TIVP014: Reddit (RDDT): Valuing the Front Page of the Internet w/ Shawn O’Malley & Daniel Mahnke

30:16I would say, though, that in all, it's hard to anticipate whether this will be an enduring part of the business. I could easily imagine at some point these models would no longer need access to Reddit's data as they advance and move past the training stages, which are kind of front-loaded with lots of data and demand for things like Reddit posts. But I'd rather focus anyways just on the core business without the licensing revenues because there's just no way to know how sticky they're going to be. On the other hand, while I don't want to bank on these AI licensing fees, it is fair to say that they need to be continuously fed data to remain up-to-date.

30:57and Reddit is as good a source of any or up-to-date data on what's happening on the entire internet. That's sort of its entire purpose of existence. Yeah, that's a good point. When I heard about the deal, I felt like Reddit just struck a deal to get at least something out of what is happening anyway. We all know that ChatGPT is training their models for years now on pretty much every data available on the internet. So this is a way, as you said, with 10 % of revenue, it's pretty significant. to still bank in on that without just sharing your data for free. But it does not seem like it's a sustainable part of a long-term business model.

31:36Since you just mentioned the core business, I will take that opportunity to ask, how is it doing since the IPO? By all accounts, it's doing well. Ad revenues have grown 60 % year over year. And what's compelling there is that Reddit offers some really unique advertising options. it's not entirely just harvesting user data and selling targeted ads though that is a big part of what they do but not all of it one of the more differentiated forms of advertising that they're able to offer is the sponsored amas and for anyone who doesn't know amas stands for ask me anything and it's a popular format specifically on reddit where someone with compelling or unique life experiences offers to answer all the questions that people could ask them over a given period of time so this could be a musician and promoting a new album and doing a two-hour ama where they answer questions about what it's like to be famous or write music or whatever or it could be an ama about beating cancer or being born with some strange medical condition and i've even seen ray dalio do amas so it really i mean anyone could do it and that's one of my favorite things about Reddit.

32:51There are all kinds of AMAs. And like I said, Reddit has tried to tap into that by helping advertisers do sponsored AMA sessions as a way to generate brand awareness and have authentic, organic interactions with real people online. And to go back to AI for a moment, this is something they're apparently leaning on heavily to to revamp their advertising business by using it not only to help improve their ad targeting, but also user engagement by predicting, for example, how well certain users will respond to different types of ad copy and images. And as sort of another way to look at the health of advertising on Reddit, I should add that click volumes on ads have doubled in the last year, which is a really great sign that advertisers are choosing to spend more on promotions across Reddit and getting a better bang for their buck in terms of the cost per click, which creates this flywheel effect where it'll probably only attract more advertisers to spend more and so on.

33:51Its number of weekly average unique users is also up over 40%. So the business is really spinning fast on all fronts and building a powerful flywheel where more users attracts more advertisers who provide funding to Reddit to attract even more users and collect better data on said users, attracting even more advertisers and so on. And if I were to be a real Reddit bull for a moment, what's exciting about Reddit is how under monetized the platform is and has been. The average Reddit visitor generates the equivalent of four cents in revenue per day versus on Facebook and Instagram, that number is close to being three times higher.

34:26From sponsored comments to sponsored AMAs and ads targeting specific subreddits, like a protein powder brand paying for sponsored posts and these supplements or bodybuilding subreddits. I just think there's considerable room here to earn more advertising dollars per user. Looking at those numbers, it certainly looks like that. There's just so much potential left for users to be monetized that the main question will be, can Reddit monetize those users as well as Facebook does? Or will it be more like Snapchat with having continuous problems with monetizing the users in an effective way? I've mentioned before that most of my interactions with Reddit were based on Google searches.

35:10And that is a development that seems to concern many investors. Do you think Reddit has become too dependent on Google search and that it has in some ways inflated Reddit's user numbers? It's a great question and a timely one because it is one of the big things on Reddit investors' minds these days. The elephant in the room here is that more than half of Reddit's visitors come from search engines. specifically Google. And Google has increasingly been driving search traffic to Reddit for answers for very specific types of questions. But if Google were to ever change its mind and see Reddit as a risk to its business in some way, that would just ring a lot of alarm bells for Reddit's business.

35:58So Reddit is actually the sixth most searched term on Google. So people are intentionally Googling things with Reddit in the query so that they're directed to relevant Reddit threads. And I think that's in large part due to people oftentimes trusting the answers they get on Reddit more than Google. So they want to use Google to help them find relevant threads and then go into Reddit to actually get the answer as opposed to reading some article on Google. And if you look at the search data on Reddit over the last five years, it's a pretty steady line up and to the right. Reddit's COO has described it as a symbiotic relationship where Reddit and Google codepend on each other in a way.

