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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." The pinstripe-and-wingtip crowd is entitled to its opinions, but we have some pretty sharp stock pickers down here on Main Street, too. And we're not always impressed with how Wall Street does its job.
So perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We 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.
Goldman Sachs: Serial party-pooper
Here we go again. Two months ago, electric car-battery maker A123 Systems (NYSE: AONE ) was riding high on a wave of good news. General Motors (NYSE: GM ) had confirmed that it was contracting with the company to build "thousands or tens of thousands of battery packs" for a new electric car to be named later. A123 shares surged 45% in a single day.
But just as A123 seemed to be picking up momentum, Goldman Sachs dropped a brick wall in its path. The shares were overvalued, Goldman said. There was no "catalyst" to "drive the stock" up farther. Given the "limited clarity on the range of profitability and ongoing macro uncertainty," Goldman advised investors to stop buying. Assigning a new $5 price target to A123, within just a few cents of the then-current price, Goldman effectively put the stock in "park."
Second verse, worse than the first
Since then, A123 shares have bounced around a bit, never exceeding Goldman's price target -- but not for lack of trying. Last week, the shares leapt 18% in a day when GM agreed to name names and provide details on its contract with A123.
Specifically, GM advised that the car it wanted to build would be called the Chevrolet Spark and would be an all-electric subcompact designed for city driving. Now, you might think the added clarity would appeal to Goldman, and maybe encourage the analyst to re-up its "buy" rating on A123. Instead, the opposite happened. Far from praising the Spark development, Goldman sees it as increasing the risks to A123 shares. The analyst not only downgraded the stock to "sell," but it also cut its target price in half, to just $2.50 per share.
Strange as that sounds ... I'm afraid Goldman is right.
Warning: This Spark may burn you
Why do I say this? Why does Goldman Sachs? I'll tell you why. The first big problem is cash: Cash that A123 must find to fulfill its obligation to provide batteries to GM. Cash it currently lacks. According to Goldman, ramping up battery production for the Spark's 2013 introduction will necessitate raising a lot of cash over the next 12 to 15 months -- more than the $295 million or so cash A123 currently has on hand.
Problem is, as a perennial cash burner, A123 can't really self-finance the production ramp. It's going to have to either increase its debt load (which now stands at $175 million) or, more likely, issue new shares. And if the latter, then A123's tiny $3.30 share price may force it to issue a lot of new shares to raise the needed cash, causing significant stock dilution. So much dilution won't be good news for the share price after the capital-raise. It won't be good news for shareholders.
And that's the good news. The bad news is that while A123 probably has no choice but to raise the cash to expand production and meet its obligations to GM, it may not help A123 at all. Remember: While it's an all-electric car, Chevy Spark isn't really a rival to Nissan's Leaf or Ford's (NYSE: F ) electric Focus, much less to Tesla's (Nasdaq: TSLA ) upcoming Model S. It's expected to have a driving range close to or inferior to that of the Leaf and Focus, and far below the base Model S's 160-mile range. The Spark will be even more limited in comparison with the ranges available with hybrid electric vehicles from Honda (NYSE: HMC ) and Toyota (NYSE: TM ) .
Based on its limited range and tiny size, the Spark looks to be a dedicated city-commuter car, akin to the abject failure that was the Th!nk City -- the car that broke A123 rival Ener1. This suggests that GM -- and A123 -- may be overly optimistic if they expect to make 15,000 Spark sales in 2013. To the contrary, Spark may be hard-pressed to reach even the more modest success that GM's Volt and Nissan's Leaf have enjoyed.
If that's the way things play out, A123's expensive investments in expanding production may be all for naught. Given the risks, I think Goldman's right to advise selling the stock.