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Since 2022, the IPO market has cooled dramatically in both the number of IPOs and with poor performing following. One potential exception may be Reddit’s (NYSE:RDDT) recent public offering, which had notable volatility, with the stock between the $40 and $70 range. Arguably, Reddit’s IPO is late, and the company may have seen better results a year or two ago when its user growth was soaring amid the lockdowns and investor interest in IPOs was higher.
That is why I would not dismiss RDDT as I have most large public offerings in recent years. Still, Reddit has a significant battle ahead of it. It is a very established platform with a vast user base, but despite nearly two decades of operations, it is not a profitable company. Only recently has it shifted its focus toward monetizing through advertising. Like its near-peers, it went public at a high price-to-sales around 10X while having a notably negative forward EPS of -$4.95.
As discussed in many of my recent articles, the time value of money is relatively high today, so investors have less cause to wait for cash-flow negative firms to turn positive patiently. Reddit is likely one of the best social media growth firms today, particularly when monetizing its platform. On that front, it has the potential to do so faster than Facebook and others because it can replicate their actions. That said, Reddit is, in many respects, unique, potentially making those monetizing strategies less feasible.
What Do Investors Expect of Reddit?
Firstly, as a recent IPO, we need to gauge how much growth and profitability are accounted for in Reddit’s valuation today. The decision to buy RDDT should not have much to do with how you like the platform. Although that matters, it is more important to gauge what the market expects. Reddit is a buying opportunity if, and only if, you think it will perform better than the market is accounting for.
At the time of writing, Reddit’s market capitalization is $7.37B. According to its S1, its 2023 revenue was ~$804M, up from ~$667M in 2022. As such, its price-to-sales is around 9.16X. Its 2024 analyst consensus expectation sales is $984M, giving it a forward “P/S” of ~7.5X. Based on the consensus of 13 analysts, its 2026 expected sales are between $1.46B and $1.64B, averaging at $1.5B. Some analysts expect it to continue that fast sales growth rate through 2033, to $5.54B. Even then, it is not likely to break even until 2027 and should not see a high profit until the 2030s.
Based on these estimates, Reddit is valued similarly to its near-peers and is possibly discounted. Meta (META) trades at a “P/S” of 8.17X with YoY sales growth of 27%. In the past, when it was called Facebook, it often traded at a “P/S” closer to 15X. Shopify (SHOP) trades at a “P/S” of 13X today, with YoY sales growth of ~24%. Before SHOP’s crash, it traded at a stupendously high “P/S” of 30-60X. So, comparing sales growth to its valuation, Reddit appears reasonably priced, depending on the profitability of its sales.
Its gross margin in 2022 was about 84%, and 86% in 2023, showing a positive trend. Its 2022 gross profit was $562M, while its 2023 figure was $693M. In 2023, around 65% of its gross profits went to R&D, 33% to marketing, and 24% to G&A.
The central eye-catcher is the staggering 65% R&D to gross profit ratio. Adding its R&D back to its $140M operating loss, we’d get a $298M operating profit (pre-R&D). Adding back all R&D spending is unreasonable, as only some portion of it will create a profitable IP. In my view, R&D fuels sales growth, but if the company decided it best to stop innovating, it could cut that segment dramatically and become profitable immediately. While not a wise business strategy, Reddit’s huge R&D budget does point to its potential for significant profits.
In my view, Reddit could earn a profit of around $200M today (after tax) by cutting its growth spending and possibly up above $300M. That would give it a “P/E” of around 29X. That figure is not high compared to its growth, but it’s slightly high because cutting R&D and marketing would hamper its development. Still, Reddit’s valuation is more sensible than public offerings I’ve seen, particularly around 2017 to early 2022. To me, it is very reasonably valued based on the consensus expectation of its performance, essentially a linear extrapolation of its growth since 2022.
The Quest for Monetization
One reason Reddit does not garner the same high valuation as Meta and Shopify is likely that it is not so monetizable. Its sales and margins point to likely monetization, but nuances to its business make it more difficult. In the past, Reddit was a fundamental forum, a self-curating area where people could discuss various topics, primarily self-managed by moderators.
