Reddit Deep Dive: Decoding the financial potential behind the internet's meme factory
Reddit's growth, challenges, and AI opportunities in a post-IPO world
Welcome back, tech investors! Today we're revisiting our deep dive into Reddit (RDDT), the self-proclaimed "front page of the internet" that went public this year. With the release Q1 2024 data and the partnership with Open AI, we have fresh insights to incorporate into our analysis of this unique platform. Let's break down what makes Reddit tick and whether it deserves a spot in your tech portfolio.
🌐 The Reddit Ecosystem
Founded in 2005, Reddit has grown into a sprawling network of over 100,000 active communities (subreddits) covering virtually every topic imaginable. The platform's user base continues to expand impressively.
In Q1 2024, Daily Active Users (DAUs) reached 82.7 million, representing a 37% increase year-over-year.
This growth accelerated from the full year 2023, where DAUs averaged 73.1 million, up from 57.8 million in 2022, marking a 26% annual growth.
Weekly Active Users (WAUs) also showed strong growth, averaging 267.5 million in 2023, up from 237.2 million in 2022, a 13% increase.
💼 Business Model
Reddit's revenue model is primarily based on advertising, supplemented by a growing data licensing business. Advertising accounted for 98% of revenue in 2023, bringing in $789.0 million.
This dominance continued in Q1 2024, where advertising represented 91.6% of revenue at $222.7 million. Reddit's advertising platform offers contextual targeting, access to high-intent audiences, and various ad formats, making it attractive to advertisers seeking engaged users.
The data licensing business, while still a smaller portion of revenue, is showing significant growth. "Other revenue," which includes data licensing, reached $15.0 million in 2023, representing 2% of total revenue. However, it grew dramatically to $20.3 million in Q1 2024 alone, accounting for 8.4% of quarterly revenue. This business leverages Reddit's vast trove of user-generated content for AI model training and other applications, presenting a promising high-margin revenue stream.
📊 Financial Performance
Comparing Reddit's full-year 2023 results with Q1 2024 reveals encouraging growth trends. In 2023, total revenue reached $804.0 million, marking a 21% year-over-year growth.
The company reported a gross profit of $693.0 million, translating to an impressive 86% gross margin. However, Reddit still recorded a net loss of $(90.8) million for the year, with Adjusted EBITDA at $(69.0) million.
Moving to Q1 2024, we see acceleration in several key metrics. Quarterly revenue jumped to $243.0 million, representing a robust 48% year-over-year growth. Gross profit for the quarter was $215.3 million, with gross margin improving to 88.6%.
While the company reported a significant net loss of $(575.1) million, this was largely due to IPO-related stock-based compensation. Notably, Adjusted EBITDA turned positive at $10.0 million, showing progress towards profitability.
🚀 Growth Drivers
Reddit's growth strategy focuses on several key areas. The company aims to continue its strong user growth through improved onboarding, enhanced content discovery, and international expansion.
There's also significant room for Average Revenue Per User (ARPU) expansion, which grew from $11.00 in 2023 to $2.94 in Q1 2024 (though these figures aren't directly comparable due to different calculation periods).
The company is actively enhancing its ad technology across various areas including formats, placement, ad load, targeting, delivery, automation, and measurement. The rapidly growing data licensing business presents another exciting avenue for growth, expanding from $15.0 million in all of 2023 to $20.3 million in Q1 2024 alone.
International expansion is another focus area, with Reddit targeting key markets such as the UK, France, Germany, Australia, and Canada. This effort is already bearing fruit, with international revenue growing from $118 million in 2022 to $149 million in 2023.
Lastly, Reddit is leveraging AI to enhance content recommendations, improve search functionality, and develop new tools for users and moderators, potentially driving increased engagement and monetization opportunities.
🤖Focus on AI opportunity
Reddit's recent partnership with OpenAI marks a significant milestone in the platform's evolution, showcasing its potential in the burgeoning AI landscape. This collaboration not only highlights Reddit's unique position as a treasure trove of user-generated content but also demonstrates the company's strategic vision in monetizing its vast data resources.
The deal, expected to inject $40-$50 million in high-margin annual revenue into Reddit's coffers, represents a shrewd move by the company to capitalize on its most valuable asset: the diverse, real-time conversations happening across its numerous communities. By providing OpenAI with access to its data through the Reddit API, the platform is essentially offering a window into the collective consciousness of millions of users discussing a wide array of topics.
This partnership is multifaceted, extending beyond mere data access. OpenAI will be able to integrate current Reddit content into its tools, including the popular ChatGPT, potentially driving more users to discover and engage with Reddit's communities. In turn, OpenAI has committed to advertising on Reddit's platform, creating a symbiotic relationship that could drive user growth and engagement for both parties.
