Reddit Stock Surges in IPO

Shares of the social media platform Reddit surged in their stock market debut Thursday, a sign of strong investor appetite for a company that has yet to profit and operates in a highly competitive industry.

Reddit shares opened at US$47 on their first day of trading under the RDDT ticker on the New York Stock Exchange, well above the $34 public offering price set on Wednesday. The stock climbed as high as US$57.80 in afternoon trading before closing at US$50.44, a jump of 48% from the IPO price.

That strong performance signals that Reddit’s plan to expand its nascent advertising business and diversify its revenue sources by licensing its content to third parties has struck a chord with investors. The company’s cash flows are improving, and it generated buzz by reserving some shares at its IPO price for users.

However, investors will own shares of a company without a full year of profitability. Reddit also faces stiff competition for digital ad dollars from established firms many times its size, including Alphabet (GOOGL) and Meta Platforms (META), a giant in the social-media landscape. The site is also no stranger to controversy, most recently over its 2023 decision to charge third-party developers for access to its API.

As interest rates have climbed over the past few years, investors have soured on paying premiums for companies with no clear path to profitability, according to Nick Smith, senior research analyst at Renaissance Capital.

“In that sense,” he says, “Reddit will certainly be one to watch”.

Reddit IPO Valuation

Reddit’s US$34 IPO price valued the company at about $6.4 billion – significantly less than the US$10 billion price tag it carried in 2021, according to PitchBook data. That fundraising round was led by Fidelity Investments, whose Blue Chip Growth fund now holds roughly US$17 million worth of Reddit shares (a 0.032% weight in its portfolio).

The company closed with a market capitalisation of roughly US$8 billion on Thursday, significantly closer to its 2021 valuation.

This is the first major social-media IPO since Pinterest (PINS) debuted in 2019.

Reddit Still Unprofitable Despite Growing Revenue

While the company’s cash flow is improving, Reddit has yet to see an annual profit. The firm reported a net loss of US$90.8 million in the 2023 calendar year on revenue of $804 million, compared with a $158.5 million loss on $666.7 million in revenue in 2022. The company acknowledges that it is in the “early stages” of monetizing its platform.

The vast majority of Reddit’s revenue comes from advertising. Some 98% of its cash flow was from third-party advertising on the platform in 2022 and 2023. Much of that advertising comes from a small core group of customers.

The company’s plans to diversify its revenue streams include licensing its vast pool of user data to third parties for various purposes, including research and training artificial intelligence models. Analysts say this could draw attention from investors, especially given the connection to the AI theme, which has propelled markets higher this year.

Social Media Stocks Face Competitive Landscape

This comes after a series of buzzy listings – Arm Holdings (ARM), Instacart (Maplebear) (CART), Klaviyo (KVYO), and Birkenstock (BIRK) – failed to ignite the IPO market last fall. With stocks fresh off a major rally to start the year and the interest-rate landscape looking more certain, investors wonder whether Reddit’s debut will open the floodgates for new listings in 2024.

Analysts say Snap (SNAP) and Pinterest will be Reddit’s closest competitors in public markets. Both stocks have struggled since the beginning of the year, with Snap down nearly 30% since January and Pinterest down 7.3%, while tech titans like Meta and Alphabet have soared. Snap and Pinterest carry market capitalisations of $19.5 billion and $23.7 billion, respectively.

Michael Hodel, Morningstar’s director of communication-services equity research, recently pointed out that Snap could struggle to pull in ad dollars.

“We believe wide-moat firms such as Meta and Alphabet, which have proved the value of their ad inventories to advertisers over the years and together dominate the market, will probably continue to take more digital ad dollars over time,” he wrote.

Reddit may see the same challenges, especially with advertising budgets still recovering.

“We face significant competition across many areas of our business,” the company’s IPO filing reads. “We compete directly with all other major advertising platforms, as well as publishers including Google, Meta, Snapchat, TikTok, Pinterest, and X.”

Social Media Stock Performance

Source: Morningstar Direct, Morningstar Indexes, March 11, 2024

Is Reddit Stock Expensive?

Compared with 2021, Smith says investors are “more discerning in how much they’re willing to pay for certain levels of growth and profitability … they’re just not willing to pay the sky-high valuations that they were in 2020 and 2021”.

But that doesn’t mean investors won’t stomach a price in Reddit’s target range. He points to solid growth in user numbers and revenue as potential green flags.

And if investors are willing to take a chance on Reddit with the market climbing and lower rates on the horizon, it could set the stage for more listings this year.

“Other companies in the pipeline, especially in the tech space, will be looking to see how well this does … to gauge investor sentiment,” Smith says.

Reddit Users Could Make Stock More Volatile

Reddit made headlines after announcing that a small portion of its IPO shares would be reserved for users, and the listing also commanded attention because of the role Reddit’s WallStreetBets community played in the meme stock frenzy of 2021.

In its filing, Reddit laid out various risks to its business that could affect the performance of its stock, including risks related to its user base. The company warned that high interest in the 1.76 million shares it will set aside for moderators of its platform could artificially inflate prices in the early days after the listing.

“Redditors’ participation in this offering could result in increased volatility in the market price of our Class A common stock,” the statement reads.

Reddit also nodded to the outsize influence that its users had on the prices of GameStop (GME), AMC Entertainment Holdings (AMC), and other meme stocks in 2021, and said the same phenomenon could affect its shares, resulting in heightened volatility.

But Smith doesn’t expect a small subset of retail investors to make a major difference in Reddit’s stock, especially since the bulk of the shares will be purchased by institutional investors.

“It’s a little bit more of a bark than a bite,” he says.

The author or authors do not own shares in any securities mentioned in this article.