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Rough Waters for

By Robert D. Hof Ouch! Investors have taken their buzz saw to another e-commerce giant. On Feb. 2, (AMZN) missed fourth-quarter profit expectations by about 13% and shaved its forecast for 2005 operating profits. The only bright spot: The leading e-tailer posted better-than-expected quarterly revenues of $2.5 billion and boosted its revenue-growth forecast for 2005 to as much as 25%, lifting it to $8.7 billion.

No matter. Unimpressed investors lopped more than $6 a share, or 15%, off Amazon stock in after-hours trading. For good reason, says Scott Devitt, an analyst with Legg Mason Wood Walker: "It was a pretty weak quarter for profitability."

WEB-SAVVY BUYERS. The earnings report threatens to take even more air out of Internet valuations, which had already developed a serious leak. On Jan. 26, online marketplace eBay's (EBAY) penny-per-share profit miss caused its stock to plummet 19% in one day. Search giant Google's (GOOG) blowout fourth quarter, reported Feb. 1, gave investors a temporary reprieve, as its 7% stock rise provided a modest lift to most Net stocks the next day.

Those mixed results signal a clear shift in where investors see the most value online. Google and Yahoo! (YHOO) have been reaping the benefits of the surge in online advertising. But that same improvement has hurt the e-commerce giants. So even though Google's price-to-earnings (p-e) ratio is a breathtaking 143, vs. Amazon's 56, it might have more lift for some time to come. "We've had a power shift from the e-commerce guys to the online-ad guys," says Mark Mahaney, an analyst with American Technology Research.

What is Amazon's particular problem? Intensifying competition, mostly, both online and off. Liquidator (OSTK) saw sales more than double in 2004, to $494.6 million -- still a relatively small fraction of Amazon's, but potentially enough to make a dent. Comparison shopping sites such as (SHOP), which reports earnings Feb. 3, became more popular destinations for increasingly knowledgeable and deal-driven consumers, sending them to sites other than Amazon. Most important, mainstream retailers came on strong. "Most traditional retailers had a wildly successful holiday season online," says Forrester analyst Carrie A. Johnson.

TIME TO SPEND? All that competition is keeping a lid on profits by forcing Amazon to spend more aggressively on everything from hiring to research and development to marketing. Chief Executive Jeffrey P. Bezos said his company is hiring more computer scientists and programmers, who are helping it launch a stream of new features. The latest: its first membership program, in which frequent buyers can pay $79 a year to get free two-day shipping on more than 1 million items.

The biggest surprise came in marketing costs, which rose 44% -- far more than the 26% sales growth after stripping out the weak dollar's foreign-exchange benefit. Capital spending is also rising, from $89 million last year to $175 million this year, by Amazon's estimates.

While international expansion, especially in China, accounts for some of that, at least half will be the cost of software development, not new buildings. Amazon is hardly alone, since other Net companies such as eBay and Google also are upping capital spending. But they have more profits to play with.

CONSUMING PASSIONS. Bezos contends that this is one of those times when the company has to belly up to the bar and spend on projects that will pay off in the long term, from new search technologies to beefed-up distribution centers that cut shipping times.

"We see this as an important time to be investing," Bezos told analysts during a conference call. "There are a lot of opportunities."

There are a few bright spots. Sales of books, music, and movies in the U.S. jumped 18%, the fastest in four years, thanks to higher discounts. And nonmedia sales, such as electronics gear, shot up 53%, to $1.7 billion, or nearly a quarter of sales.

WILD ABOUT HARRY. Amazon optimists may have good reason to see a little more promise in 2005. For one thing, it's a Harry Potter year: In July, the sixth in the popular book series will be released. In previous years, earlier books in the series have noticeably hiked Amazon's sales in the quarters when they were released, also serving as major catalysts for acquiring new customers. Amazon has offered deliveries as early as midnight on the day of release, potentially attracting millions of new customers at relatively low cost.

Moreover, Amazon has yet to jump into two new opportunities that analysts expect this year: international expansion of its "Merchants@" program for other retailers to list products on Amazon's site and the launch of an online DVD rental service in the U.S. But for now, it's clear that investors may have to wait to see a boost to the bottom line. Hof is BusinessWeek's Silicon Valley bureau chief

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