Wall Street bets on Reddit

0:06Pushkin. Reddit is home to 73 million of the internet's most intelligent commenters, and the company is going public. One of the biggest U.S. debuts in quite a while has generated a lot of attention. And the question really for Reddit is, is it a good business and can it survive in Metisworld? This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I'm reporter Ethan Wu here in the New York studio, joined by my boss, Robert Armstrong, who, despite not being a Reddit user, has just written two articles. But you are a Redditor. That's the important thing. I just crunched the numbers.

0:48You're a Reddit guy. Well, I wouldn't call myself a Reddit guy necessarily, but I have been on in some capacity for the past, I don't know, like decade or so. I joined in middle school to follow like gaming forums. What's the last thing you read about on Reddit? There's a subreddit called Mildly Vandalized that I was looking at recently, which is just like petty acts of vandalism on science. It's funny because that was our second choice for the name of this podcast. Mildly Vandalized Markets News. That's what we like to present. Yeah. So it's weird communities like that, like, you know, r slash mildly vandalized or whatever it might be that is the product, right?

1:23Being sold to advertisers and ultimately to investors. I think you've put your finger on something that is central to whether this is a good business and central to just the future of the site, which is looking at it from the outside, reading the IPO filing documents, browsing the site a little bit for the first time. Clearly, what is special about this place is the work that the users put in to make it a better place and a more interesting place, not just upvoting and downvoting things, but more importantly, moderating the individual Reddit conversations and so forth. and the overarching question, I think Wall Street is asking and users of the site are asking, this becomes a big public business that makes money and that everybody knows how much money it's making and the C-suite is making all this dough.

2:18Are the Redditors cool with that? Yeah, yeah. And if they're not, it's going to change the business and change the site. Just to take it back a step for people that may not know exactly how Reddit works or haven't used it before, the basic premise is that it's a big form with a lot of subforms called subreddits. People make posts on the subreddits and then can comment on those posts. And both the posts and the comments can be upvoted or downvoted by other users. So it's a form with a user-generated rating system on all of the content, which is supposed to mean that the cream rises to the top. The most popular stuff is more visible.

2:57The junk sinks to the bottom. No one ever sees it. And that feature, alongside the fact that you can create these subreddits, these little micro communities dedicated to shared interests has meant a different type of engagement. And the sub communities, the subreddits are self-regulating. Exactly. They have rules. This is crucial. That are stated by a moderator and that moderator does work to keep that subreddit a kind of positive and useful place. This is crucial. So when you set up a new subreddit, if I wanted to set up r slash unhedged, right, I am then the moderator of r slash unhedged. And I can decide, okay, what are the rules we're going to put in place?

3:35How are we going to enforce them? What kind of culture do we want to promote? Those tools are given to the volunteer moderators who are users fundamentally. They're not paid. They can curate a subreddit's expectations, rules, community, culture. And that is kind of core to the Reddit product. That's why people want to go on it. And so does all of that and the good vibes associated with that, is that able to survive the transformation to a properly profit-making publicly traded entity? I think that is a huge question. That's right. The CEO in the S1 document, the public filing to take Reddit public, had a very unencouraging quote about his understanding of how Reddit works.

4:16So the preface to this quote, which I find unbelievable, is that clearly one of Reddit's business plans, which we'll talk about in a little more detail shortly, is Reddit is this incredible repository of people's thoughts about stuff and text people have generated on every possible topic, which makes it potentially a perfect training data set for an artificial intelligence company. And so one of the business plans is to sell the data to AI companies in return for fees. That would be a very high margin business, et cetera. Anyway, in the founder's letter at the front of the filing document, Steve Huffman writes the following.

4:56And I find this quote more effective if you read it in a robot voice. So I will. Reddit is one of the Internet's largest corpuses of authentic and constantly updated human generated experience. Reddit data constantly grows and regenerates as users converse. As the world becomes increasingly data-driven, we offer solutions that are human and experience-focused. I love human solutions. I know. This is my favorite solution. It's like he wants to alienate the Redditors as badly as he can. Is Steve Huffman an artificial intelligence already? Unclear. He is the Borg. So this gets to, there's a serious point here, which is, does the CEO of Reddit understand what makes Reddit tick?

