This Just In: More 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.

Alcatel implodes
It's shaping up to be a perfectly awful week for Alcatel-Lucent (NYSE: ALU  ) shareholders. On Friday, the Franco-American telecom-equipment manufacturer posted a decent-sized profit for fiscal Q3 but confirmed that it experienced a decline in quarterly revenues, warned of another weak quarter in Q4, and consequently cut guidance for the fiscal year. CEO Ben Verwaayen said the company was "not at a level we are satisfied with."

He's not the only one.

As soon as markets reopened for business Monday, Alcatel was immediately hit with a one-two downgrade punch from Germany's WestLB and Citigroup. Both analysts now advise investors to sell the stock, with Citi citing a lack of visibility and warning that the company has further disappointments in store for investors. This morning saw a third downgrade added to the list, when Bank of America pulled its "buy" rating on the stock and went to "neutral."

Shocker
Now, I'm not going to say "I told you so" ... but I did. For those who took the time to look, it's been apparent for quite some time that Alcatel-Lucent wasn't all its income statement said it was cracked up to be. Optimism to date has hinged on the hope that Alcatel could rake in beaucoup profits from selling EVDO software to CDMA operators such as Verizon (NYSE: VZ  ) , Sprint Nextel (NYSE: S  ) , and US Cellular. (If you're wondering whyAT&T (NYSE: T  ) doesn't play into the buy thesis, it's because Ma Bell still prefers the GSM standard for cell-phone traffic.)

And yes, by all accounts, Alcatel has become profitable on a GAAP basis. The problem is that the company's cash-flow statement belies what the income statement seems to show. While some years are better than others, Alcatel's still burning cash like mad. Its most recent report shows that nearly $660 million in cash burn took place over the past 12 months, or three times the rate of smaller rival Ciena (Nasdaq: CIEN  ) . Meanwhile, Cisco (Nasdaq: CSCO  ) -- from which Alcatel has supposedly been stealing market share -- seems unfazed by the (supposed) loss and generated $8.9 billion in free cash flow over the past year.

Time to sell Alcatel?
So is all hope lost? Is it time to sell Alcatel? If you ask the CEO, the answer is certainly "no." His earnings warning notwithstanding, Verwaayen still insists that his company will be back to "normal" by year's end, profitable and generating free cash flow. So all's well that will end well, right?

I very much doubt it.

Now, I don't mean to sound harsh, but if Verwaayen believes what he's saying, he's living in a dream world. Consider: Over the past five years, Alcatel-Lucent has averaged more than $570 million in capital spending every year. Verwaayen says he intends to cut more than $680 million off the company's annual costs, but I really don't think that's realistic. Alcatel has been remarkably consistent in its capex spending for at least the past half-decade, you see. I find it difficult to believe that it's now suddenly going to find a way to cut its costs by more than its entire annual capex budget -- CEO's promise or no.

Failing that, to become free cash flow positive and remain regularly so, Alcatel must find a way to generate operating cash flow equal to or greater than that number -- a feat it's not managed to accomplish even once since merging with Lucent back in late 2006.

Foolish takeaway
Miracles happen, and I won't exclude the possibility that Alcatel can turn things around entirely ... but I wouldn't bet on it. This stock has lagged the S&P 500 by some 39 percentage points over the past year for a reason, Fools. And based on the numbers I see, Alcatel is going to keep on underperforming for a good while longer.

Did you make a bad bet on Alcatel? Looking for a way to hedge your risk of betting too heavily on a single company, with a questionable track record? If you've decided it's time to make broader-based bets, the Fool is here to help. Read our new -- and free! -- report on 3 ETFs Set to Soar During the Recovery.

Fool contributor Rich Smith does not own (or short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 339 out of more than 180,000 members.

The Motley Fool owns shares of Citigroup, Bank of America and Cisco, and has created a bull call spread position on Cisco. Motley Fool newsletter services have recommended buying shares of Cisco and formerly recommended shares of AT&T.

We Fools don't 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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