This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, our headlines cover the gamut, with downgrades hitting French game maker GameLoft (NASDAQOTH:GLOFY) and Brazilian plane manufacturer Embraer (NYSE:ERJ). Meanwhile, one company -- Twitter, which isn't even tradable yet -- nonetheless receives a prospective buy rating. Let's start with that one.
Like I said, while widely reported to bear the ticker symbol TWTR, Twitter shares are not yet public and cannot yet be invested in. But that didn't keep analysts at CRT Capital from jumping the gun this morning by urging investors to go ahead and buy the stock anyway. Likewise, we've heard in recent weeks that analysts at Topeka Capital, Sterne Agee, and others -- five analysts in all -- have begun chiming in on Twitter's prospects, with most advising investors to buy the stock.
Well, as USA Today reported today, Twitter has been making the case for buying its stock lately. According to the newspaper, the company is telling people that it expects to double revenue from current levels by 2015, raking in $1.24 billion, and expects to transform $200 million of that into earnings before interest, taxes, depreciation, and amortization, or EBITDA.
That all sounds pretty good, but let's put it in context. Current expectations for the stock's valuation, at an anticipated $24 IPO price, suggest the company could exit the gate at a $17 billion market capitalization. Assuming the EBITDA numbers are right, this would work out to an 85 times EBITDA multiple on the stock -- or a valuation more than twice that of Facebook, and more than five times that of Google.
That valuation seems a bit excessive to me. Luckily for you, so far there's no risk of overpaying for the stock, at least until the IPO actually happens.
So let's move on now to the stocks that you can buy, but that Wall Street says you shouldn't. We'll begin with:
GameLoft pwned by analyst
Paris-based GameLoft may be one of the biggest gaming companies you've never heard of. The maker of downloadable games for mobile devices, tablets, PCs, and gaming consoles commands a nearly $1 billion market capitalization ($873.5 million, to be precise). It just finished reporting "record" third-quarter revenue of $83.1 million, up 11% year over year, with game sales for smartphones and tablets in particular (69% of the firm's business) rocketing 31%.
Yet over at Benchmark, analysts just yanked their buy rating and downgraded GameLoft to neutral. Why?
If you ask me, this is a situation best summed up as "great company, horrible stock." GameLoft's business is going great guns, no doubt. But at a valuation of 38 times trailing free cash flow -- and roughly 87 times reported income -- GameLoft stock simply costs too much for the 11% sales growth it just produced.
That 11% growth is a respectable number, sure. But it's not good enough for an 87 times earnings valuation. Indeed, even if GameLoft were growing earnings as fast as it is growing sales (in fact, earnings are falling), and even if we were to value the stock on free cash flow rather than generally accepted accounting principles profits, GameLoft would still look overpriced to me. Benchmark was right to issue the downgrade.
Embraer gets its wings clipped
Fortunately, today we get to end on a bit of good news, so let's wrap up now with Embraer -- the subject of a downgrade from UBS today.
According to UBS, Embraer shares are no longer worth buying, unlikely to reach the analyst's previous $39 price target, and more likely to stall out around $31. (The shares cost just $30 and change today.) Yet when I look at the stock, I have to wonder whether UBS is being too pessimistic.
Embraer shares may look like they cost a lot, based on trailing earnings of about $167 million. When you value these shares on free cash flow, however, rather than GAAP earnings, then the $375 million in cash profit that Embraer has produced over the past year suggests a valuation of less than 15 times free cash flow.
According to Yahoo! Finance, most analysts agree that Embraer will be able to grow earnings at better than 15% annually over the next five years -- which suggests a sub-15 times valuation is already a bargain price to pay. Plus, Embraer pays a modest 0.3% dividend on its stock. Plus-plus, this primarily civilian operator has additional upside in the form of military contracts, now that the U.S. government has officially confirmed its contract to begin selling the Afghan air force fighter planes.
Long story short, UBS may have lost faith in Embraer, but when I look at the facts, the stock still looks buyable to me today.