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 feature a pair of downgrades for United Parcel Service, Inc. (NYSE:UPS) and Riverbed Technology, Inc. (NASDAQ:RVBD). But the news isn’t all bad.
Suddenly, nobody hates Leap Wireless International, Inc. (NASDAQ:LEAP) anymore AT&T Inc. (NYSE:T)‘s announcement late Friday, that it plans to buy mobile rival Leap Wireless International, Inc. (NASDAQ:LEAP) for $15 a share, spurred a radical rethink among analysts this morning. As Monday dawned, no fewer than five separate analyst houses upgraded their ratings on Leap Wireless International, Inc. (NASDAQ:LEAP), with BTIG, Baird, BMO, and J.P. Morgan all upgrading the shares to various flavors of “neutral,” and Barclays suggesting investors actually “overweight” the stock.
Of the five, Baird’s ratings switcheroo was perhaps the most surprising. Previously positing a mere $3 stock price for Leap Wireless International, Inc. (NASDAQ:LEAP), the analyst now says the stock is worth all $15 that AT&T Inc. (NYSE:T) wants to pay for it. But are these analysts right? Is Leap Wireless International, Inc. (NASDAQ:LEAP) now “safe” to hold?
No, I don’t think so. And I’ll tell you why. Already, Leap Wireless International, Inc. (NASDAQ:LEAP) shares have leapt over the bounds set by AT&T Inc. (NYSE:T)’s buyout offer, and currently trade north of $17 a share. That means investors are betting that either AT&T Inc. (NYSE:T) will be forced (perhaps by shareholder lawsuits) to raise its bid, or that a competing offer (perhaps from T MOBILE US INC (NYSE:TMUS), which bought MetroPCS three months ago) will emerge. Either of these scenarios are possible of course. But what if they don’t happen?
Why, then, investors who follow Wall Street’s advice and hang onto the shares today, instead of taking their winnings and bidding Leap adieu, will be stuck owning an unprofitable telco with $2.6 billion net debt. A telco that might be worth $15 a share if regulators approve AT&T Inc. (NYSE:T)’s purchase, or that might be worth far less if the deal gets KO’ed, and Leap shares plunge back down to their pre-buyout-offer valuation.
Personally, I see far more minuses than pluses in today’s stock price. If I owned Leap, I’d take the money and run.
United Parcel Service, Inc. (NYSE:UPS) and downs
Speaking of stocks to run from, investors are scampering pretty much pell-mell away from shares of United Parcel Service, Inc. (NYSE:UPS) today, as the stock attracts downgrades from each of Raymond James, BB&T, and J.P. Morgan. Last week, as you may recall, a weak guidance announcement from United Parcel Service, Inc. (NYSE:UPS) sent the shares down nearly 6%. Today, they’re off a further 0.5% on news of the downgrades. But are these sell-offs justified?
Yes. To an extent, I think they are. Just on the face of it, you can see that United Parcel Service, Inc. (NYSE:UPS) shares cost a pricey 95 times earnings today. Personally, I don’t put too much stock in that P/E ratio, knowing as I do — and as you should, too — that UPS is a strong cash generator, which churned out $4.5 billion in free cash flow last year. Still, this leaves the stock trading for 18 times cash profits, and with an enterprise value-to-free-cash-flow ratio that’s even higher than that, once you factor in debt.
A 2.9% dividend yield lessens the pain of ownership on this one, but still, 18-plus-times free cash flow seems too much to pay for an 11% grower like United Parcel Service, Inc. (NYSE:UPS). (And if last week’s earnings warning is any indication, UPS may not even grow as fast as that).
Riverbed Technology, Inc. (NASDAQ:RVBD) running dry?
A second downgrade today is Wunderlich’s takedown of Riverbed Technology, Inc. (NASDAQ:RVBD), which the analyst says costs too much — and with which I disagree.
Wunderlich’s characterization of its downgrade to “hold” as a valuation call makes sense initially. After all, at 71 times earnings, Riverbed Technology, Inc. (NASDAQ:RVBD) looks not that much less overpriced that UPS at 95 times earnings. However, also like UPS, Riverbed Technology, Inc. (NASDAQ:RVBD)’s valuation can be deceiving — because the company generates just so much more cash profit than GAAP accounting rules let it report as “net income.”
Last year, Riverbed Technology, Inc. (NASDAQ:RVBD)’s free cash flow practically ranneth over, approaching $247 million, versus GAAP net income of less than $40 million. That means that this stock which appears to cost “71 times earnings” can more accurately be described as costing just 10.5 times free cash flow. With a projected growth rate of nearly 22% annually over the next five years, that’s a pretty cheap price investors are being asked to pay for Riverbed’s abundant growth. If you ask me, it’s a price worth paying. I think the stock’s still entirely cheap enough to buy…
…and judging from how well the stock is holding up in Monday trading, despite the downgrade, it appears a lot of other investors agree with me.
Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Riverbed Technology and United Parcel Service (NYSE:UPS). The Motley Fool owns shares of Riverbed Technology.
The article Monday’s Top Upgrades (and Downgrades) originally appeared on Fool.com is written by Rich Smith.
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