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.

Ha! Told you so!
Great was the rejoicing among Alcatel-Lucent (NYSE: ALU  ) investors last month when ace analyst Raymond James announced it was anointing the stock a "strong buy." Great was the lamentation when Alcatel revealed its first-quarter numbers last week... and Mr. Market brought the hammer down on said thumb.

How bad was the news? Nomura Securities noted that revenue from selling wireless telecom equipment "fell 12% sequentially with North America down 5%, and gross margin of 30.3% was the lowest seen since the Alcatel-Lucent merger." The company beat on net profit, but missed on revenues. More worrisome still, CEO Ben Verwaayen warned that with "market uncertainties high in Europe," he's just not sure what the company will earn this year. Guidance remains unchanged for now, but Verwaayen asked investors to wait till the end of this quarter for a new forecast.

Antici-pa-tion…
Not everyone's content to be patient. Global Hunter Securities, for example, lamented Alcatel's "410bp sequential decline in gross margin," and warned: "We now foresee the company barely breaking even in 2012." And even that's not the worst of it.

Yesterday, investment banker RBC Capital went one step further. Citing "weaker demand, increased competition" from the likes of Cisco, Juniper, Ericsson, and Nokia -- which is hurting gross margins across the industry -- RBC blasts Alcatel as perhaps the weakest link. Whereas all of these competitors, and Cisco in particular, are sitting atop plump cash cushions, Alcatel today sports a balance sheet with more debt than cash.

Alcatel's also burning through what little money it does have at an "alarming" rate. On one hand, RBC credits Alcatel with selling off assets to raise cash. On the other, the analyst warns that Alcatel could very well "burn through all this cash and then some by year-end."

That's particularly worrisome because it, well, basically smashes to smithereens the modestly bullish scenario that Raymond James put forward last month, after Alcatel showed some evidence of being able to generate cash from its business in the fourth quarter. While I pronounced myself "skeptical" of Raymond James' recommendation, and reiterated my own prediction that Alcatel would underperform the market, Q4 was a good cash flow quarter. All the company needed to become a buy, I thought, was to repeat the feat.

Adding insult to injury... and with more injury to come
It didn't. Instead of furthering the Q4 trend, Alcatel went right back to its old, cash-burning ways last quarter. While Alcatel claimed to be "profitable" in Q1, in truth is, the company was anything but: Free cash flow for the quarter amounted to negative $217 million, partially negating the FCF-positive Q4, and leaving Alcatel FCF-negative to the tune of $125 million for the past 12 months.

What does all this mean for shareholders? Warning that the stock will fall to $1 within a year, RBC predicts a 33% haircut for investors who followed Raymond James' advice last month. And investors who've already suffered a 25% loss since following RJ's advice won't be glad to hear this, but... that's the good news.

So what's the bad news?
Think a $1 price target is too harsh? Well, better sit down for this. Looking further down the road, RBC warns that $1 might actually be too optimistic a stock price for Alcatel. Opines the analyst: "Our DCF based on a long-term growth rate of 1% and discount rate of 12% supports a price target near $0.00."

Don't say you weren't warned.

Looking for a way to make good on your Alcatel losses? We're here to help. Check out the Fool's Top Stock for 2012.

Fool contributor Rich Smith owns shares of Nokia. He also has public recommendations available on more than 50 separate companies -- Alcatel included. Check them out on Motley Fool CAPS, where he goes by the handle "TMFDitty" -- and is currently ranked No. 349 out of more than 180,000 CAPS members. The Motley Fool has a disclosure policy.

The Motley Fool owns shares of Cisco Systems. Motley Fool newsletter services have recommended buying shares of Nokia. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


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  • Report this Comment On May 01, 2012, at 3:39 PM, mariocuturic wrote:

    Rich,

    If you have followed the company and its tremendous globally promising Light Radio technology(e.g. small cells), you will see they are at the front of this revolution. Cell towers will disappear and be replaced with this technology. In addition, the company shaved off $100 billion Euros(fixed costs in Q1) and is on track for a $500 billiion/Euro fixed cost reduction for 2012. Cisco, Ericson, Juniper, and the like have NOTHING even close to the revolutionary technology pipeline ALU has ready to be deployed in over 70 major contracts. Look out my friend!!!

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