Gateway specifically, the report said.

For one thing, because Gateway sells heavily to consumers and individual buyers, almost 65 percent of its fourth-quarter sales come in the month before Christmas. In addition, the processors in short supply are used in Gateway's most popular systems. In fact, almost 40 percent of Gateway's total sales were made up by its $1,299 computer, which uses the Pentium III running at 450MHz, according to Merrill Lynch.

The company is in the process of broadening its product mix to rely less on the consumer hardware sales which have traditionally made up the majority of its sales, but its nascent Internet and corporate computing businesses are not yet mature enough to offset the damage done by the Intel shortages, analysts say.

Instead, Gateway ought to bolster its Internet revenues by focusing on high-profit markets like corporate PC and server sales, according to Piper Jaffray's report.

"While substantial increases in non-PC revenue should support declining hardware margins, Gateway will not be able to sustain its current revenue growth without a major increase in business-oriented revenue," the report said.

Despite the short-term glitches, analysts still give Gateway's long-term strategy the thumbs-up. Citing new industrial designs, the company's aggressive strategy in going after non-PC Internet revenues and the strength of its internal sales force, Salomon Smith Barney this week reiterated its Buy rating of Gateway.

"Opportunities abound for Gateway during 2000," analyst Richard Gardner said in his report.