Mario Tama
March 21st ended up being a really fascinating day for market participants. This is because, in their debut, shares of Reddit (NYSE:RDDT), the famed internet company, saw shares skyrocket from their opening price of $34 to close up 48.4% at $50.44. This values the company at just over $8 billion and brings to the market another social network of sorts to bank on for future growth. Even though the company is already fairly large and has been around for almost 20 years, revenue is growing nicely. The company is seeing some improvements on its bottom line. But unfortunately, the financial picture could be better. Despite its age and size, Reddit still struggles to generate positive cash flows or earnings. Even EBITDA is deeply in the red. But there is some good news here. For starters, the business now has a hoard of cash at its disposal. Second, while the firm is deep in the red from a profit and cash flow perspective, much of this is voluntary and management could eventually reduce the pain and even turn the company cash flow positive if it were comfortable growing the company at a slower pace.
An old social network becomes new again
If you are an avid user of the Internet, there is a high probability that you know about Reddit and what the company does. But it wasn't until the firm started preparing filings to go public that the sheer magnitude of the business became known to outsiders. Operationally speaking, the firm has grown to have over 100,000 active communities. Community examples include those dedicated to drawing, travel, answering questions, chess, anime, sports, and a variety of other topics. While the company portrays these active communities as precisely that, users of the site refer to them as subreddits.
At the end of the day, the purpose of the site is to connect people who are like-minded and to provide them a sense of community and guidance for issues that are important to them. Management gives multiple examples of this. An Internet user might visit r/Parenting 'for help when they're having trouble with a child', or they may go to r/lgbt 'for advice about coming out', or they may even visit r/stopdrinking 'for help quitting drinking'. In addition to providing guidance, the platform seeks to help those who are creative express their creativity. This includes, but is not limited to, influencers of all types.
Reddit
Although nowhere near as large as Facebook (META), Reddit is a behemoth in the online space. In December of 2023, for instance, the platform boasted 500 million visitors. In terms of active users, it is quite a bit smaller. But with this number averaging 73.1 million over the span of the final quarter of the company's 2023 fiscal year, it's undeniably a large and vibrant network. Of course, the platform has not always been this large. One year earlier, it stood at 57.5 million daily active users. That implies a 27.1% growth rate from the final quarter of 2022 to the final quarter of 2023. As a note, while I use the term 'daily active user', management uses the term 'daily active unique'. For all intents and purposes, these are comparable terms. The same applies when talking about weekly data. And speaking of weekly data, the number of users on the platform is even larger, averaging 267.5 million in the final quarter of last year.
Reddit
Geographically speaking, Reddit is large and diverse. However, just like many Internet companies that began in the US, Reddit is US centric. 36.4 million, or 49.8%, of its daily active users in the latest quarter were from the U.S. market. That leaves the remaining 36.7 million, or 50.2%, coming from other countries across the globe. Just like with the daily average data, a large portion, approximately 131.1 million, or 49%, of the weekly average users on the platform, come from the US. The remaining, meanwhile, come from other nations across the globe.
Reddit
Financial data provided by management has been limited to results from 2022 and 2023. But that's enough to give us a good understanding of where the business stands and how fast it's growing. In 2022, the firm generated $666.7 million worth of revenue. By 2023, that number had grown 20.6% to $804 million. There were a couple of different factors behind this. As I mentioned already, the number of users on the platform did manage to rise from 2022 to 2023. In addition to this, the company also saw a modest uptick in ARPU (average revenue per user). There does appear to be a cyclical nature in this revenue stream. From the first quarter of 2022 to the end of 2022, ARPU rose from $2.54 per quarter to $3.49 per quarter. And during 2023, it rose from $2.72 per quarter to $3.42 per quarter.
