Tuesday's Top Upgrades (and Downgrades)

Analysts shift stance on LifeLock, AMC Networks, and Zynga.

Feb 4, 2014 at 2:16PM

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense and which ones investors should act on. Today, though, we're going to focus exclusively on potential buying opportunities that may have been uncovered by the recent market sell-off. Read on as we examine why analysts have begun believing there's value to be found in shares of...

Shares of the Walking Dead and Mad Men network have slumped 12% since the stock market sell-off began in mid-January. But analysts at Topeka Capital see this less as a crisis and more as an opportunity to scoop up AMC on the cheap. This morning, Topeka initiated coverage of AMC with a "buy" rating, predicting that the shares -- currently trading at $61 and change -- will soon be worth $78.

Why? Topeka believes that AMC's decision to shell out $1.04 billion to by Liberty Global's (NASDAQ:LBTYA) international content division, Chellomedia, back in October is going to turn into a real growth driver for AMC. Topeka thinks that in 2014, pro forma profit at AMC could be as much as 10% above consensus analyst estimates -- and keep growing from there. If Topeka is right about that, the shares could be a real bargain.

Consider: Priced at about 16.5 times earnings today, most analysts are looking for AMC Networks to grow its profits at 27% annually over the next five years. That already makes the stock look cheap, and if Topeka is right about the growth estimate being conservative, the stock could be even cheaper than it looks.

(Caveat: Debt levels at AMC are rather high -- about $1.5 billion net of cash. Free cash flow lags net income, too, with AMC's $247 million in FCF backing up only about 91% of reported income. Factor these numbers into the picture, and AMC looks closer to "fair" valuation than to the bargain that Topeka says it is).

LifeLock (NYSE:LOCK)
Like AMC Networks, anti-identity theft company LifeLock is seeing its shares surge today on the back of a new "buy" rating -- this time from analysts at Sterne Agee. But unlike AMC, LifeLock shares actually haven't gotten any cheaper since the market sell-off began. Rather, LifeLock has gotten more expensive -- a lot more expensive. Shares are up 33% since the New Year began, and now, Sterne Agee is predicting they'll go up even more, from $21 today, to $24 by year-end.

Is Sterne right about that?

At first glance, you might not think so (and second glance doesn't look much better). With barely any GAAP profit to its name, LifeLock shares currently trade for the mind-boggling valuation of 575 times earnings. Granted, things aren't quite as bad as GAAP makes them look. LifeLock is generating quite a bit of free cash flow after all, $50 million annually to be precise. And most analysts expect it to keep on growing its cash pile, increasing profits at the rate of 26% annually over the next five years.

Still and all, 26% growth probably isn't fast enough to justify the stock's triple-digit P/E ratio. With the price-to-free cash flow ratio looking similarly stretched -- 38 times -- I'm forced to conclude that Sterne Agee has jumped the gun on this one. While a fine company and a fast grower, we'll need to wait and see if the market sell-off can bring the valuation down on this one a bit, before calling LifeLock a buy.

And finally: Zynga. You remember Zynga. This maker of online "social" games such as FarmVille used to be the growth driver behind Facebook -- before Facebook grew up and didn't need Zynga to earn profits anymore. Now, the company's trying to reinvent itself as more of a stand-alone player in the social and mobile gaming space, spending $527 million to acquire Britain-based mobile gaming company NaturalMotion.

Not everyone likes the idea. Merrill Lynch, for example, cut its rating on Zynga to "underperform" just yesterday. But over at UBS, analysts are more optimistic. According to StreetInsider.com, UBS is assigning a new price target of $6 on Zynga shares (an increase of 50%) and upgrading the stock to "buy" -- partly because UBS thinks that "the $527mm acquisition of NaturalMotion (a leading iOS gaming company) will result in a greater level of scale and innovation to the broader Zynga mobile game pipeline."

Notes the analyst, "NaturalMotion... is one of the leading iOS game developers & has seen tremendous success with its CSR Racing and Clumsy Ninja franchises." And UBS thinks that by bringing NaturalMotion in-house, Zynga will be able to "materially" improve its profit margins, earnings, and free cash flow.

It had better, because at last report, Zynga was only generating real cash profits of about $21 million annually (giving the stock a price-to-free cash flow ratio of 190), and as for GAAP profits -- Zynga had none at all. Meanwhile, the company's spate of recent acquisitions continues to drain Zynga's cash reserves -- now down to $1.1 billion at last report.

Long story short, after the sell-off, there are probably bargains to be found out there in the markets. Zynga is not one of them.

Rich Smith has no position in any stocks mentioned, and doesn't always agree with his fellow Fools. The Motley Fool recommends AMC Networks, for example, but it also recommends LifeLock. 

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