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Reddit's IPO - The most important details & red flags
Main Post:
It has been a while since there was an exciting IPO, but finally, there is one.
I went through the Reddit prospectus, and here's my summary of Reddit as a company, the IPO, and some of the red flags I saw.
The post will be divided into the following segments:
Current business model
Future business model
Analysis of financial statements
Why IPO?
The IPO strategy
Sam Altman
Valuation
Current business model
Reddit's primary revenue source is - advertising. In 2023, it accounted for 98% of the $804 million in revenue. The remaining 2% comes from Reddit premium subscriptions, as well as products within the user economy (Reddit Gold / Avatars).
Given the significance of the advertising revenue stream, let's focus on that. The simple formula that can be derived is: Number of users multiplied by Average revenue per user.
These are the two most important numbers that any investor needs to focus on when analyzing almost any advertising business.
Let's start with the number of users. In an ideal world, we should know the exact number of users, and divide that with the potential user size. This will allow us to calculate the so-called "penetration rate". So, if the penetration rate is 10% for example, it indicates that the company has plenty of room to grow.
Reddit discloses two metrics: DAUq (Daily active uniques) and WAUq (Weekly active uniques). This could be seen as the first red flag. Here's why:
If we define the market size as users who are above the age of 14, that's over 270 million in the U.S.
The U.S. daily active uniques are 36 million. Hence, if we use these metrics, the penetration rate is about 13%.
However, if we use the weekly active uniques, we get to a penetration rate of almost 50% (131 million WAUq).
So, which one is it?
I'll argue that even the 50% is understated. Why? Because first of all, not everyone will be on Reddit, just as not everyone will be on any other platform. Second of all, there are users who use Reddit once every few months, when they need someone's advice or opinion. These, once in a while users are not taken into these metrics.
In theory, the company can innovate, and bring new features, that attract more users, and the average time spent per user increases. Given that the platform doesn't change too much over time, I'll argue that the platform applies only to a certain type of user and is getting close to the ceiling when it comes to growing within the U.S.
Internationally, on the other side, there is plenty of room to grow. However, as George Orwell said, "All animals are equal, but some are more equal than others".
This brings us to the 2nd part of the equation - average revenue per user.
The average U.S. user brings 4x more revenue than the average user from the rest of the world. So, although there is room to grow, it is less valuable.
Future business model
This is a good short summary of Reddit's main income stream, but it is backward-looking, and there is one more thing that we need to take into account. Its data.
It is fair to say that the platform is one of the internet's largest archives of human experiences and conversations, and this data definitely has value. It can be used for various reasons, including, training large language models. Pretty much the same day as filing the prospectus, Reddit and Google announced a partnership, that is expected to be worth $60 million per year. This is 8% of its 2023 revenue and I believe this revenue stream - licensing data - is what will create all the hype around the company.
Here's why I think that:
Analysis of financial statements
Despite being around for 19 years, Reddit is still struggling to find its way to profitability and loses around $100m per year. It can be argued that the company is poorly managed, and it reminds me of Twitter prior to the acquisition of Elon Musk, when the R&D was incredibly high and couldn't be justified with the new features introduced by the platform.
Reddit's R&D for 2023 was $438 million (55% of revenue). Of course, this is lagging, as in many cases, the value created from it is somewhere in the future. However, this isn't something new. Reddit has historically had high R&D expenses. Whether this is justified or not, of course, you be the judge.
Its revenue growth in 2023 was 20%, which isn't too exciting and can be barely labeled as a growth company. Especially considering there's not much room to grow in the U.S. and its international growth is less valuable.
The expectation is that the valuation will be above $5 billion. The company has over $1.2 billion in cash and marketable securities and no debt apart from leases. Meaning, that the valuation of the business is above $3.8 billion.
I'd argue with the current business model and lack of profitability, this cannot be justified. Its future value is highly dependent on the success of data licensing, a revenue stream, that we have very little information on.
Why IPO?