5:45Right. And in the, so importantly, Reddit is not profit making. It is a loss making company. Yes. In the push to greater profitability and monetization, whether it's through AI based strategies or from trying to squeeze more money out of users themselves, do you end up corrupting what makes Reddit work, which is the sense of kind of micro communities that are self-policing, self-regulating, where there's not much top down. It's very bottom up. Now, one thing that is encouraging on this front, if you care about Reddit as a business and as an investor, one thing that's encouraging is we know that once a social network reaches a certain scale, it's extremely hard to screw it up.

6:23And the reason we know this is because Elon Musk bought Twitter and tried. Yeah. Right. Everyone agrees that Twitter has gotten noticeably worse, less relevant, less powerful, less nice since he bought it. But everyone is still there. I'm still there despite this. And I tried to switch to some of the alternatives. But once you've built a community at a certain scale, the community itself is like this irreplaceable resource. It's just too hard to build again. So it may be even if and what's the word everyone is using now? In shitification. Yes. Whose word is that? That's Cory Doctorow. Cory Doctorow's term is when a social network or internet platform sort of rots on the vine.

7:07His word for that is in shitification. When you reach critical mass, you have leverage because network effects to make the user experience a little bit worse. But more profitable. But more profitable for you and people can't leave because they're already bought in. So it could be that Reddit has reached that point. I don't know. Every one of these things is going to be different but that's one point in favor. But it's worth making a comparison to the kind of broader social media landscape with Reddit. So Reddit's unprofitable. It's going to have an uphill battle to try to develop new business models or cultivate their older ones to reach profitability.

7:39Yes. And there's a big outlier in terms of social media profitability. So the outlier, of course, is Meta. Meta. Meta, which came first, grew to massive, massive scale first, and developed really good technology for selling ads against social media first. It is like the most profitable, one of the three or four most profitable companies ever. I can't even remember the revenue number, but it's something on the - What was the compound growth rate? The compound growth rate since 2009 of free cash flow is like 50%. Yeah. It's ridiculous. To do that every year for 15 years is like you can't even conceive what that is.

8:20And so it sort of blows everything off the map and it now towers over the social media business. No other business can compare to it in size or profitability. And it's not just Reddit. It's Twitter. It's Snapchat. It's Pinterest. But all of those ones that you just mentioned are sort of snatching for the little scraps of advertising money that fall out of Meta's mouth as it gobbles it all down. One industry analyst described to me yesterday as advertisers spend money on Twitter, Pinterest, Snap when something is left over from their budget for spending on Meta. Now, that said, these other businesses, Pinterest, Snap, definitely Twitter, these have grown to be relatively big businesses.

9:05We're talking about multibillion dollar revenue lines for these businesses. But they are very different from Meta. And the question is, you know, they've followed a certain trajectory. Will Reddit follow the trajectory they've followed? Can it maybe get bigger? Can it get closer to? Are the profit dynamics different? But those are the kind of, you know, is it a Pinterest? Is it a snap? Or is it something between those and the giant meta? Yeah. An interesting comparison to bring in is TikTok, which has actually given meta via Instagram a run for its money. in terms of basically TikTok perfected the short form video format, the kind of highly addictive, high touch, high speed, you know, short videos that really, really drive engagement.

9:53You could hear in the meta earnings call them seeming a little nervous about TikTok, getting a lot of questions from analysts, and they had to really invest in their short term video capacities. And you can be sure, or at least I'm pretty sure, that the government is not going to make the same mistake twice and let Meta buy that thing, even if it's for sale. Like they made that mistake with Instagram. Yeah. That did massive damage to the competitiveness of the social media space. You can't just buy your rivals at this point. It's true. In this business. But what TikTok was able to do is basically create a new dimension of competition.

10:27Here's this new video format that like people hadn't really seen before. And Facebook, you have to come compete with us on our terrain. So has Reddit done that? Has Reddit done that, right? And so it's an interesting question. Reddit in many ways precedes meta. It's part of the kind of OG old internet forms. Obviously, there was some form of Facebook around, but it was at like Harvard or whatever at the time. And you could argue that meta via Facebook has invented a lot of the capacities that Reddit has. The groups system on Facebook is a really significant feature now that they've put a lot of development time into.

