It’s been about 12 years since the giant social network Facebook went public. Next month, Reddit — a much smaller social network — plans to sell shares in an initial public offering.
After making its prospectus available to the public on February 21, there are plenty of reasons Reddit thinks you should buy into its IPO:
- Large addressable market. Excluding China and Russia, Reddit sees itself taking a piece of the $1.4 trillion global advertising market, according to the prospectus.
- Revenue growth and narrowing losses. Reddit reported a 21% increase in 2023 revenue to $894 million while reporting a net loss of $91 million — about 45% smaller than the year before, noted the prospectus.
- Licensing user generated content. With over 73 million daily active users — 2.3% of Meta’s 3.2 billion DAUs — Reddit sees an emerging opportunity to license the content those users create to Google and other companies seeking data to train AI models, according to the prospectus.
Although the IPO is expected to value Reddit at half its 2021 private market valuation of $10 billion, according to the New York Times, the lower price does not make the social media platform an attractive investment.
My reasons for hesitancy about Reddit’s IPO include:
- Redditors may take their act elsewhere as the company licenses their content
- Reddit may not be able to compete effectively against Meta and others for advertising revenue
- Reddit’s capital structure puts the general public at a disadvantage
Reddit is excited about the prospects of going public. “We are going public to advance our mission and become a stronger company,” wrote CEO Steve Huffman in a founder’s letter included in the prospectus. “We hope going public will provide meaningful benefits to our community as well. Our users have a deep sense of ownership over the communities they create on Reddit.”
Redditors May Bolt Post-IPO
The key to Reddit’s success is the unpaid labor of the social network’s mostly anonymous communities.
Volunteers moderate the topic-specific forums — called “subreddits” based on their own rules. By persuading famous people such as former President Barack Obama, Microsoft’s
MSFT
One such subreddit — WallStreetBets — is not thrilled about Reddit’s forthcoming IPO. Here are three comments:
- “This s$@# is going to absolutely plummet and I can’t wait to see it,” wrote SnooDingos3776.
- “Lmaoo like they think we’re all just gonna buy reddit for s$@#s and giggled while they sell off early no ducking thank you,” noted Tangentkoala.
- “free speech is already heavily censored on reddit, rip forever now,” posted Dangerous_Blood1666.
Reddit warned future revolts or departures of these communities could harm the site. “We have many opportunities and much to do,” Huffman noted in his founder’s letter. One such opportunity is enabling unpaid Redditors to own stock in the company. To that end, Reddit is reserving shares for 75,000 of the company’s “most prolific users if they wished to purchase them,” wrote the Times.
Given the tone of the WallStreetBets posts, it is difficult to determine whether the IPO and the resulting effort to post expectations-beating results each quarter will drive those anonymous community members away.
Perhaps some will buy shares in Reddit and stick around to boost the company’s growth rate by providing the free content needed to attract advertising and train chatbots.
Reddit May Struggle To Generate Revenue Growth
Compared to Meta, Reddit is an advertising also-ran. Globally and in the U.S., Reddit’s average revenue per user fell in 2023. In the fourth quarter of 2023, Reddit’s U.S. ARPU fell 7.4% to $5.51 while the company’s global ARPU dropped 2% to $3.42, noted CNBC. By contrast, Meta’s ARPU rose 2.4% to $40.60 in 2023, reported Statista.
Reddit’s business model has evolved — but it still seems rudimentary compared to Meta. Initially Reddit avoided advertising — focusing instead on operating a “user-generated e-commerce system and awards that users could buy one another,” the Times reported.
While Reddit still does these things, the company eventually embraced ads aimed at subreddits that would find them valuable. For example, makeup brands such as Laneige advertised to the Makeup Addiction subreddit where users “discuss cosmetics and how to apply them,” noted the Times.
To be sure, not all Reddit content is friendly territory for advertisers. Reddit is much like the social network formerly known as Twitter in that anonymous communities are a breeding ground for speech likely to repel many advertisers.
For example, Reddit played a role “in spreading misinformation during the Boston Marathon bombing in 2013, and hosting racist and misogynistic content in some of its smaller subreddits,” reported the Times.
Will Reddit moderators keep their subreddits clean enough to attract advertisers?
Even if advertisers seek to reach Reddit community members, the company’s advertising platform does not perform as well as those of rivals such as Meta and Google. “Reddit may face a daunting challenge in growing its advertising business, given the gap between its platform’s capabilities and those that are best in class,” independent mobile analyst Eric Seufert told the Times.
One business opportunity that was not around in 2012 when Facebook went public is selling data to train chatbots. Reddit expects to generate more than $203 million in revenue from such undisclosed licensing agreements over the next three years, according to the prospectus.
Sadly for potential Reddit IPO investors, those licensing agreements could fuel a future threat to Reddit’s advertising business. That’s because by licensing its content, Reddit could enable LLMs to “potentially aggregate and synthesize the site’s content and let users view Reddit without visiting the site or seeing advertising,” wrote the Times.
Reddit’s Capital Structure Could Challenge IPO Investors
Finally, Reddit IPO investors will have far less power than some of the company’s largest shareholders. These include Advance Magazine Publishers — a unit of which previously acquired and spun out Reddit, Fidelity Management, and Sam Altman, a former Reddit board member and OpenAI’s CEO.
Public investors will buy Class A common stock. Reddit directors and executive officers and insiders like Advance — which owns 34% voting power — will hold Class B stock which grants them 10 votes per share to every one vote for each Class A share. Reddit will also offer Class C shares which have no voting rights, according to the prospectus.
If you don’t like how Reddit is running things, owning Class A shares after the IPO will limit your power to do anything about your dissatisfaction.
The IPO may be managed to create a big first-day pop which could enrich the Class B shareholders while making it more difficult for Reddit to generate the growth needed to keep its stock rising.
The main story for the IPO market will begin when the first pure-play Generative AI companies are ready to go public.
Reddit is going public at a time when social networks are a mature business. If you insist on buying into Reddit’s IPO — wait at least a quarter to see whether the company can exceed investor expectations.
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