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.

19% undervalued? Are you Sirius?
Shareholders of satellite radio star Sirius XM Radio (Nasdaq: SIRI) have reason to smile this morning. Yesterday, in the middle of the trading session, JANCO Partners upped its rating on the stock from a half-hearted "accumulate" to an honest-to-goodness "buy." Why? According to JANCO, even after rocketing up from the $1 range to $2-a-share-and-change, Sirius is still cheap.

The catalyst for this announcement came in the form of an offer by General Motors (NYSE: GM) to provide car buyers three free months of Sirius when they buy any used car from a GM dealer. Granted, this isn't a totally new idea. As fellow Fool Rick Munarriz pointed out last month, Sirius already has similar "certified pre-owned" deals with BMW (OTC: BAMXF.PK), Volvo, and CarMax (NYSE: KMX), too. However, the GM announcement is Sirius' first with a Big 3 automaker. Importantly, GM's offer applies not just to GM cars and trucks, but to any used car, whatever the make, sold at GM dealerships (so long as they have a Sirius radio installed).

That sounds like a caveat, but as JANCO points out, it's not a big one: "[Sirius] has over 60% market penetration of new cars." As a result, "there are millions of satellite-radio equipped cars ... in the used car market" to which this offer could apply. Returning these cars to Sirius membership offers a chance to snag millions of new subscribers at a "low acquisition cost and higher incremental margins." High enough, apparently, that JANCO believes it will turn Sirius into a $2.50 stock within 12 months.

Is JANCO right about that?

Let's go to the tape
I have to warn you, Fools, initial indications are not good. It's been well over a year since JANCO stopped issuing timely updates on its recommendations through Briefing.com, so we can't be sure how it's been doing lately. But at last report, its record on media stocks like Sirius was pretty iffy:

Historically, only about 44% of JANCO's recommendations in the media industry managed to outperform the market. It's even under water on its only publicly announced Sirius pick, a 2008 recommendation to buy the stock. So you may be surprised to learn that I actually agree with JANCO this time.

Huh?
I know. This is probably a bit of a shock, coming from a value investor like me. Plain-vanilla value seekers probably look at Sirius and its "100" P/E ratio and dismiss the stock out of hand. But the honest truth is that when I look at Sirius' numbers, they just don't scare me.

Consider: While Sirius reported earning only $80 million over the past year, this is only a GAAP number. From the perspective of the actual free cash flow it's generating, Sirius is actually a whole lot more profitable than it looks. Free cash flow for the past 12 months came to $321 million (literally four times as much as reported "profits"). Based on that number, I tend to look at Sirius not as a "100 P/E stock," but as a company trading for 25 times the amount of free cash it earns in a year. A company that, by the way, is expected to grow its profits at 30% per year over the next five years.

I know this is going to sound crazy ... but at the rate its free cash flow is improving, I actually think I like Sirius more here at $2 a share than I did back when it only cost a dollar.

Foolish final thought
Mind you, I'm not saying Sirius is an obvious buy at today's price. The company still has to hit that 30% growth target to justify its valuation. But if you take this week's GM announcement, and extrapolate it to include potential used car-activation deals Sirius could later sign with Ford (NYSE: F) and Toyota (NYSE: TM), for example, I think the growth is there for the taking.

Automakers like Ford, Toyota, and GM have a lot to gain from this tie-up with Sirius. The extra perk will help to move metal. Meanwhile, offering freebies to used car buyers fixes a nagging problem for Sirius: When a car owner sells her car, she doesn't want to pay for somebody else to enjoy the Sirius service, so she naturally turns it off. But the new owner may not know how to turn it back on -- or may know how, but not be inclined to pay for an unknown. Sirius' initiative promises to "monetize" all those inactive hunks of Sirius-receiving electronics out there in the used car market.

Three months of free service could be enough to convert a Sirius agnostic into a Sirius fan of the service. It may also be enough to convert Sirius into a $2.50 stock.