Reddit, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Reddit, Inc. operates an online social media platform where communities organize around topics of interest, and the company derives revenue primarily from advertising and data licensing.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Reddit’s mission is “to bring community, belonging, and empowerment to everyone in the world.”

Business Overview

Reddit’s core business revolves around its online platform, a vast collection of communities called “subreddits” that allows users to engage in discussions, share content, and participate in various forms of online interaction. The company’s revenue streams are primarily derived from advertising, where advertisers can target their campaigns based on user behavior, community interests, and location. Increasingly, Reddit’s monetization strategy is also centered around data licensing, providing third-party entities access to anonymized data sets for diverse applications. The company has also started exploring other avenues for monetization like the sale of virtual goods.

The number of daily active users for Reddit is around 75 million. They come from all over the world.

Reddit has an international presence, with its communities and content accessible globally, but much of its revenue is concentrated in the United States. Advertising sales are segmented into two major categories: performance advertising and brand advertising. Performance advertising is designed to drive a specific action or engagement, while brand advertising is intended to improve brand visibility. This revenue split is not explicitly provided, however, the company provides an annual average revenue per user (ARPU). The management has discussed their plans to expand the advertising business by utilizing Reddit’s large user base, including through new advertising initiatives on its platform.

Reddit operates within the realm of social media, a highly dynamic and competitive industry. The market is largely fragmented, with numerous players vying for the attention of users and advertising revenue. Large established companies such as Meta and X.com are the key competitors. The social media market is marked by intense competition, constant innovation, and a rapidly evolving landscape. Companies differentiate themselves through unique product offerings, community features, user engagement strategies, and a host of tools.

Reddit is unique in the social media landscape due to its community-driven focus, and the high degree of anonymity which fosters open and honest discussion. The platform is known for a more text-based approach to content, rather than relying solely on images or videos. As an example, on average, Reddit users create more than 100,000 unique posts per day. Reddit has also developed a reputation for being a place where people can have sincere conversations about difficult or controversial topics with no fear of recourse.

Reddit’s management emphasizes their commitment to developing their data offerings and partnerships for new, valuable insights. They also actively improve the platform by improving moderation and community features, as well as continuing to offer more tools for advertisers. They have an aim to monetize the community they serve.

Moat Assessment: 2/5

Reddit’s competitive advantages, or moats, are somewhat limited.

  1. Network effects: Reddit benefits from network effects due to its communities. The more users it attracts, the more content the platform has and the more diverse its user base will be. The bigger that Reddit is, the more enticing it is for new users.

    -However, these advantages are not always exclusive, with a few new social media communities popping up.

  2. Brand identity: Reddit has a strong brand recognition in the area of online forums. People looking for niche communities will often find themselves on Reddit.
    • The problem is that, even with brand recognition, that doesn’t stop new alternatives from popping up and taking a portion of Reddit’s business.
  3. Data Advantage: The extensive data gathered on Reddit’s users is a good selling point for advertising.
    • Reddit’s data can also be used by other companies that require it. Also, it’s not clear if this is a strong barrier to entry since this data can be obtained by other methods.

Overall, while Reddit has some advantages, the lack of an extremely strong, highly defensible moat leads to the rating of 2 out of 5. Competitors can copy, and if a better alternative pops up, it might very well take away market share from Reddit.

Risks and Resilience

Here are some key risks that could erode Reddit’s moat:

  1. User Migration: If a compelling alternative platform emerges that provides similar functionalities, but offers different or better features or moderation policies, a significant portion of Reddit’s user base could migrate.
  2. Moderation issues: If not effectively controlled, content on the platform could also become toxic, alienating users and advertisers and damaging Reddit’s brand and image.
  3. Privacy concerns: Changes in privacy laws or a perceived breach in data security can severely diminish user confidence and the amount of data it is able to gather.
  4. Intense Competition: The social media landscape is intensely competitive, with many companies vying for users’ and advertisers’ attention. An inability to innovate or compete effectively may hinder profitability.
  5. Dependence on Advertising: A significant percentage of Reddit’s revenues are tied to advertising. If they fail to build other revenue streams, they will have to depend on this. This also makes them susceptible to changes in advertising spending.
  6. Regulation: Changes to regulation could limit or hamper Reddit’s operations. They operate in a global market where regulation can vary wildly from region to region.
  7. Disruptive Innovation: A new form of technology may create something similar that makes Reddit obsolete, or severely limits its appeal to investors.