36:41As she puts it, Reddit is this trove of human intelligence providing some of the best answers for questions anywhere on the internet. And for Google, as an engine designed to help people find answers, it's only natural that its search engine should drive people to Reddit. At some point, though, if they don't already, I think Google will have to see Reddit as a competitor because Reddit is developing its own AI powered search engine called Reddit Answers that can replace how people use Google to find answers on Reddit. I'd also imagine from Google's perspective that searches ending in Reddit aren't as easy to monetize as searches for other specific questions.

37:21Reddit Answers is sort of like ChatGBT, yet it pulls from Reddit specifically in links to related posts from Reddit, which is an interesting way to use an LLM. I hadn't even realized it before, but I am one of these people who often does a Google search and then types in Reddit at the end because I actually just want Google to help me find the most relevant posts on Reddit. And I sort of started doing it subconsciously, I guess, as I noticed that Google was helpful for searching through Reddit. And I know that's something Reddit wants to fix because it's not a good look for them. Reddit Answers is the first meaningful swing at correcting this issue where Google is better at searching through Reddit's corpus of user interactions and posts than Reddit is at searching through itself.

38:06And I'm not sold on it because for the sake of convenience, I think I still probably would find it faster and easier to just add Reddit to the end of my searches and my search bar, but maybe there's something I'm missing and maybe they have a bigger vision than what I'm describing. But at least within this context, it kind of seems like a solution to the problem that doesn't really exist because I don't think Reddit Answers is that much of an upgrade over just adding Reddit to the end of a Google search. But at the same time, it would be a really bad look for Reddit if Google continued to be better at searching through Reddit than they are.

38:41You know, today's episode is not about Google, but I just wanted to make a point because I think it's fascinating that both Reddit and ChatGPD seem to take market share from Google, although the business is technically a different one. But it does say a lot about how the mode of Google is attacked, and I wasn't aware of the part Reddit plays here. So now at the time of this recording, Reddit is actually in a pretty significant correction. it has lost 20 % today, 32 % in the past week, and over 50 % from its all-time high in the first week of February. So you might want to tell me and the audience what all of this is about.

39:21Is it just the natural correction of a stock that quadrupled within a year? Or is it something more significant that's going on? Given the way Reddit stock has run up over the last year, I can't say I'm too surprised there's been a pullback after it reported its q4 earnings the day after they reported the results i think the stock pulled back by 15 and that's just what happens when you're priced for perfection i pulled up the stock chart again now and like i said at the time of recording it sounded over 45 over the last month at least so the valuation has just become much much more reasonable than it would have otherwise been if we had done this episode a few weeks ago.

40:03But looking at the quarterly results, I mean, they had a very solid 101.7 million average daily users during the last three months of 2024, but that was maybe a million short of what analysts had expected. So that was a little bit of a negative surprise, even though net income tripled from the year before and revenue was up 71 % year over year. And as we just talked about a minute ago, Reddit relies heavily on Google search and due to some changes in Google's algorithm, Reddit reported a lot of volatility in traffic. And I know for a fact that freaked investors out. Steve Huffman, though, tried to address that in a letter to shareholders.

40:40And he says, quote, what happened wasn't unusual. Referrals from search fluctuate from time to time, and they primarily affect logged out users. Our teams have navigated numerous algorithm updates and did an excellent job adapting to these latest changes effectively. So that's how the CEO sees it. Until Reddit can figure out how to convert large chunks of what they call logged out users, who are these people who might visit from Google for a single answer and then leave the platform into bona fide Reddit users with their own accounts, the company is likely going to remain at the whim of changes to Google's search algorithm.

41:18And basically, for context, there are two types of Reddit users, you could say. Those who visit Reddit for answers to specific questions, usually from Google searches, and those who scroll Reddit. Reddit scrollers probably have the app and they simply enjoy the platform. Whereas the logged out users are coming from Google. They're sort of like tourists who are passing through, but haven't been attracted enough to the platform to create an account and download the app for whatever reason. And obviously these visits are not equally valuable, but I do think increasing their conversion rate of these tourists to scrollers is a core strategic focus for the company.

41:56still it's worth emphasizing that reddit does stand on its own to an extent it's not entirely dependent on google but i think they'll be probably the first to say they've enjoyed a tailwind from google which is maybe one way to put it and just to step back there was honestly a lot to love about this past quarter in 2024 as a whole the business is really taking off and accelerating as we've kind of talked about it's churning on all metrics reddit became profitable for the first time ever last year with advertising revenues up 50 % from 2023 and a positive swing of operating cash flow to the tune of nearly$300 million.

