Reddit IPO: Why the Social Media Stock Could Be a Hidden Artificial Intelligence (AI) Winner

After years of anticipation, Reddit will finally hit the public markets. The social media platform plans to set a price for its initial public offering (IPO) on March 20, and then begin trading on March 21.

Wondering if the Reddit IPO is worth investing in? Let's take a look at what you need to know about the newest social media debutante.

A person holding a smartphone while sitting in front of a computer.

Image source: Getty Images.

What is Reddit?

Reddit might be a household name, but its platform isn't as easily understood as social networks like Meta Platforms' Facebook or Instagram. Reddit describes itself as a global digital city, and the social network is organized around "subreddits" and threads based on specific interests, which cover things like home improvement, travel, and entertainment, as well as more obscure subjects. Users post on a subreddit and you can read responses in the subsequent thread. Currently, there are more than 100,000 active communities, or subreddits, on the platform. Users post anonymously, which also makes it different from most social networks.

Reddit has a broad audience, with 73 million average daily unique visitors and 267 million average weekly unique visitors, up 29% from a year ago. About half of those come from the United States. In December, it had more than 500 million unique visitors.

Like other social media companies, Reddit's revenues primarily come from advertising.

Reddit's key numbers

Reddit was founded in 2005 by a pair of University of Virginia roommates and a third founder, but though it has been around for a while, the company is still not profitable.

In 2023, its revenue grew 21% to $804 million, but it reported a generally accepted accounting principles (GAAP) operating loss of $140.2 million, which was a slight improvement from the $172.2 million it recorded in 2022.

Reddit is also losing money on an adjusted earnings before interest taxes, depreciation, and amortization (EBITDA) basis: It lost $69.3 million in 2023, though that was an improvement from its $108.4 million loss in 2022. It reported negative free cash flow of $84.8 million in 2023, which was better than its negative free cash flow of $100.3 million in 2022.

Reddit's growth strategy

Reddit aims to grow its user base and improve monetization by increasing awareness of the platform and its use cases, improving engagement, and encouraging more frequent use of the platform. To accomplish that, it's improving discovery on the site through machine learning, modernizing search, and improving user experience in other ways.

The company also sees itself as a leader in contextual advertising, much like Pinterest is. Pinterest caters in part to people looking for images that will help them with a certain subject, like fashion, home improvement, or children's activities. Reddit's users often come to its site for similar reasons. For instance, a visitor to the subreddit r/camping would likely be a good target for companies selling camping and outdoor equipment.

Pinterest often says that its users like to see ads since they are often looking for products. While not every subreddit lends itself to ads, out of the more than 100,000 subreddits on the platform, there are certainly some that would be particularly good spaces for targeted advertising.

A chalk drawing of a rocket and the letters IPO.

Image source: Getty Images.

How Reddit could be an AI winner

While advertising is currently Reddit's primary way of making money, that could change, and artificial intelligence (AI) is a major reason why.

The company sees itself evolving from an advertising business into one that benefits from data licensing, including AI model training. In Reddit's own words, "Reddit's vast and unmatched archive of real, timely, and relevant human conversation on literally any topic is an invaluable dataset for a variety of purposes, including search, AI training, and research."

The company also says that its data is a "foundation piece" in AI technology and training for large language models like ChatGPT.

It's perhaps not a coincidence then that OpenAI CEO Sam Altman is one of the biggest investors in Reddit and is also on its board. Given that relationship, it's easy to see why OpenAI would use Reddit posts to train its models, if it isn't doing so already.

It's unclear how much Reddit can charge for its data, but the company said it entered into data licensing arrangements in January worth $203 million over the next two to three years, and it expects to make at least $66.4 million in revenue this year from data licensing. The value of Reddit's content is likely to go up as the AI market grows, and the social media platform also has the advantage of generating new posts every day.

Should you buy the Reddit IPO?

Reddit plans to sell 22 million shares in its debut out of 160 million shares outstanding in its IPO, which does not include stock units and stock options. Based on a fully diluted basis at its target share price of $31 to $34, Reddit is targeting a valuation of about $6.5 billion, giving the company a price-to-sales ratio of around 8, which is similar to Pinterest's at 7.7 and Meta's at 9.9.

However, Reddit is still operating at a significant loss, and it could be several quarters or even years before it reaches profitability.

Given that, I think investors would be best off to stay on the sidelines for now. However, the AI story is worth watching here, as Reddit could be a big winner if it can capitalize on the value of its data.

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Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Jeremy Bowman has positions in Meta Platforms and Pinterest. The Motley Fool has positions in and recommends Meta Platforms and Pinterest. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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