Reddit: What You Need to Know Before Investing

Get the scoop on Reddit's IPO, financial challenges, moderator reliance, and leadership dynamics to decide if its the stock for you.
June 10, 2024
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Key Highlights

  • Moderator Dependence: Reddit relies heavily on unpaid moderators to manage its vast array of subreddits, posing operational risks as evidenced by recent moderator protests over API changes.
  • Financial Health: Despite substantial revenue, Reddit reported significant losses, with 55% of its revenue going into R&D. CEO Steve Huffman's high compensation package has also raised concerns among potential investors.
  • Leadership Dynamics: The relationship between co-founders Steve Huffman and Alexis Ohanian impacts Reddit's strategic direction, with notable tensions over content moderation and business priorities. 

Reddit, the internet's self-proclaimed "front page," has announced its plans to go public. For potential investors, understanding the intricacies of Reddit's business model, its challenges, and its growth trajectory is essential. Here's an in-depth look at the key factors surrounding Reddit's IPO, including its history, reliance on moderators, financials, and leadership dynamics.

A Brief History of Reddit

Reddit was founded in 2005 by Steve Huffman and Alexis Ohanian during their time at Y Combinator. Just a year later, it was sold to Condé Nast for $10 million. In 2011, Reddit spun off into an independent entity, and Huffman returned as CEO in 2015, after Ohanian rejoined in 2010. Over the years, Reddit has grown into one of the largest social media platforms, known for its diverse and vibrant communities called "subreddits."

The Role of Moderators

One unique aspect of Reddit is its reliance on unpaid moderators who manage the subreddits. These volunteers are crucial to the platform’s operation, enforcing community guidelines and maintaining the quality of content. However, this dependence poses significant risks:

  1. Moderator Strikes: In June 2023, thousands of subreddits went private as moderators protested changes to Reddit's API policy, which aimed to charge companies for data access previously available for free. Despite the protests, Reddit's management held firm on its decision.
  2. Risk Factors: Reddit's IPO filing acknowledges the potential disruptions caused by "actions or inactions" of volunteer moderators, highlighting the platform's vulnerability to internal strife.

To mitigate these risks, Reddit is offering a unique incentive: allowing moderators and active users to purchase shares at the IPO price, a privilege typically reserved for employees and early investors. However, moderators are highly skepticalof the offering.

Financial Overview

Reddit's financials reveal both its potential and its challenges:

  1. Revenue and Losses: Despite substantial revenue, Reddit reported an annual loss of $98 million. A significant portion of its spending, 55% of its revenue, goes into research and development (R&D), primarily on engineering and product development. This is notably high compared to other tech giants at their IPO stages.
  2. CEO Compensation: Steve Huffman's compensation package, worth $193.2 million in 2023, has raised eyebrows. Critics argue that such a high compensation is unwarranted given the company’s losses, suggesting that reducing executive compensation could improve profitability.
  3. Monetization Efforts: Reddit has ramped up its monetization efforts significantly since 2018, focusing more on ads. However, balancing these efforts with maintaining user satisfaction remains a delicate task. Reddit is eager to license its data to large language models (LLMs) like ChatGPT but users see this as a betrayal of their community.

Leadership and Internal Dynamics

Reddit's leadership dynamics, particularly the relationship between its co-founders, impact the company's culture and strategy:

  1. Huffman vs. Ohanian: Huffman and Ohanian, once close college roommates, have diverged in their visions for Reddit. Ohanian, who left the board in 2020 over disagreements on handling hate speech, was seen as the community's spiritual leader. Huffman, focused on business and profitability, has since taken steps to distance Reddit from Ohanian's legacy.
  2. Major Shareholders: Notable shareholders include Sam Altman, CEO of OpenAI, who owns 8.7% of Reddit. The Newhouse family and Tencent are also significant stakeholders, with 30% and 11% of the company, respectively.

The Future of Reddit

Reddit's IPO is a pivotal moment in its nearly two-decade journey. The company emphasizes its vast, constantly updating user-generated content as a critical asset, particularly valuable for training artificial intelligence models. This unique data advantage positions Reddit as a key player in the data-driven future.

However, potential investors should weigh the following:

  1. Reliance on Moderators: The ongoing dependence on unpaid moderators is a double-edged sword, offering both community authenticity and operational risks.
  2. Financial Health: High R&D spending and executive compensation amidst ongoing losses may concern investors looking for immediate profitability. Additionally, revenue growth remains reliant on user satisfaction, a difficult balancing act.
  3. Leadership Stability: The dynamic between Huffman and Ohanian, along with internal governance, will play a crucial role in shaping Reddit’s future.

In conclusion, investing in Reddit's IPO presents both exciting opportunities and significant risks. The platform’s strong community foundation, coupled with strategic monetization and data advantages, look like green shoots for growth. However, monetization efforts risk alienating users, an issue we’ve seen at other publicly listed social media companies. Without users, Reddit isn’t worth much.

As Reddit transitions into a public company, how it navigates these challenges will determine its success in the competitive social media landscape.

Should you invest $1,000 in Reddit right now?

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