However, the question "Why IPO?" has not been answered yet. The company is losing $100m per year and has over $1.2 billion in cash and marketable securities. This is sufficient to cover the losses for the foreseeable future. So, raising additional funds doesn't seem to be the main reason for the IPO.
Two reasons should be considered:
- Liquidity for the existing shareholders - However, if the existing shareholders are pushing for this, it means they're not too optimistic about the company's future.
- Executive compensation - The CEO, for example, has over 660k PRSUs (Performance-restricted share units) that are eligible to vest when the company attains a $5b market cap valuation.
In my opinion, if the current shareholders believe in the company, they would be better off if the company remained private. So far, I am not convinced that the IPO adds any value to the company.
Being a public company brings quite some costs. The list of all costs, that is disclosed in the prospectus is yet to be completed, and there are also going to be additional ongoing expenses for being a public company, that will be incurred every single year.
The IPO strategy
The price of pretty much anything is a function of supply and demand. As Reddit doesn't need additional funds, I don't expect the company will issue too many additional shares. Rumors range from raising $100m to $750m. Now, if we focus on the demand, here's another red flag.
Qualified Reddit users and moderators will be invited to buy shares in the IPO, alongside other investors, through a directed share program. In my opinion, this is a psychological trick, making the users and moderators feel special so that they use this special offer to buy shares.
In addition, there will be shares offered through Fidelity Brokerage Services, SoFi, and Robinhood. So, if someone wants to buy into an IPO, they get a chance to do that. Basically, the goal is to increase demand as much as possible.
Sam Altman
Entities affiliated with Sam Altman have 9.2% voting power. Yes, the OpenAI Sam Altman.
Have you seen the licensing deal between OpenAI and Reddit?
Me neither.
Valuation
Anyway, one of the questions that many have is - Is Reddit going to be overvalued from the start? The answer to that question depends on your expectations for the data licensing model. Based on my estimates, the current advertising business model is worth around $1.7 billion.
Add the $1.2 billion of cash on top of it, and the valuation is close to $3 billion.
Of course, I could be wrong in my estimates, but it is quite clear that the advertising business doesn't explain the $5 billion + valuation.
So, is the data licensing revenue stream worth more than $2 billion? This is one of the main questions that needs to be answered. As there is no past information, it is also the key piece of the puzzle to create hype around the company. I would not be surprised if more data licensing information followed before the IPO, which further increases the hype around the company.
However, if Reddit can land many data licensing deals, then the $5 billion valuation can be justified.
I'd love to read your thoughts about the IPO, your thoughts on how much the data licensing stream is worth, as well as if there is something else that you find important, that I missed.
Top Comment: The only red flag you need is that it's an IPO.
Reddit's IPO - The most important details & red flags
Main Post:
Not necessarily a value investing post maybe, but considering Reddit is going public, I thought it is something worth discussing.
I went through the prospectus, and here's my summary of Reddit as a company, the IPO, and some of the red flags I saw.
For those who prefer watching, here's the post in video format: https://youtu.be/DFqkMmfx9zc
The post will be divided into the following segments:
Current business model
Future business model
Analysis of financial statements
Why IPO?
The IPO strategy
Sam Altman
Valuation
Current business model
Reddit's primary revenue source is - advertising. In 2023, it accounted for 98% of the $804 million in revenue. The remaining 2% comes from Reddit premium subscriptions, as well as products within the user economy (Reddit Gold / Avatars).
Given the significance of the advertising revenue stream, let's focus on that. The simple formula that can be derived is: Number of users multiplied by Average revenue per user.
These are the two most important numbers that any investor needs to focus on when analyzing almost any advertising business.
Let's start with the number of users. In an ideal world, we should know the exact number of users, and divide that with the potential user size. This will allow us to calculate the so-called "penetration rate". So, if the penetration rate is 10% for example, it indicates that the company has plenty of room to grow.
Reddit discloses two metrics: DAUq (Daily active uniques) and WAUq (Weekly active uniques). This could be seen as the first red flag. Here's why:
If we define the market size as users who are above the age of 14, that's over 270 million in the U.S.