42:34So the first quarter of this year won't generate the same revenue numbers as the last quarter because advertisers always spend much more around the holidays. But as I said, everything is moving in the right direction for Reddit to become a juggernaut on social media in terms of both the size of their user base and profitability. What I really like about Reddit is that, as we've kind of covered a bit, is it's organized by topic. Pretty much every other platform from X to Facebook, Instagram, TikTok are all premised around following specific people, whereas Reddit isn't like that at all. I don't follow anyone on Reddit.

43:09Rather, I engage with a number of subreddits focused on topics I find interesting. And that structure is just what makes Reddit unique. and that uniqueness has some value as the internet becomes increasingly consolidated. People visit fewer and fewer websites and instead spend their time in a few different ecosystems like social media platforms or YouTube. There are a lot of people out there who exclusively go back and forth between Reddit, YouTube, and Instagram. And that's it. That's all they do. They don't really frequently visit any other types of websites. And at the end of the day, they're all competing for your attention.

43:44But my point, I guess, is that Reddit is differentiated enough that it's not nearly as close of a substitute for any other platform as, say, Instagram is for TikTok. As a long-term user of Twitter, I couldn't agree more on the culture change. And it definitely was not to the better. So I can't really comment on Reddit's culture since I spent too little time on the platform to do that. But I find it very refreshing to see focus on topics rather than people. I think both is needed and also demanded. But while following people has an oversupply of platforms, Reddit seems to be the only big player who's focused on topics.

44:27But turning from a user perspective to an investor's perspective, what other ways than the ones we mentioned before do you see for future growth? One interesting idea for how Reddit could grow its business, which funny enough, I found on a thread about the company's earnings is this idea of monetizing commerce within subreddits. So for instance, there's a popular community called Watch Exchange, but people have to leave the app to settle transactions on Venmo or PayPal, which is already just kind of a shady process. If Reddit could create a marketplace functionality for these transactions and charge payment processing fees, that could be a really powerful way for them to make Reddit an even more self-sustaining ecosystem that you never have to leave and also generates more cash for the company.

45:16And in an AMA on Reddit's investor relations subreddit, Steve Huffman answered the exact question. He alluded to the fact that this is why they've allowed users to access the company's developer platform so they can contribute to building out these types of features from within their communities. But it also doesn't sound like this is going to happen anytime soon. But again, It's just kind of an idea of things in the bigger picture that they could do to improve the business of Reddit. And for context, with the Reddit developer platform, anyone can sign up to build the future of Reddit, as they call it, with powerful tools for their communities.

45:50And this can include everything from having live sports scores to community games, daily threads around live stock price data, really anything you can envision for working across platforms and scaling apps incorporated on Reddit servers and added into these subreddit communities. My impression is that they're focused on improving advertising first and foremost, and then on improving Reddit answers, which, again, is the Reddit search engine that will allow people to find answers on Reddit instead of having to go through Google. And way below that on the list of priorities is probably making Reddit this all-in-one marketplace platform.

46:28He did say, though, that they're working on enabling paid subreddits where you could create paywalled content within Reddit. So it does sound like it's on the way within the next year or so. There is a lot of what you might call adult content on Reddit. And I'd guess that a lot of this is used as a funnel to direct people off Reddit to platforms like OnlyFans, where these mature content creators can charge subscriptions and monetize their following. And I'm sure Reddit is keen to keep that activity on their platform by pulling users back from OnlyFans. which has built a massive multi-billion dollar business in the past few years.

47:09So this feature doesn't only extend to adult content, of course, but this is one of the main areas where people often talk about Reddit losing out on a good deal of potential monetization. The tricky thing is finding a balance between hosting this kind of content privately while also trying to run a large advertising business on the rest of Reddit's content. And I'll add that another way Reddit could grow the business on sort of a different note is through further data licensing beyond what we've already discussed with large language models. Reddit is often described as a hive mind. And if you can harvest that data at scale, you can get some very powerful real-time insights into the collective intelligence that is the internet.

47:51And as a result, there have been some studies that suggest that Reddit comments can be good indicators of sentiment around stocks, which I'm sure you might imagine is of interest to a bunch of hedge funds and stock traders. And as a result, Reddit recently announced that they're tapping into this demand for real-time data on what people across Reddit think about certain companies by partnering with Intercontinental Exchange to sell data captured from posts on financial subreddits like the infamous Wall Street bets. And I suspect they could do something similar for a variety of different companies that want insights into what a large body of internet users think about a given topic, whether for marketing or branding purposes, stock trading, product development, or anything else.

48:34Some people have historically made their own scraping tools that extract data from Reddit, which is a real kind of point of sensitivity for them. But the company is clearly trying to crack down on that. They refer to this as their API defense initiative. And the hope is to deter this kind of scraping activity and block it before much data can be extracted. And it's hard to say how well this works. I'm not really technically minded enough to know whether they're doing a good job at it. Legally, Reddit owns all of the user data and big parties like Alphabet are clearly inclined to pay for it legally.

