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.

All telecom, all the time
While still new as a fresh-fallen snow, 2013 is already starting to look like the Year of the Telecom Stock -- at least if you listen to Wall Street. Yesterday, no fewer than three separate stock shops took a close look at different niches of the industry, and came away impressed with a series of winners. Who did they pick, and why? Let's find out.

Headlining our list is the always controversial Alcatel-Lucent , which scored an upgrade yesterday from analysts at CreditSuisse. Alcatel had a rough time of things in 2012, but the telecom equipment maker ended strong, putting together a plan to cut its costs and improve its cash flow, and securing a financial lifeline from a couple of bankers to help pay for it.

Of course, one of the bankers who gave Alcatel its loan was... Credit Suisse. As a result, the analyst may be a bit conflicted in its assessment that the company is now "viable."

That that's pretty weak praise to begin with. Plus, even Credit Suisse admits the company is "likely to burn cash through 2014," has set sales goals that are "difficult to achieve," and relies on a "questionable" cost-cutting program. With more debt than cash on its balance sheet, and a business that's still burning cash like crazy, Alcatel may not even deserve the neutral rating Credit Suisse now assigns it.

Similar worries surround rural telecom provider Windstream , now covered by Pivotal Research at a hold rating. As Pivotal points out, Windstream "has underperformed the RLEC peer group" -- and for good reason. Its 11.4% dividend payout, the number that attracts most investors to the stock, "is unsustainably high and could potentially be cut. ... there is very little margin for error."

Plus, Windstream inspires similar worries over a too-high debt level ($9 billion, net of cash). The company generates a goodly amount of free cash flow ($551 million over the past year), but profits are projected to shrink over the next five years, and Windstream already isn't generating enough cash to justify its $14.3 billion enterprise value.

Level 3 Communications
In contrast, telecom backbone provider Level 3 gets a more positive buy rating from Pivotal. quotes Pivotal citing "strong bookings" and "deal synergies" as pointing to "a 200 bps improvement in EBITDA margin in 2013."Combined with lower interest costs, Pivotal projects that 2013 will be the year Level reaches free-cash-flow-positive status for the first time in three years.

Let's hope so. Post-merger with Global Crossing, Level 3 struggles under the weight of a massive $8 billion net-debt load that's half-again as big as its own market cap. Unprofitable last year, many analysts agree with Pivotal that this is the year Level 3 turns the corner and begins digging itself out from under the mountain of debt.

My advice: Even if you want to trust that they're right about that, verify that the free cash is indeed flowing before you take Pivotal's advice and buy.

Limelight Networks and Akamai Technologies
Both of these companies, in the business of making communications networks work better, received new initiations at Macquarie yesterday. Both scored only neutral ratings, however -- and that's the good news.

The bad news is that Limelight is unprofitable today, and not expected to earn any profits this year, either, while profitable Akamai costs more than 37 times those profits for a share of stock. That seems quite a lot given that the consensus on Wall Street is that Akamai will only grow at about 14% per year over the next five years (while Limelight is pegged for even slower 12% growth. It's also burning cash).

Honestly, given the state of its business, it's hard to see why anyone would want to own Limelight but for the fact that after a 52-week, 22% slump in share price, it's now got more than half its market cap made up of cash in the bank, and is arguably a good prospect for a buyout. As for Akamai, it's a considerably better business, generating $366 million in positive free cash flow over the past year, and selling for a bit less than 19 times FCF. That said, it's hardly a buy at 14% growth.

Long story short, neutral ratings are probably the best either of these stocks deserve. Out of all the five stocks named above, only Level 3 appears to offer a reasonable chance of success for investors today -- and even that one, only if it achieves a turnaround in cash generation of truly staggering proportions. Fingers crossed.

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Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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