The U.S. daily active uniques are 36 million. Hence, if we use these metrics, the penetration rate is about 13%.
However, if we use the weekly active uniques, we get to a penetration rate of almost 50% (131 million WAUq).
So, which one is it?
I'll argue that even the 50% is understated. Why? Because first of all, not everyone will be on Reddit, just as not everyone will be on any other platform. Second of all, there are users who use Reddit once every few months, when they need someone's advice or opinion. These, once in a while users are not taken into these metrics.
In theory, the company can innovate, and bring new features, that attract more users, and the average time spent per user increases. Given that the platform doesn't change too much over time, I'll argue that the platform applies only to a certain type of user and is getting close to the ceiling when it comes to growing within the U.S.
Internationally, on the other side, there is plenty of room to grow. However, as George Orwell said "All animals are equal, but some are more equal than others".
This brings us to the 2nd part of the equation - average revenue per user.
The average U.S. user brings 4x more revenue than the average user from the rest of the world. So, although there is room to grow, it is less valuable.
Future business model
This is a good short summary of Reddit's main income stream, but it is backward-looking, and there is one more thing that we need to take into account. Its data.
It is fair to say that the platform is one of the internet's largest archives of human experiences and conversations, and this data definitely has value. It can be used for various reasons, including, training large language models. Pretty much the same day as filing the prospectus, Reddit and Google announced a partnership, that is expected to be worth $60 million per year. This is 8% of its 2023 revenue and I believe this revenue stream - licensing data - is what will create all the hype around the company.
Here's why I think that:
Analysis of financial statements
Despite being around for 19 years, Reddit is still struggling to find its way to profitability and loses around $100m per year. It can be argued that the company is poorly managed, and it reminds me of Twitter prior to the acquisition of Elon Musk, when the R&D was incredibly high and couldn't be justified with the new features introduced by the platform.
Reddit's R&D for 2023 was $438 million (55% of revenue). Of course, this is lagging, as in many cases, the value created from it is somewhere in the future. However, this isn't something new. Reddit has historically had high R&D expenses. Whether this is justified or not, of course, you be the judge.
Its revenue growth in 2023 was 20%, which isn't too exciting and can be barely labeled as a growth company. Especially considering there's not much room to grow in the U.S. and its international growth is less valuable.
The expectation is that the valuation will be above $5 billion. The company has over $1.2 billion in cash and marketable securities and no debt apart from leases. Meaning, that the valuation of the business is above $3.8 billion.
I'd argue with the current business model and lack of profitability, this cannot be justified. Its future value is highly dependent on the success of data licensing, a revenue stream, that we have very little information on.
Why IPO?
However, the question "Why IPO?" has not been answered yet. The company is losing $100m per year and has over $1.2 billion in cash and marketable securities. This is sufficient to cover the losses for the foreseeable future. So, raising additional funds doesn't seem to be the main reason for the IPO.
Two reasons should be considered:
- Liquidity for the existing shareholders. However, if the existing shareholders are pushing for this, it means they're not too optimistic about the company's future.
- Executive compensation - The CEO, for example, has over 660k PRSUs (Performance-restricted share units) that are eligible to vest when the company attains a $5b market cap valuation.
In my opinion, if the current shareholders believe in the company, they would be better off if the company remained private. So far, I am not convinced that the IPO adds any value to the company.
Being a public company brings quite some costs. The list of all costs, that is disclosed in the prospectus is yet to be completed, and there are also going to be additional ongoing expenses for being a public company, that will be incurred every single year.
The IPO strategy
The price of pretty much anything is a function of supply and demand. As Reddit doesn't need additional funds, I don't expect the company will issue too many additional shares. Rumors range from raising $100m to $750m. Now, if we focus on the demand, here's another red flag.
Qualified Reddit users and moderators will be invited to buy shares in the IPO, alongside other investors, through a directed share program. In my opinion, this is a psychological trick, making the users and moderators feel special so that they use this special offer to buy shares.
