Reddit (RDDT 1.87%) has gone on a wild ride since its initial public offering on March 21. The social news platform went public at $34, and its shares opened at $47 before rallying to a record high of $74.90 just five days later. But today it trades at about $48.
I recently dug deeper into Reddit's business and determined that it needed to find fresh ways to expand its ecosystem, grow its audience, and stay relevant in the shifting market for news aggregation platforms in order to be a sustainable investment.
Today I'll take a closer look at the five biggest risks for the so-called "front page of the internet."
Image source: Getty Images.
1. Its user growth is unpredictable
Reddit ended 2023 with 73.1 million daily active unique users (DAUq) across it platform. That represented a 27% increase from a year earlier -- but only half of those users were logged in.
The other half was just browsing or visiting from links across search engines, social networks, and other websites instead of posting new content and engaging with other users. The company wants to convert those logged-out users to logged-in ones so it can monetize them more effectively with ads, but its percentage of logged-in users actually declined sequentially and year over year in the fourth quarter of 2023.
In its registration filing with the Securities Exchange Commission, Reddit also warns that its DAUq growth could "fluctuate or decrease" after certain events like the COVID-19 pandemic, the WallStreetBets meme stock phenomenon, the outbreak of the Russo-Ukrainian War, and the releases of popular video games. These unpredictable growth spurts can set it up for tough year-over-year comparisons, and makes it more challenging to predict the long-term growth trajectory of Reddit's audience than other social media platforms.
2. It's struggling to monetize its U.S. audience
Reddit's DAUq in the U.S. grew 33% year over year and accounted for nearly half of its daily audience in the fourth quarter of 2023. Its international DAUq only rose 21%. But Reddit's average revenue per user (ARPU) in the U.S. declined 7% year over year in the fourth quarter, marking the region's second consecutive quarter of decelerating ARPU growth -- and caused its total ARPU to decline 2% year over year.
That's troubling because its U.S. DAUq generate four to five times as much revenue per user as its overseas DAUq. Meta Platforms' ARPU in the U.S. and Canada rose 16% year over year in the fourth quarter of 2023.
3. Growth could be derailed by browser and OS changes
In its registration filing, Reddit noted that web and mobile browser developers like those from Apple, Microsoft, and Alphabet are implementing changes that might "impair" its ability to measure traffic and the "effectiveness of advertising" on its platform.
It warns that Apple's new privacy updates for iOS apps and Safari, Google's elimination of third-party cookies on Chrome, and other changes could all reduce its ad sales. That's not surprising, since we already saw Meta and Snap reduce their dependence on third-party data to cope with those changes, but it's unclear if Reddit can roll with those punches.
4. It's heavily dependent on unpaid moderators
At first glance, Reddit's financials seem to be improving. It expects its revenue to increase at least 20% this year and for its bottom line to break even on an adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) basis.
However, Reddit is still overwhelmingly dependent on its army of unpaid moderators to enforce its rules and clean up its communities. It admits that if it fails to retain its moderators or maintain good working relationships with them, its business could falter. Reddit offered its top moderators a chance to participate in its IPO, but many of them rejected the offer.
By comparison, Meta and other social media platforms usually outsource their content moderation to other smaller overseas companies. That practice is also controversial, but it's still driven by paid workers instead of volunteers. And now that Reddit's publicly traded, there could be much more pressure for it to pay its moderators.
5. It expects to be challenged by generative AI platforms
Lastly, Reddit warns that in addition to search engines and social networks, it faces competition from generative AI platforms like OpenAI's ChatGPT, Google's Gemini, and Amazon-backed Anthropic. It admits that its users might choose to look up information with those platforms that "may have been trained using Reddit data" instead of directly visiting Reddit.
That shift might have less of an impact on its logged-in users who are having conversations with other users, but it could lure away its logged-out users who are simply using Reddit to search for information.
All these issues suggest that Reddit might not have been ready for a public debut. It's still growing, but its too early to tell if its business model is sustainable. So for now, investors should stick with more reliable social media plays like Meta Platforms.
