Tech earnings are evaporating faster than you can say
Nasdaq 1500.
As a result, now is the time to stop focusing on the highly futuristic analytical models that were common during the Raving '90s bull markets. In their place, traditional credit analysis, focusing on near-term cash flows and balance-sheet movements, is making a comeback -- despite, not because of, Wall Street's high-profile analysts.
Plenty of recent cases have prompted a rethink among investors about how they look at companies. Think of
Lucent's (LU Quote - Cramer on LU - Stock Picks) well-chronicled decline to corporate stretcher-case from New Economy highflier. Plus
Amazon's (AMZN Quote - Cramer on AMZN - Stock Picks) cash flows have attracted
a lot of scrutiny. And one other company that's going to get tracked with a beady credit analyst's eye is
Motorola (MOT Quote - Cramer on MOT - Stock Picks). Yet a good number of sell-side analysts still view the Schaumburg, Ill.-based mobile-phone maker -- which last week said it could post its first quarterly operating loss in years -- through a bull market prism.
One favored approach is discounted cash flow analysis. There's nothing inherently wrong with this model: Predicting cash flows and then discounting them with the correct rate is a justifiable way to arrive at a stock price target. The problem was that the data that analysts slotted into their DCF models tended to be wildly optimistic. And it was always debatable whether anyone could ever predict earnings five to 10 years in the future. Still, it was worth a go. And you could argue that it makes even more sense to try to arrive at a long-term growth rate when a company like Motorola goes into a trough. By the time a recovery takes place, the market will already have priced it in.
Taking Notes
That said, a recent research note on Motorola from
Morgan Stanley Dean Witter, released after the company's earnings warning last week, shows that Panglossian tendencies take a long time to die. Analyst Alkesh Shah says that Motorola is worth $34 a share, 120% above Tuesday's price of $15.45, but 45% off its 52-week high. Shah's price target is largely based on discounting 10 years of something he calls "explicit free cash flow" and a long-term growth rate of 8%. The note doesn't say why 8% is achievable or provide yearly growth rates. Nor does it say what explicit free cash flow actually is. Shah didn't return a call seeking to discuss his research; he rates Motorola an outperform. (Morgan Stanley has done underwriting for the company.)
Two observations. While highlighting bad analyst calls is an obvious and unsavory trick, one does have to ask whether it's wise to trust a 10-year forecast from an analyst who was six months ago expecting Motorola to make $1.43 a share in 2001, compared with the 10 cents a share he now forecasts. Second, any analysis of the distant future must be coupled with a forensic examination of the coming 12 months. That's crucial for cash-bleeding cases like Motorola. Enter credit analysis.
Motorola is likely to post some $5 billion in negative free cash flow (cash flow from operations minus capital expenditures and dividend payments) in 2000, reckons Carol Levenson, credit analyst at
Gimme Credit, an independent research firm that does no investment banking work. Motorola still hasn't released a cash flow statement for full year 2000, and may not do so until its annual report comes out. The company had more than $3 billion in cash on its balance sheet at the end of 2000, so there is no liquidity squeeze at the company -- yet. The company declined to comment on full year 2000 numbers and the outlook for liquidity and financing in 2001.
Forecasting
However, if 2001 earnings were to sink below current much-reduced forecasts, and efforts to extract more cash out of the balance sheet and sell assets founder, then Motorola may have real problems borrowing to make up a cash shortfall this year. Last week, one credit analyst said the
company would have problems accessing the commercial paper market this year. Motorola appears to have as much as $4.4 billion in commercial paper outstanding. Much of that is expected come due this year.
So what sort of forward-looking cash flow calculations can investors do for Motorola? Crucial is free cash flow for 2001. Let's say Motorola makes $700 million in net income this year -- a figure close to some analysts' estimates. Add back in depreciation of around $2.7 billion. Then subtract a possible working capital cash burn of $3 billion, which, while large, would be an improvement on 2000, when Levenson estimates the company's working capital ate up $5 billion. This gives an approximate $400 million in cash flow. Motorola said its capital expenditure is going to be below the originally forecast $2.5 billion, so let's make that $1.8 billion.
Subtract the reduced capex total, along with some $350 million in dividends, and the free cash flow for 2001 could be negative $1.75 billion. That deficit could be reduced with proceeds from asset sales. But any remaining shortfall after those would have to be made up with new debt, which may be hard to issue when the company already has to refinance over $4 billion in short-term obligations in 2001.
Forget what most of Wall Street's saying: Worry about cash flows now, not earnings in 2011.
Peter Eavis
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