49:09Though I'm sure there are plenty of entities operating on smaller scales that have found ways to legally scrape Reddit. When you say all that, it really seems like Reddit has so much more potential than Snapchat had at any point. I mean, there's only one marketplace, although it's far into the future thinking. It has so much potential for many, many opportunities to make more revenues and also profits. Now, getting back to the here, now you mentioned before that Reddit is still pretty US centered with over 40 % of active users coming from the States. And to change that, they now started translating content with the help of AI.

49:48I'm always a bit skeptical of AI features like that. And I'm even more so on Reddit, where a lot of communities, as you mentioned, have their own jargon and terminology. So how well do you think the translation service is doing? And could it actually help expanding internationally? I think that all comes in the spirit of making Reddit a more accessible platform and then monetizing the body of answers and insights that they've accumulated there, as we keep talking about. They've been using AI to make Reddit fully translatable into a few select languages or native speakers of those languages. And they started with French, but are now starting to expand into a half dozen other languages.

50:32So it does come with substantial computing costs, but I guess those will come down over time and ultimately should help with the goal of making Reddit into a more global platform. As you know, who's someone who speaks English as their second language? The internet is generally dominated by English and Reddit is no different. But if you buy into the idea that Reddit is this unique corpus of human intellect and wisdom, then of course, allowing more users to access this hive mind by making language less of an obstacle is objectively a good thing and probably a compelling growth engine for the underlying business.

51:13So to kind of make the point, you could imagine a subreddit in Spanish that's devoted to tapas. And maybe some of the best tapas recipes in the world exist only on that subreddit. And I would have no idea because I'm searching for recipes in English on Reddit for tapas. And just by making every subreddit language agnostic with these machine translations, I could stumble across a translated version of those threads and recipes, and they might become available to me in a way they otherwise never would have been, revealing a whole new world of authentic cooking tips for me to tap into. And the other benefit of automatic translations more pragmatically is that they might be able to make more of the platform attractive to advertisers by increasing the reach of ads and subreddit targeting, regardless of language.

52:07And that will hopefully attract a more global base of advertisers bidding on Reddit's ad inventory. So that said, Reddit, as you pointed out, remains chiefly a US platform with more than 40 % of its traffic coming from the US. And then the United Kingdom and India are the second largest users of Reddit with both having around 5 % share of Reddit's global traffic. And then there's Canada and Australia and Germany and France and Brazil and a bunch of countries with slightly smaller shares. On the bright side, I guess you could kind of invert that statistic to say less than 50 % of Reddit's users are concentrated in the US, which is a high concentration and shows that Reddit is not as much of a global platform as some other social media giants.

52:54It does also indicate there's a lot of room for progress to grow internationally. And I could imagine that's potential that Reddit will definitely fill out over time. As someone coming from Germany, while English proficiency is pretty high, people do like to watch and consume content in their native language. And I would assume that's the case in almost any country. So translating services is probably something that helps a lot with getting more international. But besides reducing language barriers, what else could Reddit do to expand globally and also appeal to audiences outside of the US? Growth for Reddit in new areas can be tricky.

53:37I'll be the first to say that. You're trying to spread communities and that has to be authentic. So you can't spend your way to growth. A lot of what Reddit does to enable growth stems from orchestrating these community meetups, training moderators on how to manage and grow their communities, and directly reaching out to people who might be positioned to build a community to encourage them to do so. I think Reddit CEO has used the expression high touch, and that's probably a good way to put it. They're trying to do things behind the scenes from a very high level to enable Reddit to spread organically as opposed to running massive ad campaigns or Reddit.

54:20So the company has and will continue to primarily grow via word of mouth, which has its pros and cons. The wonderful thing about Reddit though is that truly anyone can fit in there and find a place to belong. Whatever you're interested in or need help with, there's probably a community that already exists. And in the places that Reddit has intentionally focused on trying to grow adoption, they've had some really great success, which gives me as a potential investor, a lot of optimism. France has been a major point of focus alongside India and the Philippines. And in those three markets, user growth is up by more than 50%.

54:58So that's just very promising to me. So that proves the point that people do like to consume content in their native language. Now, you mentioned the CEO, Steve Hoffman, quite a lot. And his journey is, I would say, a bit out of the ordinary for a founder. But he still was the one leading the company through all the challenging times that any company faces when it starts off as an idea and turns into a multi-billion dollar company. So he clearly seems to have a wide skill set and also a deep personal connection to the company. And as a long-term user and also former investor, what do you think about him?