Reddit has shown some degree of resilience, owing to its ability to innovate and adapt to consumer trends. However, with the risks facing the company it is not that resilient compared to companies with a stronger moat. The platform’s community-driven nature could help with retaining some users, even if there are strong alternatives.

Financial Analysis

Reddit’s finances offer a mixed picture, combining notable growth with persistent net losses and an evolving business strategy.

  1. Revenue Growth: In the nine months ending September 30th, 2023, Reddit’s revenue was $675.9 million, representing a 20.3% year-over-year growth. This is significant growth, but growth was slower than past years and was impacted by decreased advertising in the United States. Additionally, growth has been driven by performance advertising, which has less impact and more volatility than brand advertising.
    • Revenue growth in 2022 was a much stronger 30%, so there has been a significant drop-off in growth.
  2. Net Losses: Reddit is yet to achieve profitability. Their net losses for the nine months ending September 30th, 2023, was $143.5 million. The company expects to incur losses for the foreseeable future. The company will need to either increase revenue or cut costs in order to be profitable.
  3. Gross Profit Margin: While it has a good gross profit margin at 82.3%, which shows its potential profitability, the costs to acquire users and their content is very high, as demonstrated by the company’s net losses.
  4. Cash Position: As of September 30th, 2023, the company reported $1.37 billion in cash and cash equivalents. They have more than enough cash to fund current operations and further investment.
    • As of 2024, they also added $748 million in new capital.
  5. Debt: The company has low debt. They have $147 million in long-term debt and the interest payments are very low.
  6. Operating Expenses: Most of Reddit’s costs go into sales and marketing, as well as research and development. They will need to cut costs while continuing to grow the company.

The company also has substantial liabilities in its balance sheets due to convertibles and share-based compensation.

The financial performance of the company shows that it has the potential to be extremely profitable but needs to find a way to minimize costs. A big portion of their value is in intangibles such as goodwill and software development costs, which could be impaired in the future. They will need to find ways to manage and monetize their users to get a higher profit. They are not as cash-flow positive as other tech companies. The strong balance sheet helps mitigate the risks of high spending, while the company tries to attain profitability.

Understandability Rating: 3/5

Reddit’s business model is moderately complex, receiving a 3 out of 5 rating.

  • While the core concept of a social media platform is easy to grasp, Reddit’s revenue streams involve several key differences from companies that are primarily focused on advertising.
  • The influence of network effects on the company and its communities can have complex implications for long-term profitability and sustainability.
  • The company’s accounting practices, which are especially affected by its emphasis on share-based compensation, can make its financials complicated to analyze for the inexperienced investor.
  • Finally, understanding why and how the company wants to prioritize monetization and innovation are more difficult, and requires a degree of analysis and research into the company’s actions and statements.

Balance Sheet Health Rating: 4/5

Reddit’s balance sheet is quite healthy at the moment. They have high cash and short-term investments and a low debt. They are still quite unprofitable, so their resources are being spent. They have significant liabilities, however. I’d give them a rating of 4 out of 5.

  • High level of liquidity, which provides protection and flexibility.
  • Low debt levels limit the company’s vulnerability in a downturn in the economy.
  • They are currently not profitable, which is a large concern, and they are continuing to lose money.
  • High share-based compensation can be detrimental to existing investors.

Recent Concerns, Controversies and Management Response

In the filing for IPO, management made some statements about the business which included:

  • They do not track the total time their users spend on the platform
  • The platform is not designed for or intended to enable communication among small subsets of users
  • They rely on AI to manage its platform, and may be unable to maintain quality of content moderation if AI performs poorly
  • They have had significant net losses and do not expect to have profitability anytime soon These are all points that may make investors worry about the company’s future financial performance and sustainability. In terms of competition, their CEO stated that:

    “It’s competitive because they are competing for people’s time. And that time is also spent playing video games, watching TikToks, and going out, whatever they might like to do.” - Steve Huffman

The CEO notes that they don’t see those other social media platforms as the main source of competition, but they are more focused on capturing people’s time.

In previous quarterly reports, Reddit has consistently underperformed on earnings growth, despite significant efforts to attract new users and advertisers to the platform. Also, some data points on usage have been negative, which is worrying. While it did have an increase in revenue in the latest quarterly earnings, it’s still not enough to be profitable.

Management has mentioned that their top priorities are to expand their advertising business and to develop new ways to monetize user data and interactions. The platform is being improved through various measures, including better content moderation and new tools for advertisers and users. However, it’s still unknown whether they will be able to achieve these goals, and become a stable and profitable company.