Reddit S-1 breakdown: On community, profitability, AI, and meme stocks

Tanay Jaipuria
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Reddit, the front page of the internet, is going public. Dive into the company's journey, challenges and opportunities as it navigates the path to becoming a publicly traded entity.

Reddit, one of the largest community platforms in the world, recently filed for an initial public offering (IPO). As the company prepares to go public, it's worth examining the key factors that have defined its journey so far — including its product, user engagement, revenue, monetization strategies and potential challenges.

Without further ado, let’s jump into it.

Product and engagement

Reddit describes itself as a “global, digital city where anyone in the world can join a community.” The platform includes over 100,000 different communities, and SimilarWeb ranks it as the 17th most popular website in the world.

For social media websites, there are three key drivers that affect the business: the number of users, their engagement, and the ways in which they can be monetized.

Reddit differs from traditional social media platforms like Facebook, Instagram and Snapchat in terms of user engagement. Many users discover Reddit posts through search engines or other external sources, and they may not actively participate in the platform or even be logged in while consuming content. This means that a significant portion of Reddit's user base may not be as engaged or active as users on other social media sites.

This is evident when we dig into Reddit’s user base numbers:

  • Monthly actives: In December of 2023, Reddit had over 500 million monthly active users.
  • Weekly actives: In Q4 of 2023, Reddit had 267.5 million weekly active users. That means roughly 53% of monthly Reddit users are active on the website weekly.
  • Daily actives: In Q4 of 2023, Reddit had 73.1 million daily active users. That represents a Daily Active Users (DAU) to Monthly Active Users (MAU) ratio of only about 15%. In addition, only about 50% of those daily actives were logged in, which makes them likely to have lower engagement levels and lower monetization rates. On the plus side, daily active users have grown substantially, at 27% year over year.

Source: Reddit S-1 filing

From an engagement perspective, the DAU/MAU ratio is one key measure of engagement. When comparing Reddit’s engagement with Facebook and Snap, it doesn’t stack up well. Reddit appears to have a lot less of a frequent use case for the vast majority of its user base, as evidenced by its low DAU/MAU ratio. In some ways, its usage is closer to Pinterest, which also has approximately 500 million MAU but doesn’t disclose its DAU.

The other key measure is time spent. Reddit doesn’t disclose full metrics, but does note that the average minutes per logged-in user is about 20 minutes per day, but that number goes up the longer individuals have been users — 35 minutes a day for those who have been on Reddit for over five years and over 45 minutes a day for those who have been on Reddit for over seven years. That’s not bad, but not comparable to Snap, TikTok, Facebook or Instagram, which have upwards of 30 minutes per day on average across much larger user bases.

The tough part, however, is that only about half of the daily active users are logged in, and only a small percent of overall users are active daily.

Revenue and monetization

At present, Reddit primarily monetizes via advertising. The company made $804 million in 2023, up 21% year over year — and 98% of that revenue came from advertising.  

Reddit notes that it is relatively early in their advertising journey in terms of the tools they are building. While they have been in the ad business since 2006, they only meaningfully started to build adtech solutions in 2018. Reddit also has a few other sources that it intends to layer in over time, including data licensing, which we’ll discuss shortly, and a user economy (tips, commerce, creators, etc.). First, let’s focus on advertising.  

Looking at their ad revenue per user, one concern is that it seems to be plateauing a bit at about approximately $12.5 per DAU per year in the last two years.

Source: Reddit S-1 filing

From a product perspective, Reddit has a few advertising-related benefits:

  • Interest-based advertising: Given that Reddit is made up of clear communities (Subreddits), ads can be clearly targeted based on interest to certain communities while respecting user privacy.
  • Unduplicated audience: Reddit allows advertisers to reach an audience they often can’t connect with on other social media platforms, as the chart below illustrates.
Source: Reddit S-1 filing
  • Higher audience intent: Because users occasionally reach Reddit from search engines or other places when seeking out recommendations or information, they often have higher intent than, say, somebody scrolling through a Facebook, TikTok or Snap feed. This means Reddit can earn higher cost per thousand (CPM) ad rates.

However, Reddit also faces significant downsides: fewer logged-in users, less engagement and being relatively more text-based compared to other platforms. These three factors sometimes result in ads either sticking out or not feeling as organic.

On a per-daily-user basis, Reddit actually fares better at monetization than Snap. However, Reddit’s user base is about one-fifth the size of Snap’s. Similarly, Pinterest, which has a similar monthly active user base to Reddit, earns almost 3.8x the revenue. So depending on how you look at it, the “issue” with Reddit may be that it under-monetizes relative to a higher-intent platform, or that it is too niche to be as big as a platform like Snap or Instagram.

Spending and profitability

On the surface, things look pretty good for Reddit. The company brought in $804 million in revenue in 2023, with those sweet 86% advertising gross margins. But Reddit still lost $100 million in 2023, though losses did decline from $150 million the previous year.

What’s going on? As a percentage of revenue, Reddit’s spending breaks down as follows:

  • Cost of Goods Sold (COGS): This number is at 14%, which is quite reasonable for an ads business at its scale.
  • General and administrative (G&A): Reddit spends 20% on G&A, which has been trending down over time. This is relatively reasonable.
  • Sales and Marketing: Reddit’s Sales and Marketing costs are 29% which is slightly high, but it’s justifiable given the ads business investments are relatively recent and still have room for growth.
  • R&D: Research and development expenses are at 55%, which is quite shocking for the company’s scale. After all, Reddit is largely a UGC (user-generated content) text-only website that has been around for almost 20 years, and isn’t investing in things like AR (Snap), AI/VR (Meta), multiple platforms, apps or anything else.

