IT S BEEN AN

ugly few months for

Gateway

But there is a silver lining: While the San Diego-based company may be reducing earnings estimates and cutting jobs, it's also exiting the risky consumer-finance business. And given the deteriorating state of the economy, that's a good thing for Gateway investors.

As part of the restructuring initiated by Gateway Chairman Ted Waitt, the PC company sold nearly two-thirds of its consumer-loan portfolio to an unnamed buyer for $500 million. From now on, the company plans to rely solely on partnerships with major credit-card companies some of which are already in place to provide customers with special financing deals and payment plans.

The sale not only provides the company with an immediate infusion of cash, it also eliminates any possibility that Gateway will have to eat some of those loans later if customers start defaulting. "We elected to sell the portfolio because that is not going to be a core thing for us," says Gateway spokesman John Spelich. "Having the ability to finance our clients is core to our business, but running our own bank is not."

For Gateway, of course, the bigger issue is boosting PC sales at a time when margins are thinning and consumer spending is waning. And no matter who finances the sales Gateway or its credit-card company partners the economic slowdown is hurting demand. In good economic times, providing innovative financing for customers was key to driving volume. Indeed, last year Gateway customers borrowed more than $3 billion to pay for computers, which works out to about a third of the company's $9.6 billion in total annual revenue. But with consumers dialing back on both spending and borrowing, the impact on Gateway is magnified more than it might be for a retailer that's less dependent on financing deals to propel sales.

Waitt, it appears, made this calculation: A slowdown is bad enough, but with Gateway owning 10% of that $3 billion in financings, the company was doubly exposed if existing customers weren't able to pay their bills. And that's a real possibility. The nation s consumer-debt burden a measure of the average household's debts vs. its disposable income is at 14.1%, its highest level since 1986, according to the Federal Reserve. Meanwhile, the delinquency rate on credit-card debts rose last year to 4.9% from 4.8% in 1999. Delinquencies had been falling steadily since 1996, when the rate stood at 5.5%.

"We do think delinquencies will climb...but to what level is complicated by what happens with the economy," says David Fanger, a vice president and financial-institutions analyst with Moody s Investors Service, the corporate-rating agency. With the average household shouldering a near-record level of debt, Fanger says consumers are particularly vulnerable to any sudden downward shift in personal income. A big increase in unemployment, he says, could cause an upward spike in credit-card defaults.

A jump in consumer defaults, of course, could be bad news for investors in big credit-card lenders like MBNA and Household International two companies already providing financial deals to Gateway s customers. But by selling off its loan portfolio, Gateway s management gets rid of a potential loan headache and can now focus squarely on the more pressing matter of boosting PC sales.

Past Due
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Source: Moody's Investors Service

The downside is that Gateway will no longer be able to include the interest earned on those consumer loans in its annual budget. Presumably, the company does receive payments from the credit outfits it has entered into partnerships with. But those fees undoubtedly are far less generous than revenues generated from doing your own consumer financing. It s difficult, however, to tell just how profitable the consumer financing has been to Gateway. The company doesn't break out a separate figure for interest on consumer loans in its financial statements. Instead, it includes those revenues under the catch-all category: net sales. A Gateway spokesman says the amount of interest revenue is meager compared to the company s overall sales.

Steve Baker, a PC Data vice president for technology and research, says the main goal of consumer financing more than making money off of the loans is to develop a "stranglehold relationship." By that he means financing deals that enable the computer retailer to develop an ongoing relationship with its customers. They give Gateway an opportunity to develop a customer base it can keep going back to with offers to sell new products.

With Gateway taking a back-seat role in arranging those financing deals, there s a chance it could lose touch with some of its better customers. But given the PC retailer's other problems, that s a chance management and shareholders will gladly take.