Author - SEC EDGAR Data
Most of the company's revenue comes from advertising. Given the margins associated with advertising and considering the size and age of the business, it would be reasonable to think that it's generating a profit. Or if it's not generating a profit, then it would at least be generating positive cash flows. But neither of these are true. The good news is that profitability is improving. But even with that, it's still deeply in the red. Take net income as an example. In 2022, the firm generated a loss of $158.6 million. Last year, this number improved to a loss of $90.8 million. Operating cash flow went from negative $94 million to negative $75.1 million. Even if we adjust for changes in working capital, it only went from negative $83.9 million to negative $45.1 million. And lastly, EBITDA for the firm went from negative $108.4 million to negative $69.3 million. This is even with adding back stock-based compensation.
Reddit
It is worth noting that, in theory, a lot of the company's problem is self-inflicted. This is because a good portion of its cost structure is in the form of research and development expenses. These expenses include, but are not limited to, personnel related costs like salaries, benefits, and more, for engineers and other employees that are associated with designing and developing new features and improving existing products. It also includes consulting services and hosting costs involving internal research and development activities, plus it includes some other miscellaneous expenses. During 2023, $438.3 million worth of expenses fell under this category. That was up from $365.2 million in 2022. It's also important to note that only $23.8 million worth of research and development expenses involved stock-based compensation. So in all likelihood, the rest ended up being true cash costs. This means that management could easily turn the company's cash flow positive if it merely cut back materially on innovation. As an example, if the firm were to reduce its cash costs involving research and development down to $100 million, and assuming there ended up being no difference in taxes paid at the end of the year, then adjusted operating cash flow for the business would be positive to the tune of about $269.4 million.
Reddit
This flexibility, combined with this dedication to spending on innovation is interesting because the company is in the early phases of a rather significant change. As I mentioned earlier, the vast majority of the firm's revenue is from advertising. In fact, only $15.2 million, or 1.9%, of sales last year came from other activities. And yet, management plans to generate additional growth by non-advertising activities moving forward. Already, the company is in the early stages of permitting third parties to license access to certain content. This includes both historical and real time data. The company provides this through API access. Management also believes that the vast amount of content on the platform could be used for model training for large language models that are integral to the development of AI technology.
Reddit
Outside of this, the company also sees a path forward with what it calls the 'user economy'. According to management, many of the communities on the platform have already developed into marketplaces of sorts. This has largely been an organic thing that has happened on its own. However, management intends to invest heavily in empowering developers through the introduction of additional tools in order to increase monetization opportunities. The company's Contributor Program will allow creators, builders, and developers to receive monetary benefits from the company and other community members as time goes on. And the company has already experimented with certain marketplace ideas that will allow them to receive some proceeds from products sold, as well as royalties, on the platform.
All combined, these represent some major opportunities for the business. When it comes to advertising, the company believes that its market opportunity, excluding China and Russia, could be worth around $1.4 trillion by 2027. That would be up from $1 trillion today. The search advertising market represents another $750 billion opportunity within this space. Once again, excluding China and Russia, the data licensing market, particularly when it comes to AI and related technologies, is expected to grow to roughly $1 trillion by 2027. And the user economy is forecasted to expand from around $1.3 trillion today to $2.1 trillion by 2027.
Takeaway
Operationally speaking, Reddit is a very interesting company. When I first saw the fundamentals, I was dismayed by how painful the bottom line looked. But once I realized just how much of the cash related costs came from research and development activities, my mind said on the matter changed significantly. The company has significant potential because of the markets in which it operates. Although some of the growth the firm experienced in prior years was slow, we have seen an uptick in it recently. The business should also have no debt on its books and it enjoys $1.50 billion of cash and cash equivalents thanks to cash on hand and its successful IPO. Given these factors, I believe that a soft 'buy' rating makes sense at this time.
Crude Value Insights is an exclusive community of investors who have a taste for oil and natural gas firms. Our main interest is on cash flow and the value and growth prospects that generate the strongest potential for investors. You get access to a 50+ stock model account, in-depth cash flow analyses of E&P firms, and a Live Chat where members can share their knowledge and experiences with one another. Sign up now and your first two weeks are free!
