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." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)

Given this, 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.

Christmas is over for Akamai
Last month, we were talking about how Christmas came early for Akamai Technologies (Nasdaq: AKAM  ) shareholders. An upgrade from Wall Street analyst Craig-Hallum added fuel to the fire ignited when Akamai bought Cotendo -- and sent the shares soaring, up 20%.

Today, though, Akamai is getting its wings clipped as another analyst downgrades the shares. Pointing directly at the stock's strength as reason to claim some gains, analyst D.A. Davidson is arguing that it's time to take chips off the table, and count winnings, before Akamai gets a chance to report earnings.

So what?
Why is this important? One word: performance. Craig-Hallum, you see, does not report its recommendations to ratings aggregator Briefing.com for independent analysis; D.A. Davidson does. As a result, while no one can be certain whether Craig is a good analyst or not, we here at Motley Fool CAPS can tell you with no reservations: D.A. Davidson is. In fact, with its CAPS rating of 93.53, we can tell you that Davidson is one of the better analysts on Wall Street, outperforming well over 90% of the investors we track.

And Davidson is worried about Akamai Technologies.

Prospects and peril
You should be, too. You see, yesterday my Foolish colleague Anders Bylund wrote a piece on Akamai, describing how the Internet traffic facilitator has been slashing the cost of content delivery in a bid to steal market share from Limelight Networks (Nasdaq: LLNW  ) and Level 3 Communications (NYSE: LVLT  ) . Anders thinks Akamai's strategy of selling more CDN services at lower prices should have Limelight and Level 3 "biting their fingernails." But there's another way of looking at this. And if I might introduce a battle of the metaphors: It's something that might set Akamai investors quaking in their boots.

When talking about tech, things can get pretty complicated pretty quick. The business of selling content delivery is pretty ephemeral, so let me explain Akamai's problem with an analogy to an easier-to-understand, more physical business: cars.

Back in the bad old days of the late 1990s/early 2000s, Detroit had three big automakers -- Chrysler, Ford (NYSE: F  ) , and General Motors (NYSE: GM  ) -- and they all shared one big problem. With a limited pool of car buyers to compete among, they battled for market share through a strategy of undercutting each other on prices. As the prices they charged dropped lower and lower, they argued they would make it up on volume. But they didn't, because they were really just stealing business from one another, shuffling market share from Ford to GM and back again. The result of all this you already know: GM and Chrysler went bankrupt, with Ford escaping that fate by the skin of its teeth.

This episode may be getting ready to repeat itself, by the way. Earlier this week, The Wall Street Journal ran a story describing how a glut of small cars is piling up on dealer lots, with Ford in particular now holding as much as twice the monthly supply of cars that it ordinarily wants to have on hand to satisfy demand, while GM is approaching the danger zone. The worry now is that Ford and GM may revert to their old habits -- and the temptation that Akamai is now succumbing to -- and start cutting prices on their cars and trucks, rather than maintaining pricing discipline and maximizing profit margins.

From trucks to tech
Now here's the point: When a limited pool of suppliers decides to engage in an internecine price war, the result may well be that no one wins (well, except for the consumer). Market share shifts around a bit, but overall, everyone's profits wind up dropping, and the result is bad news for shareholders.

This seems to be the worry at Davidson, too. Because even if Akamai has strong profit margins today, its new strategy of cutting prices to grab market share could result in weaker profits going forward. Davidson believes that when Akamai reports earnings next month, whatever it tells us about fiscal fourth-quarter 2011 results may be overshadowed by "disappointing" guidance for fiscal first-quarter, and full-year 2012 -- the time period in which its price cuts will be most acutely felt.

Foolish takeaway
Is Davidson right to worry? The analyst's record, and its rank as a member of the top 10% of investors we track on CAPS, suggests it may be. And when you consider that Akamai is already richly priced at nearly 32 times earnings -- with a projected growth rate of less than 14% -- any slippage in profit margins or in growth rate would be cause for concern.

My advice: Take Davidson's advice to heart. Akamai's plan to cut prices could be hazardous to your wealth.

Akamai clearly believes that cutting pricing is the way it needs to go, but here at the Fool, we think there's a better way to profit, and have discovered "The Only Stock You Need to Profit From the NEW Technology Revolution." Read about it in our new report, absolutely free of charge.

Fool contributor Rich Smith does not own shares of, nor is he short, any company mentioned above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 328 out of more than 180,000 members. The Motley Fool has a disclosure policy.

The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares of Ford and General Motors, as well as creating a synthetic long position in Ford.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


Read/Post Comments (2) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 13, 2012, at 7:14 PM, 5574tjh wrote:

    I would like to offer another perspective on Akamai's decision to lower prices .

    Akamai has always said that when they could save money they would pass it along to the customer- at the Customer Summit they indicated their volume is saving them money on purchasing bandwidth .

    In addition, value added services which now accounts for over 60% of revenue (and rising)is not subject to this discount in pricing.

    Could Akamai now gotten to the point where cost of content delivery can be considered a loss leader.

    Their competition does not have this advantage since neither Level 3 or Limelight has the portfolio of value added services. In addition both are having profitability issues.

    With the addition of the portfolio of Cotendo services

    I think yours and DA Davidsons premises is flawed.

    If anyone in this sector can afford to lower prices it is Akamai.

  • Report this Comment On January 14, 2012, at 11:34 AM, TMFDitty wrote:

    "Other perspectives" are what makes the Fool motley. Thanks for contributing, 5574tjh.

    TMFDitty

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