Interestingly, the deal also involves Reddit leveraging OpenAI's advanced AI tools for moderation and translation purposes. This aspect of the partnership could significantly enhance Reddit's ability to manage its vast network of communities more effectively, potentially improving user experience and content quality across the platform.
The financial implications of this deal are substantial. With an estimated 90% incremental margin on the new revenue stream, Reddit could see its 2025 adjusted EBITDA increase by approximately 18%. This boost in high-margin revenue could accelerate Reddit's journey towards consistent GAAP profitability, a crucial milestone for the company.
Perhaps more importantly, this partnership serves as a proof of concept for Reddit's data licensing business. By successfully monetizing its unique corpus of data in the AI world, Reddit has positioned itself as a valuable player in the growing AI and machine learning industry. This could pave the way for similar partnerships in the future, potentially establishing data licensing as a significant and growing revenue stream for the company.
The timing of this deal is also noteworthy. Signed in the middle of Q2, the partnership's financial impact will begin to materialize in the current quarter, with the full effect expected to be visible from Q3 onwards. This gives investors and analysts a clear timeline to monitor the deal's impact on Reddit's financial performance.
In the broader context of Reddit's business model, this AI-focused partnership represents a strategic diversification of revenue sources. While advertising remains a core part of Reddit's business, the ability to monetize its data through AI partnerships opens up new avenues for growth and profitability. It also underscores the inherent value of Reddit's platform - not just as a space for user engagement and advertising, but as a rich source of data that can fuel AI innovation.
⚠️ Risks and Challenges
Despite its growth, Reddit faces several challenges. While Adjusted EBITDA turned positive in Q1 2024, the company needs to demonstrate a clear path to GAAP profitability. The net loss widened from $(90.8) million in 2023 to $(575.1) million in Q1 2024, though this was largely due to IPO-related expenses.
Competition remains fierce, with Reddit vying for user attention and ad dollars against established players like Meta, Google, and TikTok. Content moderation presents an ongoing challenge, as the company strives to balance free speech with brand safety. In 2023, Reddit spent $48.8 million on content policy enforcement.
Regulatory scrutiny is another concern, particularly around data privacy and content regulation, which could impact Reddit's business model, especially its growing data licensing operations.
Lastly, stock-based compensation increased dramatically from $47.6 million in 2023 to $577.5 million in Q1 2024. While much of this increase was related to the IPO, ongoing levels will need to be managed to avoid significant shareholder dilution.
💡 Investment Thesis
The bull case for Reddit centers on its unique, engaged user base with high-intent browsing behavior, as evidenced by its 82.7 million DAUs in Q1 2024. There's significant room for ARPU growth, with Q1 2024 ARPU of $2.94 still well below some peers. The promising data licensing business, which grew from $15.0 million in 2023 to $20.3 million in Q1 2024, offers high-margin potential.
Additionally, Reddit boasts strong and improving gross margins, reaching 88.6% in Q1 2024, up from 86% in 2023.
The bear case, however, points to ongoing GAAP losses and an uncertain path to profitability, with a $(575.1) million net loss in Q1 2024. Intense competition in digital advertising, ongoing content moderation challenges, and regulatory risks around data usage and privacy also present significant hurdles.
🎯 Valuation
Based on the company's 2023 revenue of $804.0 million and Q1 2024 revenue of $243.0 million (annualized to $972 million), Reddit is trading at 9.5x annualized Q1 2024 revenue.
These multiples position Reddit between pure-play social media companies and more diversified tech platforms, reflecting its unique position in the market and strong growth rate. Reddit has higher projected revenue growth (22% 2023-2026 CAGR) compared to peers like Pinterest (18%) and Snap (15%).
🤔 Final Thoughts
Reddit's investment case centers on its unique position as a hub for diverse communities and high-intent users.
The platform's recent financial results demonstrate accelerating revenue growth and improving adjusted EBITDA, suggesting progress towards profitability. The rapid growth in data licensing revenue is particularly promising, offering a high-margin complement to the core advertising business.
However, investors should closely monitor Reddit's path to GAAP profitability, its ability to manage stock-based compensation, and its success in international expansion and ARPU growth. The company's ability to effectively monetize its user base while maintaining its unique community-driven culture will be crucial for long-term success.
As Reddit's journey as a public company unfolds, it will be fascinating to watch how this "front page of the internet" evolves. The platform's engaged user base, unique advertising opportunities, and potential in AI and data licensing make it an intriguing investment opportunity, but not without risks.
What's your take on Reddit's investment potential? Do you see it successfully competing with social media giants, or carving out a unique niche? Let me know in the comments below!
Happy investing,
As always, investors should conduct their own due diligence and consider their risk tolerance before making investment decisions. Keep an eye on Nu's quarterly reports, particularly focusing on customer growth, credit quality, and progress in international markets.
Disclaimer: This article is for informational purposes only and should not be considered as financial advice. Always conduct your own research and consult with a professional financial advisor before making investment decisions.