Many will be concerned that if an ads business that is 20 years into its journey is still losing money, will it ever really be profitable? In some ways, Reddit’s income statement paints a clear reason why it hasn’t been profitable so far and outlines a clear path to fixing the problem.

I once noted that Twitter spent almost $900 million a year in R&D without any clear change in its product (we know how that played out). I think the same can apply to Reddit today, which is spending around $480 million a year in R&D.

Source: Tanay on X

If Reddit’s R&D spend as a percent of revenue was brought in line with their peers, such as Pinterest and Meta, at around 30-35% of revenue, Reddit would be a profitable business with 5-10% margins, absent any other changes. While that’s not great, it clearly indicates that the path to profitability, should Reddit aim to get there, is quite achievable and entirely controllable.

The good thing for Reddit is that it has a war chest of $1.2 billion in cash. Given its losses of $100 million a year, it’s well on the path to becoming profitable without needing more money as its revenue grows, even if it doesn’t adjust its R&D efficiency.

Data and AI

While Reddit’s primary source of revenue in 2023 is advertising, they’re going public at an interesting time, in the middle of the AI boom.

Source: Reddit S-1 filing

Reddit is one of the few large-scale UGC corpora, and perhaps one of the most interesting text-based ones, given its anonymity and authenticity. It has a corpus of over 1 billion posts and over 16 billion comments, generally well-categorized across thousands of different niches and communities. In the age of LLMs, that makes it one of the world’s most valuable sources of conversational data and knowledge. Reddit is now looking to monetize this data for model use.  

This is still a business and market in its early stages, and no one knows exactly how it will play out, but it stands to reason that there will be a number of buyers willing to pay for access to this data, which could provide a compelling revenue opportunity for the company.

Earlier this year, Reddit entered into a $203 million ACV data licensing agreement with Google for a 2-3 year period. Reddit expects to recognize $66 million of this revenue this year and the remaining amount over the next two years. As part of the agreement, Reddit will provide access to a data API and quarterly transfers of the Reddit API.  

The information provided in Reddit's S-1 filing does not suggest that the data licensing agreement with Google is exclusive. It is reasonable to assume that Reddit will likely pursue similar data licensing deals with other companies, such as OpenAI, to further monetize its vast dataset of UGC.

At the same time, AI could pose a threat. If all these models are trained on Reddit data, people could seek to use these models and ask them questions directly instead of coming to Reddit.

Reddit itself notes that users “arrive at Reddit organically or even by appending ‘Reddit’ to their searches for better results.”

Shareholders and the IPO reaction

Most startup journeys are rarely up and to the right continuously — typically, they're full of plenty of ups and downs. Reddit's journey has certainly followed this pattern, as the company has finally reached the milestone of going public, 19 years after its founding. During this time, Reddit has experienced multiple leadership changes and shifts in ownership.

The key stockholders of Reddit ahead of its IPO include:

  • Advance Magazine Publishers, the parent company of Conde Nast, which purchased Reddit in 2006, owns 30.1%.
  • Tencent, which invested in Reddit, owns 11%.
  • Sam Altman, who invested more than $50 million in Reddit and was the CEO for 8 days, owns 8.7%.
  • Steve Huffman, one of the co-founders of Reddit and its current CEO, owns 3.3%.

Reddit’s directed share program

As part of its IPO, Reddit is allowing active users and moderators to participate in its offering via a directed share program. Although this gesture provides these individuals the opportunity to buy Reddit stock at the initial offering price rather than after trading begins, I believe its significance should not be overstated. In the current market conditions, there is no guarantee that Reddit's stock will experience a substantial price increase immediately following the IPO.

Besides, platforms such as Robinhood and others have allowed users to participate in general IPOs recently. In fact, this directed share program may also increase the likelihood that some Redditors band together to pull some shenanigans around meme stocks.

IPO pricing risks

Although Reddit's most recent private market financing round valued the company at $10 billion, it is probable that the actual valuation at the time of the IPO will be closer to $5 billion, given the company's current financial performance and prevailing market conditions. However, predicting the exact trading price and performance of Reddit's stock post-IPO is difficult, and I’m cautious about making definitive predictions regarding its market reception.

Why? Because it's not every day that you come across a company going public that openly acknowledges the risk of becoming a meme stock in its IPO filing. This unusual disclosure by Reddit highlights the potential for its stock to experience extreme volatility driven by factors unrelated to the company's fundamental business performance or market conditions.

Reddit’s challenges and opportunities

Reddit's IPO filing gives us a peek behind the curtain of what’s been happening with their platform and gives us hints about their future plans. While the company has an impressive user base and community engagement, it faces challenges in monetization, profitability and the potential impact of AI and meme stock volatility. As Reddit navigates this new chapter, it will be crucial for the company to address these issues and capitalize on its unique strengths to ensure long-term success.

For more in-depth analysis and insights on startups, tech and business, be sure to sign up for my Substack newsletter, where I dive deep into the latest trends and developments shaping the industry.

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