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." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best...
Ciena (Nasdaq: CIEN  ) shareholders woke up to a dowsing on Monday, as analysts from Swiss banking powerhouse UBS dumped a bucket of ice-cold, red ink into their warm, safe beds. Shares seem to be recovering some of their losses today, but what was it, exactly, that sparked the sell-off in the first place?

"Sell." That's the rating UBS slapped on Ciena yesterday (no mealy mouthed "underweights," "market underperforms," or "reduce-s" here, folks. UBS calls 'em like it sees 'em.) And here's how UBS sees Ciena: As just another telecom equipment maker.

Ever since Ciena bought Nortel's metro Ethernet business, UBS argues the company has been evolving from a targeted play on the more profitable segments of the telecom business into a "broad-based" provider of optical networking equipment. And while that may not sound so bad, in UBS's opinion, what it means is that Ciena now faces a whole host of competition, from the likes of not just Cisco (Nasdaq: CSCO  ) and Juniper Networks (Nasdaq: JNPR  ) , but Alcatel-Lucent (NYSE: ALU  ) and Huawei as well. Considering that Ciena remains one of the smaller players in this market, with a 10% share versus Huawei's 16% and Alcatel's 23%, UBS isn't optimistic that the company will thrive.

Is UBS right?

Let's go to the tape
Initial indications aren't good. While a fine analyst in many ways, boasting a record of 53% accuracy across its many, many recommendations, UBS has struggled to pick winners in the Communications Equipment industry:

Company	UBS Said	CAPS Says	UBS's Picks Lagging S&P by
F5 Networks (Nasdaq: FFIV  )	Underperform	***	58 points (picked twice)
Nokia (NYSE: NOK  )	Outperform	***	39 points (picked twice)
Cisco (Nasdaq: CSCO  )	Outperform	****	9 points

It's had particularly bad luck with Ciena, recommending that investors abandon the stock back in 2006 -- only to watch Ciena's business rebound, and its stock soar, outperforming the market by nearly 50 points in the ensuing months.

All that being said, UBS has improved its performance in the industry of late. Its recommendation to buy Corning in 2009 turned out to be timely advice, and the stock is beating the market handily. Last year's "green thumb" for Adtran is also outperforming. Right now, the analyst is batting better than .500 on these kinds of stocks. Ciena, therefore, looks to be the tie-breaker -- and to me, I think the tie will break in UBS's favor.

Time to sell Ciena?
Here's why. Crunching the numbers on Ciena, I see a company that hasn't earned a profit in two years, and that is currently burning cash at the rate of $280 million a year. True, many analysts expect Ciena to earn a profit this year, and a larger profit in 2012. But still, even looking way down the road, that gives Ciena a valuation today of 21 times the profit it might earn two years from now. That's awfully rich for a company that even optimistic analysts believe will average only 15% long-term profit growth.

And it might not even make that much. Consider: According to UBS, Ciena's having troubles getting its "5400 optical switch" to market, which will crimp profit from that device this year. Across other product categories, UBS warns that the company's expansion into a "fragmented" market in which it lacks commanding market share makes Ciena vulnerable to "continued price competition" as it takes on more and more rivals.

If true, that won't be good for profit margins -- and it could get even worse. UBS warns that unless Ciena changes course on its business plan "we expect CIEN to make more acquisitions to increase global share over time." While such expansion could strengthen Ciena's market share, and mitigate margin concerns -- it also raises the risk of "diworsification" into less and less profitable businesses, along with the ever-present risk of overpaying for acquisitions. And lacking free cash flow to fund its buying spree, further acquisitions will almost certainly add to Ciena's debt load.

Foolish takeaway
Any time a situation looks particularly grim, there's a possibility that investors are overestimating the risks, and overlooking the possibility of success. UBS has a record of making such flubs, and I admit that this is a possibility here. Still, the numbers at Ciena are grim. The more I look at them, the less I like them -- and the more convinced I am that UBS is right to be selling Ciena.