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Upvote or downvote: what you need to know about the Reddit IPO

The birthplace of r/wallstreetbets is asking investors to take a wager on its big stock debut. Stéphane Renevier considers the firm behind what could be the first social media IPO since 2017.

1st March 2024 14:00

by Stéphane Renevier from Finimize

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  • What’s hot here: Reddit’s got a unique user base, a growing slice of a growing pie, and new revenue streams. And it will likely trade at a reasonable valuation.
  • What’s not-so-hot: its revenues are heavily concentrated in ads, it’s sharply dependent on its user base, it’s yet to turn a profit after two decades, the competition’s heating up, and its own crowd could turn it into a meme stock.
  • So its stock price could go anywhere based on sentiment, but based on its fundamentals, it’s hardly a bargain.

Reddit’s gearing up to hit the NYSE under the ticker RDDT, and could start trading in a matter of weeks, making it the first social media IPO since 2017. But before you jump on this bandwagon, let’s cut through the noise and see what’s up with the platform that’s been a slowpoke in monetising its massive, meme-loving community.

What’s going on?

Think of Reddit as the social media world’s cool, offbeat cousin, popping up a year after Facebook but chasing vibes over viral fame. Here, it’s all about what lights your fire, not who your friends are. Reddit’s built on a give-and-take with its users, who are viewers, creators, and unpaid content moderators all at once. This model fosters tight-knit, mostly anonymous, communities that become diverse, highly engaged and sometimes powerful entities of their own making. Case in point: the r/wallstreetbets frenzy, when a subreddit group took the market by storm and sent a few stocks (almost) to the moon.

This social hub has a devoted following – with 73.1 million Redditors hanging out daily and popping into its 100,000 buzzing forums – but what it doesn’t have is profit. That said, its losses have been getting slimmer and its sources of income have been getting fatter. Reddit makes money (though not much) by offering a premium, ad-free zone, and it’s recently stepped into the AI-feeding game, agreeing to deliver data access to Google for $60 million this year alone.

Having multiple irons in the fire is probably very welcome right now because Reddit derives about 98% of its revenue from ads, and is highly concentrated to just a few big clients. And with about 81% of its revenue coming from the US, it’s also pretty concentrated geographically.

Last year, the platform pulled in $804 million in revenue – 21% more than the year before. And it’s recently pulled off a complicated gymnastics move too – not just pulling in more users, but earning more per month from each ($3.10 on average last year, compared to $2.90 in 2022). Yet, with all that, the company posted a $91 million loss in 2023 – an improvement on its $159 million loss in 2022, but a reminder that it’s still got work to do. What’s more, its negative free cash flow of $22 million shows it’s still burning lots of money.

If some of this sounds familiar, that might be because Reddit was pushing for an IPO back in December of 2021, listing a valuation of up to $15 billion, but then shelved those plans when the market started to go south.

This time around, the firm’s reportedly aiming for a more modest $5 billion. And it’s doing something a bit cool and different too: it’s offering shares to 75,000 of its core users at the IPO price before they hit the stock market, a level of access usually reserved for professional investors.

Whether you’re part of that elite group or not, you will soon have a shot at buying Reddit’s shares. So let’s take a look at whether it’s worth your hard-earned money.

What makes Reddit a portfolio upvote?

It’s got a small slice of a huge and growing pie. Reddit’s playing the long game here, striving for its piece of the whopping $1 trillion digital advertising pie. Right now, it’s grabbing less than 0.001%, or a tenth of a percent, of that. But the pie is only getting bigger. And so is the overall global social media market: it’s set to balloon by 13.2% annually to $413.2 billion over the next five years.

Its ad revenue has room to grow. Some 41% of Reddit’s US crowd is aged 18 to 34, and 64% rake in over $75,000 annually. That’s music to advertisers’ ears. Plus, Reddit’s AI-driven ad targeting is based on context and interests, so its ads hit close to home, making those marketing dollars work harder. And because a hefty chunk of its users shun other social platforms, Reddit gives advertisers a unique access.

It’s got data to sell. Reddit is more than memes and AMAs: it’s a data platform and a search engine. That deal with Google is a testament to the goldmine Reddit sits on: data the behemoths can use for sentiment analysis, trend spotting, and to train their colossal language models.

It also plans to profit from the user economy. Reddit plans to monetize the so-called user economy by enhancing tools and incentives for creators, and by launching a developer platform for community innovation, a contributor program to reward content creation, and a community marketplace for goods exchange.

Reasonable valuation: At $5 billion, Reddit would be valued on a multiple of just over six times estimated trailing sales. That would put it well below both Meta (at 9 times) and online scrapbook Pinterest (at 7.2 times). It’d be valued at roughly the same multiple as Snap, though it’s growing at a faster clip. More simply, its price – though not yet set – might not be suffering from the same speculative fever as Snap, which debuted at 60 times trailing sales back in the day.

What makes Reddit a portfolio downvote?

It’s got the usual social media headaches. These are the ones the whole industry faces: Google’s whims can slash the platforms’ traffic and the online ad economy could grind to a sudden halt if the economy slows down.

It’s dependent on its user base. Reddit’s magic ingredient – a universe powered by users – doubles as its biggest risk. Keeping this crowd happy is a tightrope walk. Reddit’s moderators aren’t cashing paychecks by sticking around, after all, and for users, the internet’s awash with alternatives. An unpopular new ad format or content change could send them hurtling toward the exits. But what’s good for the meme crew might not always jive with profit goals. And don’t forget: these users have a rebellious streak and they’ve hit the off switch before, with over 7,000 subreddits vanishing in protest.

It’s yet to turn a profit. This wouldn’t necessarily be an issue for a young startup, but Reddit’s had nearly two decades in the trenches. You’d think that by now this company would’ve have cracked the code on how to turn its vast playground into a cash cow.

Its competition is heating up. Reddit operates with a core focus on communities, but startups like Quora, 9gag, SmartNews, and Knotch have all created intense competitive rivalry in this niche.

It may have some stock karma to contend with. Dishing out IPO shares to hardcore Redditors is innovative, but it could ultimately backfire. If the stock takes a dive, those same enthusiasts could flip sides faster than you can say “sell,” and there’d be no lockup period to hold them back. Just imagine Reddit becoming the next doomed meme stock craze, à la GameStop, courtesy of r/wallstreetbets.

AI is a double-edged sword. Reddit may be making money on AI now, thanks to its Google deal, but as AI gets smarter, so does the risk that this booming platform will become just another dataset, with no driver for direct site visits or ad views.

What’s the opportunity here?

It’s not hitting the market with eye-watering valuations, and sure, it’s sitting on some pretty neat growth avenues that could potentially line its shareholders’ pockets.

But let’s not kid ourselves here. It’s not what Ben Graham, the godfather of value investing, would’ve called a bargain. It’s definitely not in Warren Buffett’s high-quality stock playbook. And if it’s growth you want, there are probably more exciting opportunities around.

That doesn’t mean you can’t make money by investing in it – after all, market vibes will play a big role in its stock performance – but based on its fundamentals, it’s hardly worth going out of your way for.

If you’re still on the fence with this IPO, remember this: stock market debuts, by and large, aren’t the golden tickets they’re hyped up to be. Yeah, they can be exciting, but they’re hardly your ticket to long-term riches.

Stéphane Renevier is a global markets analyst at finimize.

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