Reddit ($RDDT) -Threads of Opportunity.

Table of Contents

1. Summary

2. Why is now the time to buy $RDDT?

3. REDDIT Q3CY24 Highlights:

4. Sales Growth

5. Daily Active Visitors (U.S.)

6. Average Revenue Per User

7. Gross Margin and Pricing Power

8. EBITDA

9. Earnings Per Share(EPS)

10. Cash Is King

11. Balance Sheet Assessment

12. Final Thoughts

Summary

Founded in 2005 by two University of Virginia roommates, Reddit (NYSE:RDDT) facilitates user-generated content across niche communities (called subreddits) that discuss anything from stocks to dating and memes.

• Revenue growth was exceptional over the last three years, indicating it’s winning significant market share

• Estimated revenue growth for the next 12 months is robust and implies its market share will rise

• Best-in-class gross margins reflect the prominence of its products and the elite pricing power that follows

Why is now the time to buy $RDDT?

Reddit is trading at $142.22 per share, or a 95.5x forward EV-to-EBITDA ratio. The premium valuation means there’s much good news priced into the stock - we certainly can’t argue with that.

Are you a fan of the business model? If so, you can own a smaller position, as high-quality companies tend to outperform the market over a long-term period regardless of entry price.

REDDIT Q3CY24 Highlights:

• Revenue: $348.4 million vs analyst estimates of $314.8 million (10.6% beat)

• EPS: $0.16 vs analyst estimates of -$0.07 ($0.23 beat)

• EBITDA: $94.15 million vs analyst estimates of $60.04 million (56.8% beat)

• Revenue Guidance for Q4 CY2024 is $392.5 million at the midpoint, above analyst estimates of $361.6 million

• EBITDA guidance for Q4 CY2024 is $117.5 million at the midpoint, above analyst estimates of $88.16 million

• Gross Margin (GAAP): 90.1%, up from 87.3% in the same quarter last year

• Operating Margin: 2%, up from -9.4% in the same quarter last year

• EBITDA Margin: 27%, up from -3.3% in the same quarter last year

• Free Cash Flow Margin: 20.2%, up from 9.7% in the previous quarter

• Daily Active Unique Visitors: 97.2 million (slight miss vs. expectations of 97.6 million)

• Market Capitalization: $13.56 billion

Sales Growth

A company’s long-term performance can indicate its business quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Thankfully, Reddit’s 40.9% annualized revenue growth over the last three years was incredible. This is a great starting point for our analysis because it shows Reddit’s offerings resonate with customers.

This quarter, Reddit reported magnificent year-on-year revenue growth of 67.9%, and its $348.4 million of revenue beat Wall Street’s estimates by 10.6%. Management is currently guiding for a 57.2% year-on-year increase next quarter.

Looking further ahead, sell-side analysts expect revenue to grow 25.7% over the next 12 months. This projection is still admirable and indicates the market is factoring in success for its products and services.

Daily Active Visitors (U.S.)

User Growth

As a social network, Reddit generates revenue growth by increasing its user base and charging advertisers more for the ads each user is shown.

Over the last two years, Reddit’s daily active visitors (u.s.), a key performance metric for the company, increased by 28.5% annually to 48.2 million in the latest quarter. This growth rate is among the fastest of any consumer internet business and indicates its platform's popularity is exploding.

In Q3, Reddit added 16.2 million daily active visitors (u.s.), leading to 50.6% year-on-year growth. The quarterly print was higher than its two-year result, suggesting its new initiatives are accelerating user growth.

Average Revenue Per User

Average revenue per user (ARPU) is a critical metric to track for consumer internet businesses like Reddit because it measures how much the company earns from the ads shown to its users. ARPU can also be a proxy for how valuable advertisers find Reddit’s audience and its ad-targeting capabilities.

Reddit’s ARPU fell over the last two years, averaging 3.1% annual declines. This isn’t great, but the increase in daily active visitors (u.s.) is more relevant for assessing long-term business potential. We’ll monitor the situation closely; if Reddit tries boosting ARPU by taking a more aggressive approach to monetization, it’s unclear whether users can continue growing at the current pace..

This quarter, Reddit’s ARPU clocked in at $3.58. It declined 44.8% year on year, worse than the change in its daily active visitors (u.s.).

