IPO Reddit, i.e. the forum, goes public. Meme stock or an interesting business model?

For those interested in the stock exchange, Reddit is certainly associated with the place where investors moved “crusade” against investment companies on GameStop shares. As a result, shares of a company that seemed “sure thing” to further declines, it increased its capitalization many times. It was on Reddit that the trend began “meme stock". Password #wallstreetbets it was one of the most popular on the Reddit forum and was making its way into the Mainstream.

For those unfamiliar with the topic: Reddit is a place on the Internet where you can talk about everything, both about investing, serious existential topics, and exchange memes. In October 2023, this was it 18th most popular internet address in the world. On March 21, 2024, Reddit will debut on the stock exchange. It is worth mentioning that among Reddit's shareholders you can find the CEO of Open AI, i.e Sam Altman (8,7%) or the Chinese giant Tencent (11%). The largest shareholder is an entity related to the Newhouse family, i.e Advance Magazine Publishers (30,1%).

Due to the fact that demand exceeded supply four times, Reddit had no problems with placing 4 million shares. The company's valuation at its debut was $22 billion. It seems like a lot, but in 6,5 the company obtained financing from private investors at a valuation of $2021 billion. However, the time of "madness" in the valuation of technology and social media companies is over. Higher interest rates have forced companies like Reddit to lower their valuations a bit (the so-called multiplier compression).

The company's problem is that despite building a large and very active community, failed to translate success into financial results. Since the website's debut (2005), the company has recorded losses every year. Over time, it gave up its position in favor of more convenient platforms such as Twitter (currently X) or Facebook. This was because Reddit's greatest advantage (i.e. liberal content moderation) somewhat discouraged advertisers. In turn, attempts to increase "censorship" (i.e. moderation) were met with opposition from users. Since its inception, Reddit has moderated its content thanks to volunteers who are also users of the site. This allows you to reduce costs, but at the same time this form of cooperation is very flexible, which also has its disadvantages. This was the case in 2023, when many moderators ceased their duties as part of a protest caused by Reddit's introduction of fees for app developers to download data held by Reddit.

An active community is the platform's greatest value

If you are looking for things to buy, using search engines is both a blessing and a curse. Especially in the United States, it's hard to find honest product reviews using a search engine. Most often, we will receive well-optimized pages for SEO that do not always provide high-quality content. Reviews are often written to order according to the principle:

“Whoever pays better, the product will be the best.”

For this reason Reddit is one of the last bastions, where you can obtain the opinion of enthusiasts or experts on a given topic. Thanks to this, you can easily learn about the advantages and disadvantages of a given product and find opinions about similar solutions or those from the "higher" or "lower" shelf.

Let's use an example. We want to compare two budget versions of the investment terminal: tikr i Koyfin.

Source: search results on Google.com

The first page immediately contains information (hidden in Disclosure) that the website may contain affiliate links. This is not terrible news, because websites and blogs also need to make money. For this reason, advertisements and affiliate links are normal. My subjective opinion is that the knowledge provided in this blog post was very basic and certainly not a place where I learned a lot of useful information. Another problem was that the author of the text had not used both applications for several months. His conclusions were therefore based on processing information available on the Internet. This is certainly helpful, but the more valuable opinions are those expressed by real users of the solutions in question.

The next two search results are from Koyfin. Reddit is only in fourth place. We receive information about the most popular tools used by value investors (we have been moved to this subreddit). This way you could receive extensive opinions about various tools. This allows you to obtain more information about the advantages and disadvantages of individual solutions. Below is an example response in the discussion.

Source: Reddit.com

You can use the search engine, which makes it easier to find the information you need. This is useful if you don't find the information you need in the selected subreddit. Of course, we won't always get valuable information, but it is certainly a place worth visiting.

Reddit does not require users to reveal their identity, which encourages honest expression of opinions. This allows you to build a community built on user honesty, as Steve Huffman mentioned before the IPO.

Reddit is one of the most popular places on the American Internet

According to data from the prospectus, Reddit has an active community of 276 million WAUq (weekly active users). In December 2023, the average amount of active time on the platform ranged from 25 to 30 minutes per day. Every day the company has 73,1 DAUq (Daily Active Uniques). It is important for the company that the Redditor community becomes as active as possible. Then the number of interesting forums will increase, which will translate into more traffic on the website itself. More active users mean a chance for more revenue from advertising and data monetization. About 50% of DAUq comes from the United States. 41% of American users are between 18 and 31 years old. It is worth mentioning that 64% have incomes above $75, which is more than the median ($000). According to Comscore data, 32% of people who visit Reddit do not have Facebook, 37% do not have an Instagram account. In turn, 53% are not present on X.

