In the bustling market of 2024, fueled by the excitement around artificial intelligence (AI), both the S&P 500 and Nasdaq Composite are reaching unprecedented heights. This fervor has led to a surge in high-profile initial public offerings (IPOs).
Among these IPOs is Reddit (NYSE: RDDT), the popular social media platform, which recently debuted on the New York Stock Exchange. Despite an initial surge of over 120% from its offering price, the stock has since dipped more than 30% from its peak, signaling a sobering reality for investors.
As prospective investors evaluate Reddit, it’s crucial to grasp the significant risk factors impacting the company and their potential ramifications on its future prospects.
1. Social media is fiercely competitive
In the fiercely competitive social media landscape, platforms vie for user engagement, recognizing that a robust and active community is key to success. This competition is primarily fueled by the pursuit of expanding user bases, thereby amplifying monetization opportunities, typically through advertising.
Reddit, with its 73 million daily active users and $804 million revenue in 2023, relies heavily on advertising revenue like its rivals. However, it faces stiff competition from industry giants such as Meta Platforms, Alphabet, Snap, X (formerly Twitter), and Pinterest, all contending for user attention.
Meta Platforms boasts a collective daily user base of over 3 billion across Instagram, Facebook, and WhatsApp, while Alphabet dominates with Google and YouTube, each registering over 100 billion monthly site visits.
Acknowledging this formidable competition, Reddit’s management is cognizant of the uphill battle they face. Despite revenue growth, Reddit witnessed a 7% decline in average revenue per user in Q4 2023, following stagnant performance in the previous quarter.
Reddit’s strategy to diversify beyond conventional advertising is met with skepticism, given its untested nature. This poses additional challenges for the company as it navigates a landscape dominated by established players.
2. Reddit’s growth path is puzzling
In Reddit’s S-1 filing, the company outlines its exploration of two potential revenue streams: e-commerce and artificial intelligence (AI).
E-commerce represents a promising avenue to complement Reddit’s existing advertising model. However, integrating e-commerce within Reddit’s unique social media framework presents challenges due to established players in the market.
Meta Platforms has successfully entered the e-commerce sphere, leveraging small businesses on Instagram and Facebook’s marketplace. Conversely, smaller platforms like Snap have struggled to gain traction in e-commerce, reflected in declining average revenue per user.
Regarding AI, Reddit has secured data licensing agreements totaling $203 million, notably including a $60 million partnership with Alphabet.
Given Reddit’s extensive repository of user-generated content, there’s potential for leveraging this data to train generative AI models. However, there’s a risk that these AI models could eventually compete with Reddit by providing users with discussion and information, potentially diverting engagement away from the platform.
3. The stock’s premium is too high
As of now, Reddit boasts a market capitalization of $7.5 billion, resulting in a price-to-sales (P/S) ratio of approximately 9.3.
This aligns Reddit’s P/S ratio with that of Meta, but surpasses the ratios of competitors like Pinterest and Snap. However, justifying this premium valuation proves challenging due to uncertainties surrounding Reddit’s potential for growth.
According to Bloomberg, Andrew Freedman, an analyst at Hedgeye Risk Management, recently labeled Reddit’s stock as “grossly overvalued” in a short report. Freedman predicts a potential retreat in the stock price, possibly back towards its IPO price of $34 per share. Such a decline would favor short sellers who profit from falling stock prices.
As Reddit prepares to conduct earnings calls, investors eagerly await insights into the company’s progress in e-commerce and AI ventures. However, until further clarity emerges, it may be prudent to exercise caution with Reddit’s stock. Instead, exploring opportunities in social media offered by larger, more established companies could be a wiser course of action.