55:40And do you think he's the right person to go forward with? Steve Huffman is co-founder and the CEO, right? And from the start, that's a combo I typically like in a company. If anyone is going to care about a business and understand everything about it, it's of course the founder. And when they've been tied to the company across two decades, that's a sign to me that they aren't just some visionary, but they actually have the managerial and practical business building skills to scale a company from startup to growth to maturity, which maybe Reddit isn't at yet, but it will be. And that requires a rare combination of skills.

56:21and you could probably say Huffman does seem to have them. His story begins in his senior year of college at the University of Virginia when he drove to Boston to attend a lecture from legendary venture capitalist Paul Graham. And after meeting at the event, Graham invited Huffman to apply to his startup incubator, Y Combinator, which is a very famous organization in the venture capital world. And the idea was for a company called My Mobile Menu, which he hoped would allow users to order food via text message. It was actually an early idea for DoorDash, funny enough, but it was rejected. And in a later brainstorming session, Graham Huffman and Huffman's roommate, Alexis Orhanian, had the idea for building what they call the front page of the internet.

57:10Huffman then kind of went out on a whim and programmed the website and launched Reddit in June 2005 with funding from Y Combinator to help bring it to fruition. In just a few months, the site's web traffic skyrockets and Huffman or Hanian realize that they're rich and they promptly sell out of the company for something like between 10 and$20 million. And Huffman goes on this backpacking trip across Costa Rica and just takes time away from Reddit and forms a new travel website called Hipmunk, which was his focus for a few years. But by 2014, though, Huffman has a lot of regret. He realizes that selling Reddit has been a mistake given how wildly its growth exceeded expectations.

57:53And by 2015, Reddit had rehired Huffman as CEO. And in the last decade that he's been CEO again, he's accomplished a lot and really improved the underlying infrastructure behind Reddit. He just made it a lot more usable, both in web and app form. And that doesn't come without significant cost. His compensation package in 2023 alone was nearly$200 million. Wow. I mean, I would like to make that much money. But you just sneaked in another name, Alexis Orhanian, who is the co-founder and has resigned in 2020. And the reasoning just seemed a bit off to me. So could you shed some light on that situation?

58:36Although it's already a couple of years ago. Right, right. So Orhanian officially resigned in June 2020 during a pretty tense period with COVID lockdowns and Black Lives Matter protests in full effect. And this is a time of protests and denouncing the wrongs of the world. And as such, Orhanian requested that his director position be replaced by an African-American. And that came after Reddit's former CEO, Ellen Powell, from before Huffman took over again in 2015, had accused the company of long tolerating racism and implicitly condoning it by not regulating speech more closely on the platform, which prompted her to say that the platform, quote, monetizes white supremacy, which is a big allegation.

59:25And I'm sure we all remember what that moment in history was like. And five years later, I don't think we found any societal clarity on what type of speech should and shouldn't be regulated online and whether that is at odds with the spirit of the First Amendment, at least in the US. But I don't think anyone seriously associates Reddit with white supremacy any more than the broader internet is associated with white supremacy. and honestly reddit probably relies on inflammatory political content to drive engagement far less than other platforms like x and facebook but i'm just saying that off my own gut feeling i don't have any data to prove that i also don't really think orhanian was that closely involved with reddit anymore anyways and so there is a pessimistic side of me that thinks that this was maybe just a clean way for him to exit the company and focus on other things.

1:00:20Reddit would also not strike me as the most political platform. Talk about the likes of Facebook or especially Twitter. And we've compared them, Twitter, Reddit, Facebook, quite a lot today already. But if you would have to boil it down to just one thing where you would say reddit and x and facebook differentiate the most what would that one thing be the biggest difference is that the platform is pseudonymous which in a way counterintuitively actually frees people to be themselves reddit on purpose tries to know as little as possible about its users even their names which is a very very different model from facebook as we all know and that has implications for advertising.

1:01:09Visibility on Reddit besides advertising has to be completely earned. We talked about a little bit earlier, but every post can be upvoted or downloaded. And as posts get more upvotes, they get more visibility. So it's a system of earned promotion, you might say, not one where the largest influencers immediately get boosted by the algorithm as soon as they click posts. Not to say that Reddit doesn't have any algorithms at all, but my point is that it's more merit-based than other platforms, where every post from the start is sort of on a level footing. Reddit instead excels with contextual advertising based on topic, interests, and keyword, as opposed to having user-level data such as where someone lives, what they do for work, and whether they're married or not or whatever it is.

1:01:57According to Reddit itself, 40 % of internet users consider Reddit recommendations as the most influential factor in their purchasing decisions, which, if that's even partially true, is incredibly powerful and telling of the company's earnings power. And in a study conducted by TransUnion, Reddit ads returned over$20 in incremental returns on ad spend for every dollar invested on the platform. So unlike Facebook or Axe, where there's kind of one main feed based on followers. When you post on Reddit, you must choose a specific subreddit to post to. So small businesses love to advertise on Facebook because they can target precise locations with their ads.

