This Just In: Upgrades and Downgrades

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At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Easy come, easy go
Shareholders of cellphone tech shop InterDigital (NAS: IDCC) watched in horror as their shares slid 20% yesterday, wrecked by the company's confirmation that:

  • No, it is not going to sell itself after all.
  • And no, it's not planning to sell off its entire patent portfolio to anyone either. So go fish.

The news that ID has concluded its examination of "strategic alternatives" by deciding against doing...anything at all, really, was devastating to shareholders. But if misery loves company, then perhaps they can take some small comfort in the knowledge that Wall Street is suffering right alongside them.

In 2010, you see, Wall Street banker Dougherty & Co. rode a bullish endorsement of ID to a stunning 55-point outperformance of the S&P 500, before closing out its buy endorsement early. But last summer, as rumors of an ID sale began to fly fast and furious, Dougherty dipped its hand in the cookie jar one more time, attempting to grab a few more chocolate-chipped profits. Instead, Dougherty got chopped. ID's surprise announcement Monday caught the analyst off guard, and threw Dougherty for a 34-percentage-point loss. It also convinced the analyst to pull its buy rating on the stock -- and cut its price target nearly in half.

Haste makes waste. So does indecisiveness.
What's most curious about Dougherty's downgrade, though, is the timing. As the analyst itself admits, when InterDigital canceled its strategic alternatives review this week, "this [was] not a surprising result. We suggested in our July upgrade that we would get nervous if nothing happened by last November."

To which I can only respond: So why did Dougherty keep its buy rating on the stock active until late January? Why did it keep urging investors to buy the stock all the way up to Tuesday's 20% drop?

In a word: hope. Dougherty hoped it was wrong, and that ID would eventually do right by its shareholders and cash out of its intellectual property holdings at a big profit. But instead, management opted to go back "to the same place [ID] was when we had it neutral-rated prior to July, with its appeal in the Nokia [ (NYS: NOK) ] case looming large." And that's just what Dougherty is saying about ID now -- that with a buyout no longer in the cards, ID is just a hold, not a buy.

In fact, the way Dougherty looks at it, ID today may actually be a worse bet than it was back in July, because "licensees Research In Motion [ (NAS: RIMM) ] and HTC have lost some market share since." That's bad news, because InterDigital told investors Monday that instead of selling itself, what it's going to do going forward is try to pursue more targeted patent sales as well as licensing deals. Problem is, licensing its tech to companies like RIM and HTC that are losing market share to Apple (NAS: AAPL) and Google (NAS: GOOG) may not be the best plan if what you're trying to do is grow earnings. And now that Apple has bought a stash of patents from Nortel, and Google has swallowed Motorola whole, my guess is that the window of opportunity to sell out to them has closed for good.

Status report
So now we know where InterDigital stands. It's not going for the big cash-out. Instead, ID is going to keep doing what it's been doing -- and investors like you and me have to value it as a going concern. So how's that work?

Seems to me, there are three ways to look at InterDigital today, all on its lonesome. On the one hand -- the hand Dougherty seems to have used to write its downgrade -- you can argue that at 16 times earnings, InterDigital today looks pretty fairly priced for the 15% long-term earnings growth that Wall Street expects from it. Alternatively, if you back out ID's $500 million cash stash from its market cap, you can argue that the company's about $500 million (or maybe $12 a share) cheaper than it appears.

There is, however, a third perspective. A perspective that Fools who are tempted to jump on the stock's newly discounted price should be aware of. While flush with cash today, InterDigital hasn't generated a penny's worth of new cash in the past year. On the contrary, the past 12 months have seen management at this company burn through $65 million in negative free cash flow.

Foolish takeaway
Which of these perspectives is the "right" way to look at InterDigital? Opinions are going to differ on that question. One thing, however, is certain: InterDigital had a chance to go for the big kill last year. It flubbed it. If you ask me, this doesn't reflect well on the competence of management.

And once you've lost confidence in management, why would you want to own the stock?

So InterDigital is a bust -- easy come, easy go. But can you still make money on the smartphone revolution? Absolutely! Read our new -- and free! -- report, and let us tell you all about "3 Hidden Winners of the iPhone, iPad, and Android Revolution."

At the time this article was published Fool contributorRich Smithowns shares of Nokia.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked in the top half-percent out of more than 180,000 CAPS members. The Motley Foolhas adisclosure policy.The Motley Fool owns shares of Apple and Google.Motley Fool newsletter serviceshave recommended buying shares of Apple, Google, and InterDigital, as well as creating a bull call spread position in Apple.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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