11:01It's not quite the same as subreddits. I prefer going on subreddits than on Facebook groups. And I think there's a culture to Reddit that's unique. But I think we have to say that it's not like Reddit is in a category of its own the way that TikTok in many ways still is. TikTok content gets reposted everywhere else on the Internet. Right. It's kind of the driving engine of where stuff is happening. One issue is to put it most broadly and most boldly in terms of money. Can a medium sized social media company make money? What is the economics of being a midsize player? Let me put it this way. So right now, I'm just checking my numbers.

11:44Revenue at Reddit is about 800 million. I think Pinterest and Snap are in like the three, four billion dollar range. And the thing is, if you look at really genuine cash earnings, I don't think Snap and Pinterest and probably not Twitter are really cash profitable. The reason I say this is because to the degree they show cash profits, it's because they have massive stock compensation plans. So they're paying their employees and IOUs. And if you treat their stock comp plans as a real expense, they are burning cash still at a scale of$4 billion of revenue. So what size in terms of revenue does Reddit have to get to from$800 million now in order to be a real cash profitable business?

12:37And I don't know the answer to that question. Part of the answer is that AI question. How much can they just straight up sell that data for? Yeah, yeah, yeah. In terms of pure finance, it's hard to see how Reddit gets to meta-level profitability just via its traditional business. I would say it's impossible. It would need to create a new business line, which is why you're seeing in the IPO documents, they mentioned AI like 50 or 60 times, right? They really want to hammer home. It's a plausible story. Sure, it is. It's just how do you estimate the magnitude of that business, right? Look, this company is not going to be as big as meta.

13:12It's not going to have as high margins as meta. It's not going to have as many users as meta. but even if the data sale for AI business turns out to be good, if this thing wants to arrive at profitability, it has to get bigger period. The number of users has to get a lot larger. 70 plus million daily active users is not going to get them to profitability. So the question is, they're this kind of do it yourself community based product. Can it get bigger? That's the question I would ask of Reddit investors. What is the story about how Reddit can bust out past its traditional roots and become something much larger?

13:56Yeah. You got to at least get over the snap bar. That's a pretty low bar. We're not there yet. All right, Rob, we'll be back in a moment with Long Short.

14:14Welcome back. This is Long Short, that part of the show where we go long a thing we love, short a thing we hate. Rob, are you long or short something? I'm going to follow my controversial long cocoa position. Big Mo. Big Mo. I said, don't mess with momentum. Here is another example. I am going to be long DJT, Trump Media and Technology Group Corp. You read a great piece about this yesterday that pointed out that at 60, 70 bucks, this stock makes no sense whatsoever. You have to assume the most crazy things to get to a$65 share price. But if we've learned anything, it's that a stupid thing can get stupider.

14:58Yes. So I am long DJT. Yes. Once you've departed the realm of fundamentals, you can go anywhere. Yeah. You can go anywhere. You're just free float. Anything can happen. Yeah. Well, Rob, I am short illustrations of Samuel Bankman Freed. People may know he's being sentenced today. By the time this podcast goes out, he may already have been sentenced. But in all the coverage of the SBF trial, there have been like various court sketches and attempts to illustrate Sam. They've all been kind of weird, in my opinion. And there was one yesterday in Bloomberg Businessweek that was like truly over the top and ridiculous.

15:34They depicted Sam as this kind of like black and red anime protagonist in the shadows. Yeah. Like an absolutely ridiculous drawing. Let's just show pictures of him. We don't need to go crazy with it, guys. Come on. Yeah. But the lesson here, of course, Ethan, is that if you want to be a major figure in finance, especially in the speculative end of finance, you need a look. say what you will about Sam Bankman-Fried and how he's come low. But the guy had a look and it really worked for him for a while there. He's a guy people just want to illustrate. It's true. The hair and the shorts. Yep. All right, Rob, thanks for being here.

16:07We'll have you back soon. And listeners, we're back in your feed on Tuesday with another episode of Unhedged. Catch you then. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhez. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Sandler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.

16:57We'll be right back.