Low-Cost PC Maker EMachines in Deal to Acquire Free-PC

Low-cost personal computer maker EMachines Inc. in Irvine said Monday that it has agreed to acquire Pasadena-based Free-PC Inc. in a stock swap, signaling a retrenchment of the much-derided practice of giving computers away in exchange for advertising.

But EMachines said it could end up backing into that same business model as it implements Free-PC’s technology by offering financial incentives that offset the purchase price of new computers.

“This deal probably says that it’s pretty hard to make money giving stuff away,” said Stephen Baker, senior research analyst at PC Data Inc., a market research firm in Reston, Va. “EMachines now is trying to use some of the back-end technologies that Free-PC had put together to create a revenue stream for themselves after the sale of the PC.”

Terms of the acquisition were not provided, but EMachines, which has filed to go public, will disclose details of the deal in regulatory filings within the next month.

Bill Gross, chairman of Free-PC and of Pasadena-based business incubator Idealab, will become the eighth member of the EMachines board of directors.

Free-PC no longer will give away computers as a result of the deal, but sometime early next year the software that Free-PC used to advertise to its customers will be installed in every EMachines computer.

While registering their computers, purchasers of EMachines will be asked whether they want to disable the software and what level of advertising intrusiveness, if any, they would be willing to accept.

The advertising would include icons on the computer desktop, preprogrammed keyboard keys to advertisers’ Web sites, targeted e-mail and a customized task bar on the bottom of the computer screen.

Company officials said they have not determined what types of incentives they will offer to encourage people to keep the software enabled. But they acknowledged that the incentive could have the effect of giving away a free computer. “This allows us to create a relationship with the consumer as opposed to a one-time sale,” said Stephen Dukker, president of EMachines.

In October, EMachines accounted for 12.4% of all traditional retail personal computer sales, putting it third behind Compaq Computer Corp. and Hewlett-Packard Co., according to PC Data.

The company has consistently pushed computer prices lower. It supplies many of the low-cost computers that are sold through marketing programs with Internet providers such as America Online.

EMachines, which filed to go public in August, needs to find revenue sources outside of its computer sales to boost sagging profit margins. It had gross margins of 3.6% during the first half of this year, far below Compaq’s 22.6%.

The company’s public offering, which was expected in late November, will be delayed “a few months” by the acquisition, Dukker said. The company, which lost $3.9 million on revenue of $351 million through the first half of this year, had said it hoped to raise $200 million from its offering.

The flaw in the Free-PC model, officials from both firms said, was not giving away the 30,000 it has distributed since February. Rather, the firm could not give away enough of them to create a big enough market to attract advertisers.

With EMachines’ manufacturing and distribution capabilities, it will be able to create a market of several million customers, officials said.

“When you are the provider of the PC, you can know so much more about the person, just starting with their address,” said Gross, whose incubator launched Free-PC.

Investors have poured $33 million into privately held Free-PC, and the company probably would have had to seek more funding soon, said Donald La Vigne, the company’s chief executive.

All of Free-PC’s 90 employees will join EMachines, remaining in Pasadena, the companies said.