Startups, like the venture capital industry that funds them, represent a power law business. The largest startups get larger, attract the best people, grow at the fastest rates, and became the majority of their representative industry.
When you think of pillars of technology, you often think about eras: Cisco and HP in the 80’s, Apple and Microsoft in the 90’s, Amazon and Google in the early 2000s, and Facebook and Tesla in the 2010s. But sometimes, companies represent an outsized portion of the value created on the internet, without being able to capture that value.
Facebook, Shopify, and Reddit all have something in common: they were all founded between 2004 and 2006. The difference? While Facebook, now Meta, and Shopify have $1 trillion and $100 billion market caps respectively, Reddit was trading in the secondary markets a few months ago at ~$4.8 billion.
As of January 2024, Reddit was the 16th most popular website on the internet. But while a product like Facebook has grown to 2 billion daily active users, and $134 billion of revenue, Reddit has 73 million daily active users, and $804 million of revenue. Reddit has a few key limiters that have stopped it from reaching the scale of its internet peers.
The first? Anonymity. Reddit didn’t start even asking for a user email address until 2018, when the company was 13 years old! In addition, the company only made a real push into mandating personalized ads in 2023. The second limitation has been Reddit’s “web 1.0 forum” interface, which as been a turn off for a lot of users. The company attempted to refresh its UI for feeds in April 2023, but Reddit’s base of power users are pretty averse to change.
While these limitations have kept Reddit’s revenue from massive scale, the business is growing; albeit at ~21% year over year. But the financial data point that has caused the most consternation from potential buyers in a Reddit IPO has been the company’s continued lack of profitability. In 2023, the business had negative cash flows of $84 million. So what’s driving those losses, especially for a business whose core product is user-generated?
Source: Reddit S-1
While Reddit and Meta are certainly different businesses, they are both primarily user-generated content platforms generating substantially all of their revenue from advertising. So a comparison can be informative:
Gross Margins: Reddit has comparable gross margins to Meta (e.g. 86.2% vs. ~81% for Meta).
Research & Development: In 2022, R&D was 30.3% of Meta’s revenue, compared to 54.5% for Reddit. This is the most significant cost driver for Reddit, and for many the most surprising. “How can a product that hasn’t materially changed in years be spending nearly half a billion dollars in R&D?” Going forward, there may be opportunities for Reddit to innovate around new revenue streams, like the $60 million licensing deal the company signed with Google to share training data for AI models.
Sales & Marketing: In 2022, S&M was 13.1% of Meta’s revenue, compared to ~28% for Reddit. Notably, in 2023, 26% of Reddit’s revenue was driven by its top 10 advertisers. The outsized S&M expense for Reddit is likely due to a less efficient sales engine, given some of the anonymity and user issues discussed above.
General & Administrative: In 2022, G&A was 10.1% of Meta’s revenue, compared to 20.5% for Reddit. Some interesting potential nuggets here could be stock-based compensation or cryptocurrency impairment.
Reddit’s IPO is unlikely to perform well with traditional investors, given the lack of profitability and low-growth. The company is reportedly reserving some of the IPO for 75K of its power users, so there’s some innovation in the process, but it’s unlikely to move the needle. Other people think there could be a Wall Street Bets-style run-up on the stock as Redditors try and drive the value up. Only time will tell.
