One of the most popular social media sites on the Internet is Reddit. If you're unfamiliar, Reddit serves as an online forum on which users can search for information and discussions on just about any topic. Discussion boards on the site are referred to as "subreddits," and their content can be filtered by date or popularity, among other methods.
While Reddit's platform boasts 73.1 million daily active users, the company undoubtedly faces fierce competition among other social media applications. Meta Platforms ended 2023 with 3.2 billion daily active people across its apps which include Facebook, Instagram, and WhatsApp. Alternatively, TikTok, which is owned by a Chinese tech conglomerate called ByteDance, is experiencing unprecedented growth overseas -- the platform reportedly has 150 million users just in the U.S.
With an intense competitive landscape at its heels, all eyes are on Reddit's S-1 filing -- a major step as it gears up for its initial public offering (IPO). These forms are intended to provide fairly comprehensive information about a business and its key investors and relationships. And given its high engagement and broad reach, it's not surprising that Reddit's S-1 shows it was a hot investment among venture capitalists (VC).
Within the company's prospectus, the name of one investor really stuck out. Eccentric entrepreneur Sam Altman has been revealed as one of Reddit's largest investors. Should you follow his lead into one of the year's most-hyped IPOs?
Who is Sam Altman?
Even if you aren't familiar with Altman by name, you are almost certainly aware of his artificial intelligence (AI) company, OpenAI -- start-up behind ChatGPT. Though it's still privately held, it has raised billions in funding from the likes of Microsoft.
Altman has had an unusual career as both an entrepreneur and investor. For several years, he served as president of start-up incubator Y Combinator, which is famous for funding well-known businesses, including Airbnb, Dropbox, and DoorDash.
In addition to founding and advising start-ups, Altman also has a prolific career as an angel investor. According to Reddit's IPO filing, Altman has invested nearly $60 million into Reddit, giving him a more than 9% equity stake in the business.
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How can you invest in Reddit?
There are a couple of ways that you can invest in Reddit. The company's S-1 form includes a list of the company's primary owners. The majority of Reddit is owned by insiders, including members of its executive team, and venture capital firms. However, Chinese tech conglomerate Tencent owns about 11% of Reddit. As such, buying shares of Tencent technically provides you with passive exposure to Reddit.
However, a more direct way to buy shares in Reddit would be to participate in its IPO or wait until the stock hits the public exchanges. But the opportunity to buy shares at the actual IPO price directly from the company is almost always out of reach for retail investors -- those shares go entirely to accredited investors (usually people who have large amounts of investable assets) and institutions. The rest of us are buying from those first investors.
Should you invest in the Reddit IPO?
Investing in IPOs can carry a lot of risk. Depending on the company, trading activity can be abnormally high on the day of an IPO and even shortly thereafter. For this reason, momentum traders may look to get in on the action and push the stock price artificially higher. This can leave inexperienced investors holding the bag after early traders have sold and booked their profits, and the momentum dies down.
While Reddit has proven to be an important pillar for online community-building and information access, determining whether the stock is worth buying should rest on Reddit's actual business performance.
In 2023, Reddit's revenue rose 20% to $804 million. However, the company is still operating at substantial losses. While its net loss narrowed last year, the company still burnt roughly $90 million. Moreover, the company is nowhere near breaking even on a free-cash-flow basis.
In its S-1, Reddit outlined some ways in which the company plans to improve monetization. Given it's a social media platform, the most obvious area to seek additional revenue growth is from advertisers. However, as I pointed out above, Reddit's user base pales in comparison with other social media apps. As a result, I see Reddit hard-pressed to entice advertising dollars away from the competition.
In order to bolster its advertising potential, Reddit likely needs to exponentially broaden its reach. For the December quarter, more than 90% of posts on Reddit were made in English. To me, this shows that a concentrated cohort of users primarily uses Reddit. I think it'll be hard to attract top advertisers without proven international appeal.
One area that I think could work well for Reddit's monetization strategy is data licensing. In fact, the company recently struck a $60 million deal with Alphabet in which the search giant will use Reddit's data to help train future generative AI models. Again, while the idea of data licensing may sound good on the surface, the potential will be limited unless Reddit unlocks a way to significantly increase its user base and engagement.
Given Reddit's somewhat mediocre financial profile, as well as the number of unknowns surrounding its long-term monetization opportunities, I'm avoiding the stock for now. It's interesting that Altman is such a big stakeholder in the company, but I think Main Street investors are best served not to follow him into it at its IPO.
