3 Reasons Why Cautious Will Be Profitable with Reddit's IPO

I like using Reddit.

But I also like flying Southwest (LUV) – though I’d never own their stock.

For the former, I think the platform does an incredible job bringing users together, probably better than Facebook or Twitter (I know, I know) ever has or will. It doesn’t exclusively feed us information nor does it exclusively provide us with answers to our questions.

It does both of those better than their competitors.

If I’m going on vacation and want to figure out the best local restaurants or need help finding the best local dog parks in an unfamiliar area, I don’t google these things.

We both know what that’s like.

I go to Reddit – because, often, many people have experienced what I’m trying to find answers to right now, and Reddit provides a forum of those.

That’s why I’d consider it a social media platform integral to the fabric of online community engagement.

And now, the company’s charting its course towards the landmark event in its corporate voyage—an initial public offering (IPO).

But there are three reasons why any potential investor should be cautious.

Reddit’s Landmark IPO

The platform, after a strategic gestation period, has set its IPO sights on March, planning to offer approximately 10% of its shares. It’ll list under the ticker “RDDT.”

Valued at about $10 billion during its last funding round in 2021, Reddit's market debut is poised to be one of the most significant tech listings since Pinterest in 2019.

It could very well end up being 2024’s largest IPO – even with heavy hitters like Discord, Shein, Plaid, and Chime potentially coming in.

As the listing date approaches, the valuation will be finetuned, reflective of prevailing market conditions and investor sentiment​​​​​​.

The company just filed its S-1, the IPO document required by the Securities and Exchange Commission (SEC). And after analyzing the 100+ pages, there are three major issues that we need to contend with here.

Financial Performance and Profitability Concerns

In 2023, Reddit's financial landscape was marked by a significant achievement, with the company witnessing a revenue increase of over 20%, and its advertising revenues soaring past the $800 million threshold.

This growth in revenue is a testament to Reddit's ability to harness its vast user engagement and translate it into substantial ad revenue, a feat many digital platforms strive to achieve.

However, despite this considerable revenue uptick, the platform finds itself at a crossroads. It's struggling to cross the threshold into profitability.

The tech industry, renowned for its high-growth potential, often sees companies like Reddit prioritize expansion and user acquisition over immediate financial returns.

This strategy, while successful in scaling the business and increasing market presence, has its pitfalls, primarily the challenge of turning a profit.

Reddit's scenario is a clear reflection of this industry-wide trend. Significant revenue figures do not necessarily equate to profitability due to high operational costs, investments in technology, and competitive market dynamics.

Reddit's situation is further complicated by the intricate balance between maintaining an engaged community and monetizing it in a way that doesn't alienate users.

The platform's struggle is indicative of a larger issue within the tech sector, where the path to profitability is often hindered by the need to continuously invest in growth, innovation, and user satisfaction.

As the company attempts to navigate this complex landscape, its efforts to monetize effectively while keeping its community intact will be closely watched by industry observers. This case highlights the broader challenge faced by tech firms today: achieving sustainable growth while also working towards becoming profitable entities.

Let’s dig a little deeper into the complexity of monetizing this audience.

User Growth Versus Monetization

Reddit's impressive active user base, boasting over 70 million daily visitors, underscores the platform's immense popularity and its status as a bustling hub for diverse online communities.

reddit active users
Source: Reddit

(Click to enlarge)

This significant level of engagement presents a lucrative opportunity for monetization. Yet the journey to harness this potential is fraught with the challenges we just spoke about.

The essence of Reddit lies in its community-centric model, which fosters an environment of openness and free exchange of ideas. Any attempt to monetize this environment must be carefully calibrated to avoid disrupting the delicate balance that encourages user participation and content creation.

Innovative revenue streams, such as targeted advertising, premium memberships, and sponsored content, must be introduced in a manner that aligns with the community's values and expectations.

What's more, Reddit's diverse forums, known as subreddits, cater to a wide range of interests, making a one-size-fits-all approach to monetization impractical.

Tailoring monetization strategies to the unique characteristics of different communities, while ensuring transparency and maintaining user trust, will be critical.

The platform's success in navigating this monetization path will hinge on its ability to innovate without losing sight of what makes it unique. And we don’t exactly see that yet.

We’ll have a much better idea of what this means in 6-12 months.

They’ll need to maintain an open dialogue with their user base about changes and potential impacts on their experience.

By doing so, Reddit can create sustainable revenue models that support its growth and ensure its financial sustainability. That'll also preserve the core user experience that has made it a staple of the digital landscape.

But how would you respond if someone asked you how you’d like to be advertised to? A big school of thought in the advertising world is that the user doesn’t know they’re being sold to.

How will they overcome that?

Market Position and Competitive Landscape

Within the highly competitive social media landscape, Reddit's unique community-centric model sets it apart from its counterparts, as we were talking about at the start.

This distinctive approach has cultivated a loyal user base and a rich tapestry of niche communities, each with its own culture and norms. Unlike the broader, more homogeneous user experiences offered by giants like Facebook or the highly dynamic, algorithm-driven content of TikTok, Reddit provides a platform for deep dives into specific interests, fostering a sense of belonging and engagement that is rare in the digital sphere.

However, the battle for advertising dollars in this crowded market is intense.

Reddit's challenge lies in positioning itself as an attractive option for advertisers who are traditionally drawn to the massive, global user bases and sophisticated ad targeting capabilities. Platforms like Facebook and Instagram, or the younger, highly engaged audiences of TikTok are good examples.

Reddit's diverse and segmented audience offers unique advertising opportunities, but leveraging that to make the most out of advertising revenue will be critical ahead.

Bottom Line

Again, I like Reddit as a company.

But as with all IPOs, it will pay to wait and see if the company can answer the concerns above. It’s not just a coincidence that nearly all IPOs lose money in their first six months.

That’s why investors looking to partake in Reddit's IPO journey are advised to consider these aspects against the backdrop of the company's strategic moves, market dynamics, and the inherent unpredictability of tech IPOs.

The coming weeks will be telling, as Reddit moves towards finalizing its IPO details and stepping into the public market arena. Who knows - in six months or so, I could be buying their stock.

We’ll be covering that here.

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