Reddit's offering marks return of 'junk stock IPO,' New Constructs says

By James Rogers

Reddit's IPO could happen this month, but New Constructs says the social-media platform 'should not be a publicly traded company'

As Reddit's initial public offering nears, independent equity-research firm New Constructs is warning investors to avoid the social-media platform's IPO.

"Reddit's IPO marks the return of the junk IPO," New Constructs CEO David Trainer wrote in a note. "We think the company may never monetize its platform without angering its users, and the entire premise of Reddit is user-generated content. This business model is inescapably built on a catch-22: Make money or please users."

Reddit publicly filed the registration statement for its IPO last month, citing the opportunity to grow the platform, as well as its business, through advertising, monetizing commerce on the platform and licensing data. "Advertising is our first business, and advertisers of all sizes have discovered that Reddit is a great place to find high-intent customers that they aren't able to reach elsewhere," Reddit co-founder and CEO Steve Huffman said in the S-1 filing. "Advertising on Reddit is rapidly evolving, and we are still in the early phases of growing this business."

Related: Reddit publicly files IPO papers, detailing plans to license data, sell more ads and grow its 'user economy'

The stock will trade under the symbol RDDT on the New York Stock Exchange. Its public debut is expected sometime in March, according to New Constructs' Trainer. "While Reddit's expected $5 billion valuation is half of its $10 billion private-market valuation seen in 2021 when interest rates were zero and money was cheap, it remains much too high," he said in his note. "Reddit reminds us of the fast-growing but highly unprofitable IPOs we saw in 2021."

In particular, he pointed to the IPOs of DoorDash Inc. (DASH), Robinhood Markets Inc. (HOOD), Coinbase Global Inc. (COIN), DiDi Global Inc. (DIDIY) and Rivian Automotive Inc. (RIVN). DoorDash shares have fallen 24.3% since the company's December 2020 IPO, while Robinood's stock has fallen 52.8% since its July 2021 public offering. Coinbase shares are down 33% since its April 2021 public debut, while DiDi Global's stock struggled slightly on its June 2021 debut and has subsequently fallen 75.7%. Rivian's stock is down 91.6% since its November 2021 IPO.

"A $5 billion valuation implies that Reddit will grow its user base to 26x current levels, which would be nearly 5x the size of Snap (SNAP) and a highly unlikely feat," Trainer wrote. "Reddit looks overvalued, and we think investors should pass on this IPO."

Related: Reddit's IPO filing names WallStreetBets' popularity as risk to stock price

The Wall Street Journal reports that Reddit is targeting a valuation of up to $6.5 billion.

Reddit is home to the WallStreetBets forum, which played an important role in the meme-stock frenzy of 2021 that sent stocks such as AMC Entertainment Holdings Inc. (AMC) and GameStop Corp. (GME) skyrocketing.

But New Constructs is unmoved. "Sure, Reddit birthed some of the most volatile meme stocks through the wallstreetbets subreddit, but the company has never been profitable and should not be a publicly traded company," Trainer wrote.

Also read: Reddit will offer shares in its IPO at issue price to 75,000 of its most active users: report

In its S-1 filing, Reddit cited the popularity of WallStreetBets among retail investors as a risk to its stock price, which it said could experience "extreme volatility" for reasons unrelated to the company's "underlying business or macroeconomic or industry fundamentals."

In 2023, Reddit grew revenue to $804 million, up from $666.7 million in 2022. The company's gross margin was 86% in 2023, up from 84% in 2022. Reddit had a net loss of $90.8 million at the end of 2023, although that narrowed from $158.6 million in 2022.

The company had an average of 73.1 million daily active uniques in the three months ending Dec. 31, 2023.

Related: This is what we can expect to see from meme stocks in 2024

But Trainer highlighted the challenges associated with the platform's reliance on unpaid moderators. "This unique approach makes the Reddit experience more personal, but it is not without risks," he wrote. "Moderators are extremely important and could leave at any time."

"The first social media company to go public in years will not only test investors' appetite for the next money-losing operation, but it will also provide some clarity on the IPO market in general," he wrote. "Let's hope investors aren't throwing caution to the wind and piling into the latest profitless company. Real diligence reveals that Reddit is not only unprofitable, but also highly overvalued."

Reddit has not responded to a request for comment. Companies are not allowed to publicly comment on their IPOs before they start trading.

Andrew Keshner contributed.

-James Rogers

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03-05-24 1553ET

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