Who are you going to believe on Amazon.com ( AMZN), Bill Miller or Tom Underwood?

Miller -- as anyone who's ever read about how hard it is to consistently beat the market knows -- manages the ( LMVTX) Legg Mason Value Trust , the only fund to top the S&P 500 in each of the past 11 years. His value fund owns 30.2 million Amazon.com shares -- at 6.06% of the fund's assets on Sept. 30, it was the fund's No. 4 holding. Miller and other Legg Mason fund managers are true believers in Amazon.com: Combined, Legg Mason funds own 16.58% of the online retailer, second only to Amazon chief Jeff Bezos. Miller & Co. think the stock, trading at $22, may rise to $30 in the next 12 to 18 months -- and if all goes well, it could climb to $100, Miller has said.

On the other side of the Chinese wall at Legg Mason sits Underwood, the e-commerce analyst who last month took over the Amazon beat from Holly Gustafson, who had maintained a buy or strong buy rating on Amazon since November 2000. On Nov. 15 Underwood began his Amazon coverage with a hold rating, saying he would be more comfortable with a valuation in the $12 to $16 range. If the stock is 27% to 45% overvalued, why not a sell? "We cannot think of a catalyst that would cause Amazon's valuation to be materially adversely affected in the next few quarters," Underwood wrote.

A bearish call on Amazon is nothing new -- on Friday, Prudential Securities analyst Mark Rowen slapped a $10 target on the stock. Indeed, the stock has soared 100% this year, inviting a slew of Web and retail trackers to deem it too frothy. (Amazon is one of only two stocks with a market capitalization greater than $5 billion to double so far in 2002 -- Gold Fields ( GFI) is the other, according to Baseline.) What makes Underwood's call on Amazon noteworthy is the conflict of perspective on Amazon within Legg Mason. The opposing viewpoints crystallize the debate over whether Amazon continues to deserve the rich valuation the market affords it, and whether Legg Mason will be rewarded or punished for making such a large bet on the highflier.

A Difference in Terms

In his notes, Underwood applauds Amazon as a "viable and profitable business" but raises several red flags about the company's prospects. Among the key concerns: valuation, $2.3 billion in debt, online and offline competition from rivals such as eBay ( EBAY) and Wal-Mart ( WMT), which have better capital structures and consistent profits, and the difficulty in predicting long-term growth rates. "We would not use AMZN shares as a way to play a strong retail season or a further expected increase in e-commerce share prices," Underwood wrote in a Dec. 2 note. The analyst didn't return calls for comment.

The difference of opinion within Legg Mason is one of short term vs. long term, says Nancy Dennin, a portfolio manager at Legg Mason Value Trust. "Analysts are very short-term focused," looking at current fundamentals to determine what a stock is worth, Dennin says. "It's had a huge run this year; hold is probably a fair rating in the short term."

Dennin says she and Miller are still very bullish in the long term on Amazon. While echoing Miller's recent comments that the bull market has returned and that Oct. 9 was most likely the market low, she adds, "A scarce resource is outsize growth -- Amazon has that." She believes that Amazon's return on capital will accelerate dramatically and that Legg Mason "is very reluctant to sell stocks that have improving economics."

Lessons From AOL

Miller has been known to take large bets on individuals companies, including some that fall outside the traditional definition of value -- sometimes getting burned on the back end when the stocks fall back to earth. AOL ( AOL), for instance, ballooned to 25% of Legg Mason Value Trust's assets before the shares started their long slide in 2000. As AOL, Dell, Gateway and other big-tech gambles tumbled, the fund couldn't sell the shares fast enough to avoid the downdraft. Meantime, the massive selling spurred huge capital-gains tax distributions.

"It concerns me a bit that the fund does have such large positions, and Amazon's stock has more than doubled, raising concerns that valuations are stretched," says Christopher Traulsen, a Morningstar analyst who tracks Legg Mason funds.

Legg Mason may not encounter the same troubles with Amazon as it did with AOL. According to the most recent report, Legg Mason Value pared back its Amazon stake, selling 792,000 shares in the six months ended Sept. 30. "It most likely won't be going above the 6% level," Dennin said. Given that the fund's Sept. 30 stake in Amazon would represent 7.3% of the fund's assets today, it may be that Miller has continued to lighten up on Amazon during the fourth quarter.

Also, Miller was "a bit early" in buying Amazon, Traulsen says. Amazon began buying its stake in Amazon in the third quarter of 1999, when the stock traded at an average of $59, according to Bloomberg. While the stock remains far from those levels, it also means Miller won't incur any big capital-gains tax hits anytime soon as he pares back the shares purchased at higher levels.

While a roughly 6% stake in Amazon is less risky than Miller's huge bet on AOL a few years back, the Miller-led ( LMOPX) Legg Mason Opportunity fund owns 7.85% of Amazon. Other fund skippers at Legg Mason -- including Robert Hagstrom at ( FOCTX) Legg Mason Focus Trust and Lisa Rapuano at ( LMASX) Legg Mason Special Investment -- have sizable stakes in the online retailer (both funds are concentrated funds, which means they make bigger bets on a few names).

A Legg Up on Amazon.com
Four Legg Mason funds have sizable stakes in the online retailer
Fund Total Shares Percentage of Fund's Assets
Legg Mason Focus Trust 650,000 11.99% (No. 2 holding in fund)
Legg Mason Opportunity Trust 6.1 million 7.85 (No. 1 holding)
Legg Mason Value 30.2 million 6.06 (No. 4)
Legg Mason Special Investment 5.5 million 4.73 (No. 4)
Source: Lionshares.com, Legg Mason. Data through Sept. 30.

Miller Has Company

Amazon in the Cart
The three biggest holders of Amazon.com own more than 50% of the company
1. Jeff Bezos, Chairman, CEO 29.29%
2. Legg Mason Fund Advisors 16.58
3. Janus Capital Management 6.35
Source: Lionshares, data through Sept. 30

What does it mean for Amazon shareholders that Legg Mason holds such a massive stake in the company? Equity investors sometimes get nervous when a fund firm takes on a huge stake in a company -- there is concern that the stock could face extraordinary downside pressure if the fund firm decides to unspool its ownership stake.

The fact that Janus, a firm also known to make concentrated firm-bets on a few companies, is the No. 3 Amazon shareholder may be further cause for alarm among Amazon investors. A Janus Funds spokesman said the fund managers wouldn't comment specifically on Amazon for this story.

In fact, a lot of other fund managers have piled into Amazon during the past 12 months or so since the company managed to turn a profit in 2001's fourth quarter.

Coming Back to Amazon
As Amazon.com starts eking out operating profits, fund managers are returning. The stock now turns up in about 7% of all large-cap funds.

Legg Mason's big stake may not be a huge cause for concern -- in fact, it can be viewed in a more sanguine light. First off, Dennin says Legg Mason fund managers are taking a three-to-five-year outlook on the company and feel "a great deal of confidence about Amazon as a core holding."

Second, "Miller is smart enough to trim his stake without causing the stock to get hammered," says Roy Weitz, who tracks the fund industry at his FundAlarm Web site.

But what if more bearish calls from Legg Mason's Underwood and other analysts cause Miller & Co. to view Amazon in a more negative light?

Said one Legg Mason employee: "The day Bill Miller, the greatest fund manager in the world, starts taking his investment tips from Underwood and other analysts is the day I sell my Legg Mason employee shares."

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