In addition, there will be shares offered through Fidelity Brokerage Services, SoFi, and Robinhood. So, if someone wants to buy into an IPO, they get a chance to do that. Basically, the goal is to increase demand as much as possible.
Sam Altman
Entities affiliated with Sam Altman have 9.2% voting power. Yes, the OpenAI Sam Altman.
Have you seen the licensing deal between OpenAI and Reddit?
Me neither.
Valuation
Anyway, one of the questions that many have is - Is Reddit going to be overvalued from the start? The answer to that question depends on your expectations for the data licensing model. Based on my estimates, the current advertising business model is worth around $1.7 billion.
Add the $1.2 billion of cash on top of it, and the valuation is close to $3 billion.
Of course, I could be wrong in my estimates, but it is quite clear that the advertising business doesn't explain the $5 billion + valuation.
So, is the data licensing revenue stream worth more than $2 billion? This is one of the main questions that needs to be answered. As there is no past information, it is also the key piece of the puzzle to create hype around the company. I would not be surprised if more data licensing information followed before the IPO, which further increases the hype around the company.
However, if Reddit can land many data licensing deals, then the $5 billion valuation can be justified.
I'd love to read your thoughts about the IPO, your thoughts on how much the data licensing stream is worth, as well as if there is something else that you find important, that I missed.
Top Comment: This is cool, thanks for posting. What sticks out to me: $804 million in revenue Losing $100m Reddit's R&D for 2023 was $438 million (55% of revenue) ...What are they spending their money on?
Hyundai IPO is filled with red flags
Main Post:
A lot of you are excited about the biggest IPO in India till date. Biggest IPO also means higher chances of allotment.
But is that all?
This IPO has a lot of red flags that cannot be ignored.
First red flag is that issue is 0% fresh issue and 100% offer for sale.
Means that none of the IPO money goes to the Indian arm of the company.
Yes, you read it right. The money goes to the South Korean promoters which effectively means that promoters are reducing their holdings. Or they want to mint money from the IPO frenzy in India.
This brings us to the second red flag. After the issue, the shareholding changes from 100% promoter holding to 82.5% promoter holding. But wait that's not it.
According to the amendment to the Securities Contracts Regulation Rules by SEBI in 2010, promoters of listed Indian companies (other than PSU companies) holding more than 75% had to compulsorily sell their additional holdings to bring it down to maximum 75%.
This means that, 7.5% more promoter holding has to be reduced within 3 years of listing. What does this bring us to?
A 7.5% OFS in the next 3 years which might cause the share price to drop even more
Third red flag is the low cash reserves in the company and even worse, increase in dividend payout to the parent company by taking money out of cash reserves. AFTER THE IPO! Wait what!? So this also means we cannot expect the company to issue a fair amount of dividends!
Fourth red flag is that the grey market premium (GMP) is tanking badly and is at a miniscule Rs. 65/share. Remember that the share price will fall further due to selling that happens after the listing.
Some positives are low debt, the car sales number in India and their market share but valuation is equally important if not more.
Which is why it would be wise to wait for the right valuation to enter for the long-term.
Top Comment:
That's some good research.
Too many red flags, too many signals to not to buy.
Not getting my hands burnt into this ipo.
Trusting my instincts.
Boston Red Sox Planning an IPO
Main Post: Boston Red Sox Planning an IPO
Top Comment: 834k members in the economy community. Forum for economy, business, politics, stocks, bonds, product releases, IPOs, advice, news, investment ...
Mapmyindia IPO - are there really no red flags?
Main Post:
Every review I am seeing for this IPO is very optimistic. I just wanted to add a few arguments on the weaker points of this IPO. Note that I am not saying its a bad idea to invest in this IPO - as even I feel it might do just great as this company has lots of things going for it. Also note, I am actually a software engineer by profession and have 0 finance background so my opinions can be very noob-ish, so take them with a ton of salt.
Now coming to the negatives:
- Complete Offer For Sale: I generally stay as far away from such IPOs as possible. So mapmyindia claims its not doing the IPO to raise funds, but merely to build credibility. I really doubt that's the real reason as that even doesn't sound like the only reason to do an IPO can be.