1:02:45Maybe your local bakery wants to run ads only for people who live in your town. And with Facebook, that's completely possible. And honestly, the data can get much more granular than that, but we'll leave it there. With Reddit, these types of businesses aren't running ads in the same ways. Your local baker or HVAC business does not want to advertise on Reddit because there's no good way to geotarget an audience with enough precision. They don't want to pay for impressions seen by people who live five counties over or live in another state if they only operate in one specific area. That necessarily means that advertisers on Reddit need to have at least some degree of regional or nationwide scale for it to make sense.

1:03:28on reddit the advertising opportunities are probably more like a large sporting goods brand targeting a hiking subreddit to promote new types of camping equipment to a passionate audience of outdoorsmen who may or may not in that exact moment be having a conversation about their preferred tents on facebook you may be able to target the right person with a lot of precision but you might not be targeting them at a time when they're primed to see your content a makeup brand might want to target Sally from Minnesota for a new product release. But if Sally is engaged in a heated political debate, she's not exactly going to be receptive to the makeup ads that she's getting at that moment.

1:04:07So as I've said, what is powerful about Reddit is that you can target groups of people who have self-identified by interests and niche and show them ads when visiting a certain subreddit. So you know they're trying to engage with your advertisement if it's relevant. And that sort of comes at the cost of really specific user level data. But for example, I'm sure ads for football jerseys or sports streaming packages are very effective when delivered to folks viewing various sporting subreddits. For the record, though, I do continue to think that meta is a considerably more attractive advertising destination for most businesses.

1:04:42But I definitely see why Reddit can be compelling to certain types of companies. and especially at least comparatively has been under monetized given some of the uniqueness of the advertising opportunities it can offer and on that point just as a user i've certainly noticed more ads on reddit generally and more ads from sizable corporations and i don't find them to be as intrusive as on other platforms probably in part because they're so relevant to the subreddit I'm engaging with, whether that's Fidelity or Robinhood ads in an investing subreddit or Ozimpic ads in a dieting subreddit. In theory, this sounds absolutely great.

1:05:23When I'm scrolling through Instagram, for example, I just don't feel like buying anything. But when I'm actively looking for something and then come across an ad on Reddit, I'll be much more likely to buy. That said, I have to admit, I haven't yet seen any ads on Reddit that felt like a perfect fit for the topic. And sometimes they blend in so well that I don't even see them. And that makes me wonder whether other users have the same experience. Although you say you have an experience of very targeted ads, and they also fit well into the topic or the subreddit you're visiting. So maybe that's just me.

1:06:04I guess we just have to see long term how this model works out and whether they can profit on it as great as Facebook is. Although as you said, there's still a lot of difference and also a lot of differences in earnings potential. But that's just all part of the future. That uncertainty definitely doesn't make your job of coming up with a valuation for Reddit any easier. So I'm curious, what did you come up with? reddit is going to be tricky to value because generally less mature businesses have much wider margins of error in their valuations compared to a company like hershey the range of possible outcomes is just much much wider with reddit and as a result it's easy to be overly pessimistic or overly optimistic when estimating intrinsic value for example what might reddit be worth if its user base doubles in the next five years?

1:07:01Well, its advertising revenue per user tends closer towards Facebook's. I don't even have to do the valuation. I could tell you immediately Reddit would be worth considerably more in that scenario than however it's valued today. And then I might want to imagine, okay, what if the business, if it doesn't grow as fast internationally as hoped, while advertising does continue to improve dramatically, what would Reddit be worth in that situation? And what if international growth is slow for some reason and Reddit proves unable to scale its advertising like other social media platforms, probably due to them not having much user level data.

1:07:36In that case, the company would be worth a lot less. So it's a very simple way to think about it. I'm not claiming to be doing rocket science here, but I kind of try to take where the company is at in this moment and then set my ceilings and floors for where the business can be in five years and just go from there. Again, I'll be the first to say that with a fast-growing company like Reddit, which is just now inflecting toward profitability, two investors can look at it with the same information and come to wildly different conclusions about what the business is worth. Usually, I would say I'm not a fan of comparable valuation, but I look at the price of Snapchat and they are valued at about$15 billion.

1:08:17and it's known as a chronically unprofitable business. Reddit is now about$3 billion more expensive, but there's lots of potential. So I would like to think if Snapchat might be a worst case scenario, there's only a downside of$3 billion. And don't get me wrong, this is very, very simple math and I'm not suggesting this is how you should go about valuing, but it does show that reddit doesn't seem to be too expensive still we want the intrinsic value so shall we dig into the numbers a bit yes i've got the disclaimers out of the way and i like the point you make with snapchat it's a helpful way to think through the frameworks of what a worst case scenario could look like for reddit and i do have to say my thinking has shifted a lot since i I first participated in the IPO in 2024 when I probably thought Reddit was going to be more like a Snapchat.