The greatest value of this website is the authenticity of the reviews. On Reddit you can meet real specialists in specific fields who are willing to share their advice, ideas and views. This is a particularly useful place to find out opinions about a product or service. Some professional investors turn to Reddit to find out the real opinion of users about the products of publicly traded companies. Moreover, traffic on the platform is generated by users who look for real opinions on the Internet. According to the data Vertical Path to Purchase Survey, 73% “Redditors” would be able to make a purchase faster if the product or service had numerous positive reviews on Reddit. According to survey data 75% of respondents considered the platform to be a reliable place to obtain information.

The number of active users is a bit worrying. DAUq between 2021  and 2023 was flat most of the time. This means that it is very difficult for the company to grow. The lack of a larger number of users means the risk of the portal's slow agony. More DAUq means more content, which will attract new users, which will increase the number of topics. There is a noticeable increase in Q2023 and Q2024 XNUMX, which raises the question whether this is somehow "window dressing" before the IPO. QXNUMX and QXNUMX XNUMX will tell us more about the dynamics. The advantage, however, is that Reddit is increasingly expanding beyond the United States. More foreign community means, on the one hand, a decrease in average monetization per customer (“American users” are worth more to advertisers), and on the other hand, higher nominal advertising revenues. Building a real international community is also a chance for better monetization of data left on the platform.

Source: Reddit prospectus

What is a positive phenomenon is the increase in user monetization. ARPU has been growing in recent quarters, thanks to which the company managed to increase revenues despite the stagnation in the number of users. If the trend continues, Reddit will be able to increase its revenues thanks to two growth engines: a larger number of customers and better monetization.

Source: Reddit prospectus

Community development plans

Therefore, the company's success is based on the development of its own community. For the company, the most important thing is that users who visit Reddit once a week or month do so more often. The company itself boasts that it has 267,5 million WAUq, i.e. users who use the platform once a week. Only 27% of "weekly" users visit the platform every day. So there is still a lot of room to improve the DAUq number. The company itself sees an opportunity to increase the frequency of daily visits through:

Increasing awareness of Reddit: the company intends increase the recognition of the platform among others through partnerships. In the future, the company sees a chance that content posted on Reddit will appear more often outside the platform. There are also plans for a user trying to find an answer to a question using an internet search engine to go to Reddit.

It's also important for Reddit improving the usability of the platform. For this purpose, the company uses machine learning, which allows for better classification and recommendation of content. This increases the likelihood that a user's posts will end up in the appropriate subreddits. Also, thanks to better content classification, the user will be able to find interesting threads more easily. Thanks to this, they are expected to stay on the platform longer and return to it more often during the day or week.

The success of TikTok has resulted in many social media platforms entering short video format (incl. YT Shorts). It is also worth remembering that people often prefer to listen and watch something than to read. For this reason, Reddit is committed to encouraging users to create video content. Importantly, the company also keeps statistics on this format. According to the information contained in the prospectus, the number of daily video viewers increased by 2023% y/y in December 16

Another idea to improve the functionality of the platform is search improvement. Currently, Reddit records 35 million search queries on the site every day. Improving the quality of the answers provided will make the platform even more useful, which should also result in users using Reddit more often as a "little Google". According to the company's data, users who actively use the platform's search engine have 30% higher return rates to Reddit compared to other users.

The company also plans improve the way we recommend content, using algorithms based on, among others, on users' paths. The new recommendation engine is intended to better target users and recommend content that is of interest to a similar audience. The longer a user stays on the platform, the greater his value in the eyes of advertisers.

For now, Reddit's big strength and weakness is that 90% of conversations take place in English. On the one hand, this allows for easier use of the platform's resources, on the other hand, it discourages users who do not know this language from using the website. The company sees particularly great potential for developing the platform in other languages ​​in countries such as Great Britain, France, Spain, Germany, Brazil and India.

Advertising sword of Damocles

Reddit is often characterized by the following words: real, human, authentic. It is these features that distinguish the platform from other solutions. On the other hand, the lack of "monetization" (i.e. inserting ads wherever possible) is also a weakness of the platform. Without significant monetization of content, it will be difficult to obtain funds to develop the platform and fight against competitors with more capital (X, Facebook, TikTok, YouTube). In fact, the user's time is limited, which is why he must optimize it and choose only those social media platforms that are of the greatest value to him. If Reddit places more ads, affiliate links or other such solutions, it will become a worse version of the most popular platforms (worse because it does not have such a scale and such a strong platform effect). Therefore, the company must somehow manage both the social side (no advertising) and the financial side (greater monetization).

Okay, but why do advertisers sometimes want to advertise on a poorly moderated platform? For advertisers, a thematic place (e.g. running enthusiasts) is a chance to present their products (shoes, running accessories, applications). The platform's reputation may encourage users to click on advertising links more often. However, if the advertising offer is weak, users will start to ignore them. Advertising conversion will drop, which will affect advertising statistics and cause Reddit to sell "advertising spaces" on the website for less money. Therefore, the platform itself should care that no scams advertise there.