- Valuation left to bankers: When asked in an interview, "how did you settle on ₹1000-1033 per share valuation", the founder simply said that it was what their investment banking partner suggested. It seems to me that this is just a convenient answer so that no one can ask them "Why such high valuation?" - because as we know if you leave the pricing completely to the bankers, they are going to set it as high as they can get away with as that's the way they can maximize their fees.
- Company has scope for growth but not growth mindset: Of course this is subjective criteria, and past performance/mindset need not always be the future performance/mindset. So while I see that their target market is increasing and they have the scope and capability to reach to bigger market, I am not sure if they intend to execute that strongly. Currently their client base is very small - 25 customers responsible for 80% revenue. When I look at their glassdoor and hiring behaviors it does not look like they are aiming to get the top talent. Most of their software team are paid much less than the company standards, and their glassdoor reviews are not that great (although there are some funny ones). Being asset-light, most of their costs are on salaries. If the salaries are so low, what would happen to the company if they had to increase the salaries in the future to avoid heavy employee attrition? Additionally, pricing the IPO at high PE ratio is fine with for high growth tech driven startups, but that is only appropriate if the company is actually willing to grow heavily.
Top Comment:
Only for listing gains.
There is something spooky about C2C Advanced Systems SME IPO
Main Post:
Going through the IPO documents of the company I found certain red flags.
1 - Of the total approx 9,900L capital to be raised, 1,345L is towards buying computers and software, while 4,600 crore is towards working capital requirements. Why does it need such a huge working capital? And further 25% is reserved for general corporate purposes, we don't know its end use.
2 - The company's auditors changed recently since they didn't have a Peer Review Certificate. However, the new auditors (joint auditors) have not yet completed the FY 2024 audit, which is well past due now. They have given estimated numbers in the IPO documents. They were appointed on Dec-23 and Feb-24, sufficient time to complete the audit by now. This is also the concern that SEBI has raised indirectly.
3 - Their revenue for FY 2024 was 2,206L for 9 months and 4,086L for 12 months (unaudited), so basically 50% of revenue was generated in Q4. The past revenues for FY23 and FY22 are only 805L and 35L. The real problem is their receivables as of March 31, 2024 (unaudited), which are 4,274L (more than their annual turnover). So, high sales in Q4, not yet realised, unaudited numbers, no past turnover - Is it possible that the sales numbers are inflated? Their major contract seems to be with the Malaysian Government and that is the major chunk of these numbers.
4 - The company did not pay 57L undisputed TDS as of March 31, 2023. The company did not pay PF dues within the due date, for March 2020 to October 2023 and therefore, has an interest payable of 54L. This is a huge number. PF dues of 170L were paid only recently on November 22, 2023. Their related parties are also not paying PF dues and a defaulter to the tune of 143L. Why are these companies not paying Government dues in time - cashflow seems to be a problem!
5 - The working capital has been negative for the year ended FY 2021 due to a huge amount of trade payables being 437.52 lakhs. Of the total trade creditors, 253.77 was payable to KTI Intelligent Systems Limited and 161.83 was payable to Realtime Techsolutions Private Limited, both of which are related parties and not doing any major business. The business of Realtime Techsolutions is now being transferred to C2C advanced systems. Realtime Techsolutions was in losses during FY 2021 and FY 2022 when it had significant operations.
6 - They don't have any financing arrangements with banks. They don't have any such assets based on which the bank can provide the financing. They have taken an 827L Loan from PVR Multimedia (promoter company) and given a 500L Loan to Realtime Techsolutions (related party). Most of their financing is either equity shares or loans from promoter companies.
7 - The IPO documents have so many mistakes and the drafting is thoroughly unprofessional.
Source: C2C Advanced Systems IPO: Check IPO date, Price range & Lot size
Source: Audited Financials C2C Advanced 2023_.pdf
Top Comment:
han, let us unsubscribe. eod it is hard earned money.