Reddit: Investors are Overoptimistic on Execution

Date: 11/3/24

I work in digital marketing so most of FAANG is in my wheelhouse. I am a performance based marketer, so I am always looking for performance from ads which either entails better targeting or finding undervalued channels. I last tested ads on reddit in July of 2024, and the performance was abysmal, poor analytics, poor targeting, poor UI, low CTR and low conversions. The ad interface and onboarding process was also needlessly complex. In short, I have not personally been impressed by Reddit, but I will acknowledge that the platform has a lot of potential, management is focused on the right things, and making some good changes in the past year.

I made this post because Reddit stock (RDDT) has made some notable moves lately. I decided to value the company and recheck my previous valuations of other social media companies like Facebook. This post is focused on valuing Reddit based on its potential for monetization – best measured with ARPU. Historically, Reddit has had the lowest average revenue per user (ARPU) of all the social media companies.

A note on ARPU: ARPU is the single most important metric to value the cash flow generation of a social media company. User count and engagement are meaningless to shareholders without associated ad revenue. Ideally you would want a lollapalooza of growing users, with more frequent and longer engagement, and increased revenue from users, as Facebook saw since 2012. 

Reddit Financials (Q3 2024)

There is no full year of data for Reddit yet, so I have to use quarterly data. While below, I use annual data for Facebook.

Revenue: 348.4M

Net income: 29.9M

Stock based compensation (expense): 75M

Adjusted net income (Net income – sbcomp): -45M

Shares outstanding (diluted): 192.3M

Average Revenue Per User (ARPU): $3.58

Daily Active Users (DAU) per quarter: 97.2M

Market cap: 22B

So on the surface Reddit was profitable for the first time in Q3 2024. However, considering how these tech companies operate, stock based comp is an annual recurring expense, and is indefinite, so I treat it as an operating expense. So when we subtract stock based compensation, we calculate an adjusted net income of -45M.

But this data shows that Reddit still has a lot of opportunity in terms of monetization. In a best case scenario it operates and executes similar to Facebook 2011-2021 where APRU grew at a 25% Compounded annual growth rate.

Facebook Financials (FY 2023)

Revenue: 135B

Net income: 39B

Stock based compensation (sbcomp): 14B

Adjusted net income (Net income – sbcomp): 25B

DAU: 2.075B

ARPU: $66.5 per user

Shares outstanding: 2.629B

Adj Net income/Revenue = 18.5%

Market cap: 1430B

Valuation Scenario 1: Best Case Scenario, Achieving Facebook’s ARPU

So if:

1. Reddit maintains its current DAU. (This is conservative, but I think likely, Reddit is a fairly niche English based community, while they are aiming to increase DAU by improving feed algorithms, adding translation and making a functional search feature, I think most of the benefit will be an increased time on site and not greatly increased DAU.)
2. ARPU matches FB’s ARPU standard of $66.5 (no other social media network has been able to do this, Twitter is a text based social media, similar to reddit and twitter was the runner up with an ARPU of $30)
3. RDDT matches Adj Net income/revenue = 18.5% (Currently negative, but based on managements comments about stock based comp, controlling expense, its probable that they get there.

Based on these assumptions, future revenue would be 26B, and adjusted net income would be 4.81B

Further assuming:

1. A 3% growth rate in perpetuity starting at year 16
2. A discount rate of 9.81%
3. No prior cash flows in the build up phase

The stock would be worth $303.34 at that point in time. In other words, when adjusted net income hits 4.81B and the price is below $303, I would buy it. 

Scenario 2: ARPU growth in the near term

However if I look at pricing the stock today, assuming:

1. ARPU and associated adjusted net income grows at 21% a year for 15 years (similar to Facebook), going from $3.6 to $66.5 by year 14.
2. And starting from an adjusted net income of 50M (could be reached within a year).
3. A 3% growth rate in perpetuity starting at year 16 .
4. A discount rate of 9.81%.

The stock would be worth $22.89, at that point in time. 

The market is pricing reddit as if it has reached that adjusted net income of 50M and will grow that at a 36% CAGR for 15 years, which would mean either a 50% better CAGR APRU growth rate than Facebook, or a 13% CAGR growth in users.

All things considered, I can not buy this stock.