Goldman Botched This Call

Networking giant Level 3 Communications (Nasdaq: LVLT  ) has been taking a beating in the market recently. As of Thursday night, share prices had swooned more than 25% from highs set in March. A drastic jump on surprising first-quarter results proved short-lived, just as yours truly expected. The next report, two weeks ago, didn't give Level 3 investors much to cheer about.

But the stock was always popular with the analyst crowd, scoring plenty of buy ratings and no sell calls. And on Friday, the stock jumped as much as 9.5% on the news that another Wall Street heavyweight likes the company's prospects.

Goldman Sachs opened coverage of Level 3 with a buy rating (don't you love that "new car" smell?) and a $30 price target, about 50% above Thursday's closing price.

The firm likes where Level 3's bet-the-farm merger with Global Crossing is taking the two-headed beast. According to the research note, that deal "improved [Level 3's] balance sheet and places the company on a path to sustainable [free cash flows] for the first time in its history." Goldman sees an "inflection point" drawing closer, and wants to capitalize on that singular event.

Support from a Wall Street slugger of Goldman's caliber sure is market-moving news. However, I can't say that I agree with this analysis.

Looking at the same second-quarter report that triggered Goldman's burst of enthusiasm, I reached the opposite conclusion: Level 3's cash flows are growing weaker and not stronger, and certainly don't seem destined to become sustainable any time soon.

Investing in Level 3 today is a risky turnaround bet with a highly uncertain payoff. Moreover, the typical troubled telecom at least pays out generous dividends to make its risky bets worth your while: Witness Frontier Communications (NYSE: FTR  ) and CenturyLink (NYSE: CTL  ) buttressing their buyout-based improvement plans with fantastic dividends, for example.

But with negative cash flows, Level 3 simply can't afford to take that route. And unlike Goldman, I don't see that sorry situation changing for the foreseeable future.

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Fool contributor Anders Bylund holds no position in any of the companies mentioned. Check out Anders' holdings and bio, or follow him on Twitter and Google+. Motley Fool newsletter services have recommended buying shares of Goldman Sachs Group. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On August 10, 2012, at 4:44 PM, fundyinvestor wrote:

    Goldman's buy rating is the least they can do given all the underwriting fees they've generated from the never-ending LVLT debt rollovers. It's the gift that keeps on giving.

    Let's face it, LVLT has been a great investment for bond holders and an awful investment for equity. That's not likely to change over the long-term, but I can imagine some short-term upside moves from sell-side lov'n.

    The cynic in me says GS wants to get this stock up so LVLT can use that inflated currency for another acquisition in late 2012.

    And, of course, another acquisition means more i-banking fees for GS.

  • Report this Comment On August 10, 2012, at 4:51 PM, mtf00l wrote:

    Don't forget, while Goldman is pushing this stock behind the scenes they're betting against it... :D

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