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.

Level 3: An escalator going both down and up
What does the future hold for Level 3 Communications (Nasdaq: LVLT  ) ? It depends on whom you ask. Last week, this provider of everything from data transport and infrastructure to VoIP and long-distance telephony started off strong with a bullish note from Cowen. Calling the company "significantly undervalued," Cowen praised Level 3's bookings growth and its expected performance in the "second half pipeline," predicting the company would outperform the market going forward.

Fast forward just a few days, though, and rival stock shop Raymond James put out a report on Level 3, too. And RJ didn't just mildly disagree with Cowen's stance -- it diametrically opposed it, downgrading the stock all the way to underperform -- the Wall Street equivalent of "sell." Adding to the confusion, investors sold shares of Level 3 when the Cowen endorsement came out... but bid the shares up after RJ dissed them. So what's the story? Who's right here?

Look back to look forward
Earlier this year, in his annual preview of the year to come for Level 3, fellow Fool Sean Williams cited difficulties among other players in the data transport industry -- namely, Akamai Technologies (Nasdaq: AKAM  ) and Limelight Networks (Nasdaq: LLNW  ) -- as suggesting 2012 was getting off to a rough start. Citing the difficulty of competing with a well-funded, much larger rival in AT&T (NYSE: T  ) , Sean predicted that unless Level 3 made progress getting "its costs (and its debt) under control," Level 3 shareholders should expect "another year of significant losses and integration issues." (Perhaps coincidentally, on Friday analysts at Stifel Nicolaus worried that things haven't much improved, and assigned a hold rating to Akamai.)

Analysts at Canaccord Genuity have taken a similar stance, warning that anyone expecting significant "revenue growth, sustainable margin improvements or multiple expansion" at Level 3 was bound to be disappointed. But here at the three-quartes mark for 2012, is this the way things are playing out?

Level 3: Buy the numbers?
Kinda, sorta, yeah. On the one hand, Level 3 does have a few things to boast about this year. After merging with Global Crossing, the company has been able to wring some efficiencies out of its larger, scaled operation, with the result  that operating profit margins for the past two quarters have improved significantly over their year-ago levels. In addition to growing revenues 74% year over year, the combined company is now reporting small losses on the bottom line as well.

But then again it's still reporting losses -- not profits. And not all financial metrics are flashing green here.

Gross profit margins (now 59.1%, versus 60.8% for AT&T), while up sequentially from Q4 of last year, are still down year over year versus the first and second quarters of last year (as opposed to AT&T, which is getting stronger). Meanwhile, Level 3's free cash flow -- positive in two of the past four quarters -- is still negative once the losing quarters are added in, with $214 million in cash burnt over the past 12 months.

And if Level 3 has made progress in working down its long-term debt load (2.5% lighter than it was six months ago), then it's also true that at the rate it's going, Level 3 will need some 20 years to get all the debt off its balance sheet. And even 20 years might not be enough, if Level 3 can't scare up some positive free cash flow between now and then.

Foolish takeaway
Level 3 has made some progress on its key objectives -- I don't deny it. I also don't deny the fact that data production, transmission, and storage is an exploding business, and one that some folks will surely profit from. Regardless, I personally remain virtually short the stock with a call of underperform on CAPS. Simply put, with Level 3 still in hock to the tune of $7.8 billion (against a market cap of only $5.4 billion), still unprofitable and still burning cash, this looks to me like a story of too little, too late.

Rather than sit around waiting for a turnaround that may never really happen, investors may be better off betting on a proven performer in the field of big data. Read about one such stock that's wowing markets and winning fans in our new, free report: "The Only Stock You Need To Profit From the NEW Technology Revolution."

Fool contributor Rich Smith has no position, long or short, in any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 291 out of more than 180,000 members. 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.


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  • Report this Comment On September 17, 2012, at 11:29 AM, joiseyj wrote:

    An article like this, with no in-depth analysis of Level3's assets, margin ternds and game plan, is of little value. The story is far more complicated than can be set forth in a few paragraphs. Too many people are making investing decisions based on little snippets like this, or a 5-second opinion on CNBC.

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