This Just In: Upgrades and Downgrades


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.

Last one out, turn off the light
It's starting to look like dark days (again) for Alcatel-Lucent (NYS: ALU) investors. Yesterday, analysts at German megabank Deutsche Bank pulled their endorsement for the stock, downgrading from buy to hold... and that's the good news.

The bad news is that when Alcatel announced yesterday that even its "adjusted" numbers for the second quarter are likely to show a $49 million operating loss, the shares promptly plummeted 19%. The fact that even an Alcatel that's become 19% cheaper than it was a week ago only merits a hold rating from Deutsche suggests that this stock still hasn't fallen far enough to be worth buying.

The more so when you remember that this is just the first shoe to drop.

The other shoe
According to Deutsche, you see, there's every chance that we'll hear another clunk when Alcatel releases the rest of its second-quarter numbers next week. Alcatel's hoped-for 3.9% operating margin is not likely to happen, especially not after management "disclaimed" its own margin guidance. Longer-term, Deutsche worries that "mix/margin pressure coupled with further revenue uncertainty from Europe means that H2 margin improvement will not be enough to offset the weak H1."

Translation: Not only are next week's numbers going to be ugly, but guidance is going to look pretty miserable, too.

As Alcatel goes, so goes the industry?
Perhaps this shouldn't come as a surprise. Across the telecom industry, big Alcatel customers such as AT&T (NYS: T) and Verizon (NYS: VZ) are heavily indebted, and mired in single-digit revenue growth -- situations not exactly conducive to encouraging profligate infrastructure spending. Overseas, customers such as Cellcom Israel (NYS: CEL) and Partner Communications (NAS: PTNR) are actually experiencing negative growth -- while juggling debt loads that are fully as significant for companies of their smaller size as the bigger debts are for bigger companies like AT&T and Verizon.

Given its customers' struggles, it's no great surprise that Alcatel's own sales slipped 12% last quarter -- or that things look similarly bad this quarter.

Pop! goes the bull thesis
What's more worrisome -- to me as an investor -- is that in addition to its other prognostications, Deutsche also tossed a bucket of cold water on one of the few things that had been starting to go right at Alcatel. Last year, as you may recall, Alcatel finished strong in the fourth quarter with a considerable cash surplus added to its bank account. As Alcatel's capital spending continued a multiyear decline, cash flow trends began to improve.

The company resumed burning cash in Q1 2012, however, and now, Deutsche tells us to expect more of the latter... and no more of the former. Indeed, according to Deutsche, weak sales and "margin deterioration" raise the prospect that Alcatel will increase cash burn as the year progresses.

Short-term sales fluctuations aside, for long-term investors, this is really the greater concern: It's bad enough that Alcatel is currently burning through close to a quarter-billion dollars annually in negative free cash flow. If that rate should increase -- to, say, the $700 million-plus level of cash burn we were seeing as recently as 2010 -- then Alcatel's balance sheet could soon show the company carrying more debt than cash, a situation that will put the company's viability in question.

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Fool contributorRich Smithdoes not own shares of, nor is he short, any company mentioned above.He does, however, have public recommendations available on more than 60 other companies. Check them out on Motley Fool CAPS, where he goes by the handle "TMFDitty" -- and iscurrently ranked No. 338 out of more than 180,000 CAPS members. The Motley Foolhas adisclosure policy.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.The Motley Fool has adisclosure policy.

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