UBS Global Research analysts Eric J. Sheridan, Vishal J. Patel and Timothy E. Chiodo downgrade Twitter Inc (NYSE:TWTR) from Neutral to Sell as the company presented an initial post-IPO earnings report that demonstrated strong ad trends and margin expansion but negative trends in user engagement.

Twitter

Twitter’s rating downgraded on valuation

We are lowering our rating to Sell & lowering our price target from $45 to $42 after Twitter Inc (NYSE:TWTR) presented an initial post-IPO earnings report that demonstrated strong ad trends & margin expansion but negative trends in user growth/engagement. Given the likely forward effort (multiple quarters) to improve user growth & engagement (including product development costs), we see little potential for upside in estimates over coming quarters. Even after last night’s stock correction, Twitter remains one of the most expensive stocks in our universe – EV/14 Sales of 30x (vs. FB at 13x) & EV/14 EBITDA of 208x (vs. FB at 22x). In addition, since the market close on its public debut, Twitter has outperformed the S&P 500 INDEX (INDEXCBOE:SPX) by 2000+ bps (including last night’s selloff) – an outperformance that we believe is unlikely to be sustained given questions raised by the earnings report.

Need headwinds to turn to tailwinds to become more constructive

Over the medium term, we expect that Twitter Inc (NYSE:TWTR)’s stock will underperform during a multiple quarter transition to (hopefully) better user growth/engagement. A lack of mainstream adoption or a more simplified use case was a worry of ours coming out of the IPO & seems to have come to the fore faster than we had anticipated. In addition, a small February employee share lockup (9.9mm shares) & a larger May lockup (465mm shares) will cause headwinds to stock performance. Once these medium-term headwinds have passed and/or Twitter demonstrates a clearer trajectory of user & advertising growth, we could become more constructive as we consider Twitter a unique social media platform with long-term monetization potential.

Estimates

Better Ad revenues (Offset by Weaker Engagement) & Minimal operating leverage Our new Q1 2014 estimates are revs $242mm (from $223mm); Adj. EBITDA $25mm (from $41mm), & Adj. EPS $(0.03) from $(0.01). Our new FY 2014 estimates are revs $1.22b (from $1.21b); Adj. EBITDA $177mm (from $154mm), & Adj. EPS $(0.01) from $(0.04).

Twitter’s valuation

Our $42 price target (prior: $45) for Twitter Inc (NYSE:TWTR) is based on our blended valuation approach (EV/Sales, EV/EBITDA and EV/FCF) skewed most heavily (60%) to EV/Sales.