1:09:16I was biased by my perception that there was just no way Reddit could be a good business without the kind of data on individuals that Facebook has. And at that time, I almost never saw ads on Reddit. So I saw Reddit as this platform that I got a lot of value from, but I couldn't figure out how they made enough money to stay in business. in just the last year, the functionality and usability of Reddit have improved substantially. Videos load faster. The layout is more intuitive. It's easier than ever to find communities that align with your interests. And all around, because of that and more, Reddit feels more mature than it used to.

1:09:55For my valuation, I wanted to focus on the value of Reddit's user base. And for that, we need to look at the average revenue per user, aka ARPU. And here, one of the first things you'll notice when digging into Reddit's financial filings is that there's a considerable discrepancy between how valuable users in the US are compared to users internationally. International users make up more than half the user base if they only contribute to approximately 20 % of the revenues. So there's a vast disparity in the revenues per user earned on international users relative to US funds. And the average revenue per American is something like five times higher, and that just can't sustain forever.

1:10:39As one of the wealthiest countries in the world, naturally, ARPU in the U.S. will remain very high comparatively, but that gap should narrow as Reddit focuses more on appealing to international advertisers. I suspect global advertisers will be increasingly attracted to Reddit as the company grows overseas, improves advertising technology generally, and then uses AI to make Reddit translatable into any language. So the tricky thing with this valuation is not only trying to anticipate how the user base might grow in the next few years, but also decomposing global ARPU projections to figure out what is a realistic balance between revenues per user in the US and abroad.

1:11:21If you think international ARPU can double, then that dramatically changes estimates for Reddit's average global ARPU, and the total revenue can earn off its entire user base, basically. Since 2022, for context, total user growth is up by over 20 % per year, and the US is actually not as mature of a market as you might think. It grew as fast as international markets over that period. But in that time, the ARPU spread between the US and other countries narrowed a bit because international ARPUs grew twice as fast as domestic ARPUs in the last two years. It was kind of a word salad, but I feel like with every user-based platform I've looked at, whether it's Spotify, Coupang, or now Reddit, there's a lot of optimism baked in that international users will one day be worth as much as the company's core base of users in some developed country, whether that be Korea, Sweden, or in Reddit's case, the US.

1:12:20but that can be a fraught assumption some places like australia and the uk i'm sure it can probably come closer to matching the us's arpu given the median incomes there but there are small markets and bigger markets like brazil and india are first of all much further off from embracing reddit culturally and then secondly are just much further off from generating the same amount of ad revenue per user because of discrepancies and purchasing power parity and incomes in those countries. And it's also about the time horizon. So if you want to go out 30 years, you could imagine India becoming a huge and important market.

1:12:57But if we're going for five years, you would need to focus on Europe and how Reddit is spreading there, right? I remember valuing Netflix and all the assumptions I had to come up with for the different RPUs, depending on the regions and how much they will likely spend in five or 10 years. And I always struggle with a confident assessment in those cases, since they can make or break your investment thesis. And I prefer setups where the more uncertain assumptions have a rather small impact on the investment outcome. And that's why I want to ask you, how did you get comfortable with making these assumptions?

1:13:38even more so considering that reddit is still a young company with not much data available yet i wouldn't say i'm hugely confident in the assumptions i made but to jump straight to it i got a valuation of roughly between 120 and 135 dollars for share as an intrinsic value target for reddit and at that price there are some big assumptions that not everybody will agree with that estimate anticipates reddit's growth continuing to accelerate internationally while arpu both domestically and internationally continue to appreciate as reddit improves its ability to serve ads and attracts more advertisers so while more users and higher revenue per user are boosting the top line i also try to model how reddit may benefit from economies of scale over the next five years such that their operating margin might rise from 12 % last quarter to as high as 30 % by 2029.

1:14:40And that basically just means overhead costs, R &D, marketing, stuff like that don't scale as fast as revenue and become smaller costs as a percent of sales over time such that your margins can increase. And on that point, very impressively, last quarter, Reddit grew revenue 3.5 times faster than total costs, which I don't think that's sustainable, but that is an incredible rate of achievement in their economies of scale, which makes up for many, many years of poor business results, at least in part. A 30 % operating margin by 2029, though, is aggressive. And it would mean, at least in percentage terms, Reddit is close to being in line with Alphabet's profitability, but is still a bit of a ways off from being as profitable as Meta.

1:15:38And I say that just to indicate that this thesis banks on Reddit being able to achieve a degree of profitability that is in line with some of the other big tech companies that we all know. And if anyone were to look at my model and say it's way too optimistic, I would not blame you at all. It is optimistic, but I'm also optimistic about Reddit. And the way I offset some of that is by trying to add in a 15 % margin of safety to further lower my price target and also by using a weighted range of values for possible exit multiples after five years that basically account for a bunch of different growth trajectories the company could go on down the line and sentiment around.