Gross Margin and Pricing Power

A company’s gross profit margin has a significant impact on its ability to exert pricing power, develop new products, and invest in marketing. These factors can determine the winner in a competitive market.

For social network businesses like Reddit, gross profit tells us how much money the company gets to keep after covering the base cost of its products and services, which typically include customer service, data center, and other infrastructure expenses.

Reddit’s elite gross margin is one of the highest in the consumer internet sector, an output of its asset-lite business model and strong pricing power. It also enables the company to fund large investments in new products and marketing during periods of rapid growth to achieve outsized profits at scale. As you can see below, it averaged an exceptional 87.7% gross margin over the last two years. That means Reddit only paid its providers $12.32 for every $100 in revenue..

This quarter, Reddit’s gross profit margin was 90.1%, marking a 2.8 percentage point increase from 87.3% in the same quarter last year. Reddit’s full-year margin has also been trending up over the past 12 months, increasing by 3.9 percentage points. If this move continues, it could suggest better unit economics due to more leverage from its growing sales on the fixed portion of its cost of goods sold (such as servers).

EBITDA

Operating income is often evaluated to assess a company’s underlying profitability. In a similar vein, EBITDA is the leading profitability metric for consumer internet companies as it excludes various one-time or non-cash expenses (depreciation), providing a clearer view of the business’s profit potential.

Reddit has done a decent job managing its cost base over the last two years. The company produced an average EBITDA margin of 3.4%, higher than the broader consumer internet sector.

Looking at the trend in its profitability, Reddit’s annual EBITDA margin rose by 9.4 percentage points over the last three years, as its sales growth gave it operating leverage.

In Q3, Reddit generated an EBITDA profit margin of 27%, up 30.3 percentage points year on year. The increase was solid, and since its EBITDA margin rose more than its gross margin, we can infer it was recently more efficient with expenses such as marketing, R&D, and administrative overhead.

Earnings Per Share(EPS)

Analyzing revenue trends tells us about a company’s historical growth, but the change in its earnings per share (EPS) points to the profitability of that growth – for example, a company could inflate its sales through excessive spending on advertising and promotions.

Reddit’s earnings losses deepened over the last three years as its EPS dropped 48.3% annually. We’ll keep a close eye on the company as diminishing earnings could imply changing secular trends and preferences.

In Q3, Reddit reported EPS at $0.16, up from negative $0.13 in the same quarter last year. This print easily cleared analysts’ estimates, and shareholders should be content with the results. Over the next 12 months, Wall Street is optimistic. Analysts forecast Reddit’s full-year EPS of negative $7.80 will reach break even.

Cash Is King

We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.

Reddit broke even from a free cash flow perspective over the last two years, giving the company limited opportunities to return capital to shareholders.

Taking a step back, an encouraging sign is that Reddit’s margin expanded by 33.7 percentage points over the last three years. The company’s improvement shows it’s heading in the right direction, and because its free cash flow profitability rose more than its operating profitability, continued increases could signal it’s becoming a less capital-intensive business.

Reddit’s free cash flow clocked in at $70.27 million in Q3, equivalent to a 20.2% margin. Its cash flow turned positive after being negative in the same quarter last year, building on its favorable historical trend.

Balance Sheet Assessment

Companies with more cash than debt have lower bankruptcy risk.

Reddit is a well-capitalized company with $1.74 billion of cash and $26.97 million of debt on its balance sheet. This $1.72 billion net cash position is 12.7% of its market cap and gives it the freedom to borrow money, return capital to shareholders, or invest in growth initiatives. Leverage is not an issue here..

Final Thoughts

Before deciding whether to buy Reddit or pass, we urge investors to consider business quality, valuation, and the latest quarterly results.

There is a lot to like about Reddit. For starters, its revenue growth has been exceptional over the last three years. And while its projected EPS for the next year is lacking, its admirable gross margins are a wonderful starting point for the overall profitability of the business. Additionally, Reddit’s rising cash profitability gives it more optionality.

Reddit’s EV-to-EBITDA ratio based on the next 12 months is 94.9x. A lot of good news is certainly baked in given its premium multiple, but we’ll happily own Reddit as its fundamentals really stand out. Investments like this should be held patiently for at least three to five years as they benefit from the power of long-term compounding, which more than makes up for any short-term price volatility that comes with high valuations.

Wall Street analysts have a consensus one-year price target of $78.19 on the company (compared to the current share price of $140.69).