That has changed to a degree, but one key feature of Reddit is that each subreddit is managed by moderators, who are volunteers and unpaid. As such, Reddit, in my view, has a vast free labor source that actively encourages platform growth. For example, a person may join Reddit after a Google search, where they run into a subreddit page they enjoy reading. To that degree, Reddit is like Facebook Groups but with more excellent public activity and visibility.
However, for that reason, it is harder to monetize, as many people may not react as well to advertising on Reddit as they might on Facebook. Reddit ads are subreddit-oriented, not individual-oriented, so they cannot take advantage of making an AI data powerhouse, as Facebook has, which offers highly individualized advertising. In my experience, most ads on Reddit are vast, such as credit cards and SaaS platforms (subscription software).
These ads will generally have lower value-per-impression because they’re not individually focused. This will never change as long as Reddit remains the same. Reddit is a platform centered around anonymity, so it is unlikely to develop the individual data that companies like Meta utilize.
Conversely, Reddit has some data that may be very valuable. The company wants to sell its data for around $60M annually to an AI company. User-generated content on the platform is most likely written by humans in a manner that people speak, making it extremely valuable for creating a natural language model.
As one example, many people who use search engines have learned that attaching “Reddit” to their query results in higher quality results. There are now apps that do this automatically. People do this because attaching “Reddit” to a query automatically filters for human-generated results instead of the heavy SEO-centered results found on Google searches today. For example, search “how to buy a home” on Google, and you will receive mainly promoted content for mortgages and SEO-optimized sites with far too much information, much of which is likely AI-generated today. However, by changing that to “How to buy a home Reddit,” you’ll find many human-made guides of how actual people bought homes.
That is just one example, and you can try it for yourself. It clearly shows the immense data potential of Reddit’s platform. Still, because Reddit’s data is generally publically available and copyright and royalties for AI tools remain vague, it is unclear if Reddit will sell this data or merely scrape it.
Still, Reddit faces significant barriers to monetization. Selling data to AI is constant for both Reddit users and moderators. Last year, many subreddits went down in a mass protest of Reddit’s pricing for its API model. As a result, Reddit banned many moderators who participated in the protest. In my opinion, it walks a thin line between monetization and moderators, given moderators are essentially a vast free labor source for the company; it cannot afford to upset them without compromising its core value to users.
The Bottom Line
I believe Reddit is fairly valued today and see possibilities where it could rise or fall. Given its no debt, fast sales growth, and decent potential profitability, Reddit is arguably undervalued compared to near-peer social media and web-based companies. However, that discount is offset by high barriers to monetization. It does not currently have the advertising potential as Meta, and its attempts to sell data and expand its ad platform may upset moderators and users.
Long ago, Reddit was a champion of free speech focused on its users and carried an anti-capitalist aura. Now, its CEO wants the company to “grow up.” Indeed, much of this change is likely positive, as Reddit cracked down on highly problematic subreddits, albeit much later than they should have.
Inevitably, as it’s focused on monetization and launching itself publicly, that has shifted dramatically. In my opinion (as an occasional Reddit user), its efforts at monetization have already compromised its core value with users. As it monetizes, it’s starting to look more like Facebook Groups, which have also arguably been compromised by Facebook’s advertising efforts. However, for now, Reddit is still seeing strong DAU growth, and it may even be if its platform is devalued with monetization because it has no direct competitors.
Fundamentally, I think Reddit’smost significantt issue is how its relationship with moderators has soured over the past year. I view moderators as Reddit’s greatest asset, a high-value unpaid labor pool, so if it loses them, then the whole operation could fail. Reddit could theoretically replace them with paid moderators,whicht would make it much further from profitability.
To me, RDDT can move in either direction today but will likely remain near its current level. Given its monetization hurdles, its arguable discount is reasonable. It is not cheap enough to buy, given its unclear ability to earn a consistent profit without losing moderators and users.