1:16:20the stock. So if you want to see the model, you can sign up for our intrinsic value newsletter in the show notes or at the investors podcast.com slash newsletters. And there you can download the model for free and use it and make your own assumptions. So with that tangent, the long and short of it is that even after some arguably very generous assumptions, and then some efforts to maybe hedge that a bit. I found the stock to be about fairly valued, though if it keeps slipping the way that it has in the last month, it could get very interesting very soon. And on that point, if we get some prices below$100 per share, which I would not be surprised at at all with Reddit, maybe by the time you're listening to it, that's already happened.

1:17:05I could be keen to snatch up shares at that price. Reddit's average revenue per user is like a third of Meta's ARPU. And even with some bold growth assumptions, Reddit can improve its business a lot while still not being nearly the same quality as Meta, which of course has much more data on users and much wider scale, but still. Reddit's management has said that they're probably only in the third or fourth inning of revamping their advertising services, which should only make the platform more appealing to advertisers who have more and more tools at their disposal to reach redditors and specifically whatever types of redditors are relevant to their products and services between share dilution google search algorithm changes inefficient management of the business economic slowdowns that reduce ad spending and a dozen other things there's also a lot that can go wrong here too so i probably haven't sold you on reddit daniel but i'll be curious to hear how you think about the company and how to value it?

1:18:09I wouldn't say so. I think in the last weeks and especially over the course of this episode, I feel like I have a totally different and a much better understanding of the company Reddit now and also the platform. And I went from seeing a company that seems to be walking in the footsteps of Snapchat to one that could potentially be another social media success story. Having said that though, I think there are people with a lot more confidence and maybe you're one of them who are willing to bet on that success by paying higher prices than I would feel comfortable with. The stock did come down a lot recently and it didn't yet reach bargain level prices for me, but we are close to$100 and I think that's a level where you could seriously think about adding it to the portfolio.

1:18:59And I say bargain levels because that's what it takes for me to buy a company that just reported its first profits and doesn't yet have a proven business model. And we might be five years out of knowing if this business model is actually sustainable. So at a price of about$100, I think it would be a lot more attractive and could actually become an investing opportunity, which is something that I wouldn't have thought going into this episode. I like the way you put it. And I'm glad that we've done the legwork to understand Reddit, because this is a company that, as we keep saying, could be really exciting if things continue to go their way, which is a big assumption.

1:19:38And I have some pause because this business was unprofitable for 20 years until just recently turning profitable. So make of that what you will. Management has done a nice job growing the platform, but it seems like they only recently have gotten serious about the business behind Reddit. And while the early signs are very promising, I also don't want to overestimate their ability off with just a few good quarters. while it took them so long to get to a position of success relative to what other platforms were able to achieve. Spotify also recently became profitable and it's kind of an interesting comparison.

1:20:11They're also a few years younger too. So the worst case scenario that you've touched on is that instead of becoming more like meta with Facebook or Instagram, they go in the direction of a company like Snapchat, which has never really been profitable and doesn't seem close to ever doing it. And yet they sport a fairly hefty valuation. That's another conversation. Two years ago, I would have thought Reddit was more like Snapchat, but the way they ramped up the business in 2024 and improved monetization while painting a pretty plausible picture for growth going forward, that has made me reconsider that assumption and outlook I had when I first participated in the IPO.

1:20:52So I'm not completely sold and added into the portfolio yet. I don't think you are either but i think we'll both be moving it to the top of our watch list and probably eagerly tuning into their quarterly earnings calls to see how things progress i think even in just two or three quarters from now not even five years the picture could become much clearer around their growth prospects how they're able to achieve economies of scale what sustained profitability looks like for them and correspondingly i would update my model and might even want to revisit the decision to add it to the portfolio, but we can save that for a future episode and maybe revisit the company at some point.

1:21:31I think for now we're in agreement. It's not exactly the right time to jump into Reddit shares. We are. We are. But at the same time, as you said, I would consider it to be not on top, but maybe a top five position on our watch list. And I'm still very glad you pitched Reddit. And who knows, maybe before we turn into an investor, I turn into an active user. Yeah, I love it. I'd love to see you on Reddit. But as always, we'll leave you with a quote in the wise words of Phil Fisher. He tells us that even a great company could be priced too high if there's a lot of glamour attached to it. Reddit may very well be a great company we regret not buying, but it's priced a little too richly for our tastes at the moment with too much uncertainty.

1:22:16we'll be back again next week where Daniel will assume my role today and be the one pitching a stock we'll see you all then