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The mating dance begins

Two weeks ago, rumors began to circulate regarding two of the major players in the PC market--Compaq and Gateway--companies which reflect diverging corporate Internet strategies.

Two weeks ago, rumors began to circulate regarding two of the major players in the PC market--Compaq and Gateway--companies which reflect diverging corporate Internet strategies. Both were forming a vision of the future in which traditional computer companies were gradually becoming intertwined in the World Wide Web.

Last week, one of the rumors was confirmed--Compaq would divest a majority stake in its AltaVista division. The other rumor was that Gateway was exploring partnership options with EarthLink, one of the leading Internet service providers--and that the deal might potentially lead to a merger. While the Gateway rumor is still unconfirmed, it is clear to me that Gateway is rushing to actively embrace the Internet, while Compaq is looking to passively capitalize on the technology.

As an investor, even with the uncertainty over Internet valuations and competition, I would embrace Gateway's strategy and look to invest in those traditional companies that are shifting their businesses to incorporate the power of the Net. To be blunt: I believe now is not the time for Compaq to cash in.

Gateway's strategy has two sides. First, the firm announced that it plans to integrate the spotshop.com site into its own Gateway-branded gateway.com site. Secondly, and even more intriguing, was the rumor about the potential acquisition of EarthLink.

Compaq agreed to sell an 83-percent stake in AltaVista to CMGI for a total consideration of $2.3 billion, mainly in CMGI stock. In an abrupt reversal of strategy, Compaq has decided to give up control of its portal, as well as its related properties Shopping.com and Zip2 (both of which Compaq recently acquired). As a result of the stock deal, Compaq will hold a 16.4 percent stake in CMGI, becoming the firm's largest shareholder and taking a board seat.

While Compaq maintains that this move strengthens its position in the Internet--giving it access to a number of Internet firms under CMGI's umbrella--I would have to disagree.

Speed and control are key in today's Internet economy--especially control, or access to customer "eyeballs"--and that is essentially what Compaq is giving up in its sale of AltaVista. Certainly the transaction is good for AltaVista, as the site was falling behind other search-turned-portal sites due to lack of investment by Compaq.

In my view, Compaq will maintain strong ties with CMGI in the future, but will remain more of a passive observer--a strategic partnership, granted, is very different from controlling critical Internet technologies and customer access.

In the long run, the later will prove more valuable in my view. Even if Compaq gets to work with CMGI and its partner companies, it will likely be kept at a distance, while the real business will operate at "Internet speed" and separate from Compaq.

Gateway, I believe, has realized this--ironically, they too invested in CMGI to the tune of $200 million back in May. Yet this is only one leg of their Internet strategy, as they have also taken a stake the on-line retailer NECX, integrating the firm's product line and technology in Gateway's own gateway.net.

It is this final area which undoubtedly has prompted discussions with EarthLink. However, I believe these discussions will not ultimately lead to a merger. Gateway now is enjoying the benefit of having a front-end ISP service (with the respective views and revenue stream) while outsourcing its back-end communications infrastructure to MCI WorldCom's UUNet. This arrangement is ideal for Gateway--and sets a framework for further ISP partnerships. Gateway has figured out that one doesn't need to own the infrastructure to reap the Net benefits.

Gateway's Internet strategy is also highly focused, targeting the consumer or home user. And given this target market, where access and Internet use is a key buying criteria, it is understandable why Gateway has taken such an active approach to the Web--the Net is just an extension of their already established market reach.

For Compaq, whose business customers are equally important, their move is also clear. Given that the firm has recently lost some financial momentum, focusing on its core business is of paramount importance. The current deal with CMGI allows this, as well as offers a window into the Internet through which Compaq has the option to take a more active role. I expect Compaq to become more aggressive with its Net strategy once its core business stabilizes--especially once a new executive team is named.

Regardless of the eventual outcome, I think the direction that each firm is taking is clear. Gateway wants to embrace the Internet, not only as a channel (as its closest direct-sales model competitor Dell has done) but as a means for greater revenue through stronger customer contact.

Compaq is driving toward a more focused business strategy of efficiently building PCs, and divesting themselves of distractions--but maintaining an indirect interest in the Internet. Yet both companies acknowledge that a solid Internet strategy is the key their future health.

The preceding comments should not be considered a recommendation concerning the purchase or sale of any securities mentioned therein.

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