Reddit financial results (click to enlarge).

The image of the platform shown above seems interesting. There is only one "small" problem. The company has problems with achieving profitability. In 2023, the company's revenues amounted to $804 million. This is an increase of 20% y/y, but it positions the company far behind the largest social media platforms. Even Twitter, which monetizes users poorly, boasted revenues of $3,4 billion last year (2022). Most of Reddit's revenue comes from advertisers (98%), but the company itself sees great potential in licensing its data sets for artificial intelligence models. Despite hundreds of millions of revenues, the company has problems with profitability. According to the data included in the prospectus, in 2022 the 10 largest customers generated 28% of Reddit's revenues. In 2023, the Top 10's share in revenues dropped to 26%. Therefore, it is clear that the company is diversifying in terms of customers.

The largest operating expense item is R&D (research and development), which reached $438,3 million last year. Such high costs (54,5% of revenues) may raise eyebrows. In the prospectus, Reddit explains that these costs include:

“R&D expenses consist primarily of personnel costs, including salaries, benefits and stock-based compensation for developers and other employees engaged in the research, design and development of new and existing products. R&D expenses also include consulting services and hosting costs associated with internal R&D activities, as well as allocated infrastructure and other additional overhead costs.”

Therefore, these costs are related to the development of the platform and its appearance.  This means that the personnel costs of programmers, designers and graphic artists who deal with the maintenance, appearance and new functions of Reddit dominate. This is somewhat misleading because these are not just costs related to the development of research activities. Therefore, it is difficult to hope for their drastic decline.

As much as $230 million are costs related to sales and marketing. This is a lot, considering the scale of revenues. The advantage is that they have not increased compared to 2022. One may wonder whether this is related to improving results before the IPO, or whether the company began to optimize expenses related to customer acquisition. It is worth noting that in 2022, similar costs did not translate into an increase in DAUq and WAUq, but in 2023 they did.

To sum up, operating costs in 2023 amounted to $944,2 million and increased by 12,6% y/y. Their growth is lower than revenues, which increased by 2023% in 20,6. As a result, the nominal net loss decreased by $32 million, to $140 million. The operating margin was -2023% in 17,4, while the year before it was -25,8%.

The company is not yet able to generate positive FCF (free cash flow). The mentioned indicator amounted to -$2023 million in 88,4, which is a better result than the year before (-$100,3 million). This is negative news, because without a positive FCF, the company will have to issue further shares or significantly restructure its operations in the long term. For now, buying the company's shares gives you exposure to a platform that does not have high customer monetization and has had problems with growth for many quarters (especially in the US).

Forex brokers offering ETFs and stocks

Where to buy Reddit shares? An increasing number of forex brokers have quite a rich offer of stocks, ETFs and CFDs for these instruments.

For example on XTB Today, we can find over 3500 equity instruments and 400 ETFs, a Saxo Bank over 19 companies and 000 ETF funds.

Broker
End	Poland	Denmark	Cyprus
Number of exchanges on offer	16 exchanges	37 exchanges	21 exchanges
Number of shares in the offer	approx. 3500 - shares circa 2000 - CFDs on shares	19 - shares 8 - CFDs on shares	3 - shares
The amount of ETF on offer	approx. 400 - ETF approx. 170 - CFD on ETF	3000 - ETF 675 - CFD on ETF	323 - ETF
Commission	0% commission up to EUR 100 turnover / month	according to the price list	0% commission*
Min. Deposit	PLN 0 (recommended min. PLN 2000 or USD 500, EUR)	PLN 0 / EUR 0 / USD 0	100 USD
Platform	xStation	SaxoTrader Pro Saxo Trader Go	EToro platform
	REVIEW	REVIEW	REVIEW
	CREATE AN ACCOUNT	CREATE AN ACCOUNT	CREATE AN ACCOUNT

*Zero commission means no brokerage/transaction fee was charged during the activity. However, they may still incur general fees, such as currency conversion fees for deposits and effects in non-USD currencies, fees for fees, and (if applicable) inactivity fees. Market spread also applies, although this is not a "fee" charged by eToro.

76% of retail investor accounts lose money when trading CFDs with this provider. Consider whether you can afford the high risk of losing your money.

Summation

Reddit's IPO could be an interesting event. However, it is worth remembering that a popular social media platform or application does not have to be a good investment idea. A great example is Pinterest, which is currently trading just over 40% above its debut price. For the record, I will mention that this is much less than the case the S&P 500 index.

It should be remembered that the company is not profitable, even though it has been operating on the market for almost 20 years. The company needs to think about how it wants to become a profitable company. For now, it seems that there are more interesting investment ideas than buying Reddit shares. However, it cannot be ruled out that the company will be very volatile in the coming quarters, which may be good news for people speculating on the US stock market.