Alcan Gets A Shiny New Downgrade

Alcan's stock has surged nearly 70% this year, as the aluminum maker was aggressively pursued by its rival, Alcoa. Alcan turned down a $27 billion unsolicited takeover offer from Alcoa on May 22, arguing the offer was contrary to the best interests of its shareholders.

But now, Alcan's (nyse: AL - news - people ) shares have become a bit too rich for at least one stock watcher. Anthony Rizzuto, an analyst at Bear Stearns, downgraded the firm on Wednesday. "Based on valuation of the shares, we can no longer justify our 'outperform' rating and are therefore downgrading them to 'peer perform,'" Rizzuto said.

Despite this, Rizzuto told clients he continues to be impressed by the pace of restructuring efforts Alcan is making, as well as growth initiatives into lower-cost regions. But it's not enough, he says.

Rizzuto also said he wouldn't rule out the possibility of a third party emerging as a white knight to Alcan, instead of Alcoa (nyse: AA - news - people ). However, he doesn't believe other potential acquirers could generate the same level of synergy opportunities.

Alternatively, Rizzuto said, Alcan could make a counteroffer for Alcoa, a so-called "Pac-Man strategy." He thinks the offer would likely have a greater mix of stock versus cash. He argued that Alcan could make a $50-per-share offer for Alcoa and still have the potential transaction boost earnings-per-share in 2008.

However, Rizzuto said that if Alcan were to pursue a Pac-Man strategy and bid for Alcoa, there would be consequences for the stock. The analyst argued that Alcan's shares could fall sharply to perhaps the midpoint between the current level and the price immediately prior to the Alcoa bid, thus creating a greater potential downside risk in the near term.

Alcoa had pursued its rival Alcan for two years. But Alcan rejected its competitor's overtures. At the time, Alcan Chief Executive Yves Fortier said that the offer didn't adequately reflect the value of Alcan's assets, strategic capabilities and growth prospects. (See: " Alcan To Alcoa: I Want To Be Alone.")

Given all the action in the metals market, Alcan might have figured that a higher bid could come. Metal miners and producers have been buying each other up to benefit from economies of scale.

Why all the interest in Alcan? Analysts say its low-cost power assets, and therefore low-cost smelting system, coupled with impressive free cash flow, make it an attractive target for industry players. (See: " Alcan Could Attract More Bids.") In afternoon trading, shares of Alcan traded basically unchanged at $82.46. Shares of Alcoa jumped 1.2%, or 46 cents, to $39.80.

Separately, Rizzuto also revised his 2008 aluminum price forecast and EPS estimates. He raised his 2008 aluminum price assumption to $1.10 per pound, up from $1.05 per pound. There is no change, he said, to his 2007 estimate of $1.19 per pound. The analyst said this was based on several factors, including his expectation for inventories to remain at or near critical levels. They are currently at 5.7 weeks of supply, he wrote.

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