Reddit is bucking this big tech trend. Analysts view it as a positive.

By James Rogers

'We don't really have capex to speak of,' Reddit CFO Drew Vollero told MarketWatch on the day of the company's initial public offering last month

One aspect of Reddit Inc.'s closely watched initial public offering that has grabbed attention since its debut last month is the social-media platform's capital expenditure spending, or lack of it.

"We don't really have capex to speak of," Reddit CFO Drew Vollero told MarketWatch on the day of the company's offering. "We carry text, which is a lot cheaper to carry than video or images," he added.

Reddit's comments on capex run counter to the spending trend at tech giants such as Meta Platforms Inc. (META) and Alphabet Inc. (GOOGL) (GOOG) and have piqued the attention of analysts.

"Reddit has high incremental margins and a capital-efficient business model that is simple and scalable, in our view," wrote Needham & Company analyst Laura Martin, in a note released Monday.

Needham pointed to Reddit's revenue for the years ending Dec. 31, 2022 and 2023, which was $666.7 million and $804 million, respectively, representing growth of 37% in fiscal year 2022 and 21% in fiscal year 2023. "The gross margin was 84% in FY22, rising to 86% in FY23," added Martin. Needham initiated coverage of Reddit with a buy rating and $55 price target.

Related: Reddit poised for AI and user growth, analysts say, as they initiate coverage

In a note released Monday J.P. Morgan analyst Doug Anmuth described Reddit as "capex light," and said that free cash flow should ramp given this model.

"Capex has been <$10M (1% of revenue) for the past 3 years as the company's dual cloud model allows for infrastructure costs to be expensed rather than capitalized," wrote Anmuth. "Management's capital allocation strategy is to invest in the business, with potential for some tuck-in M&A and strategic initiatives. We expect share repurchases could be possible down the line." J.P. Morgan initiated coverage of Reddit with a neutral rating and $47 price target Monday.

J.P. Morgan and Needham & Company are among the underwriters of Reddit's IPO. Monday marked the first time that the syndicate of banks and other groups that participated in the IPO can put out analysis of the stock.

In its S-1 filing, Reddit said that it uses third-party infrastructure partners to host its services and therefore does not incur "significant capital expenditures to support revenue generating activities."

Related: How the AI potential of Reddit's user data has helped send its stock soaring

Reddit's cost of revenue, or the cost incurred in producing its product, also provides a glimpse into its spending strategy. According to the S-1, Reddit's cost of revenue in 2023 was $111.01 million, compared with $104.8 million in 2022.

"Cost of revenue consists primarily of payments to third parties for the cost of hosting and supporting our mobile applications and website," the company said, in the filing. "In addition, cost of revenue includes expenses directly associated with the delivery of our advertising and other services, including advertising measurement services and credit card and other transaction processing fees."

Cost of revenue "also consists of personnel-related costs, including salaries, benefits, and stock-based compensation," Reddit added.

Julian Klymochko, CEO of alternative investment solutions company Acclerate Financial Technologies, said that Reddit appears to be bucking some broader tech sector trends.

"I believe where other tech companies capitalize infrastructure expenses, Reddit runs them through the income statement. Reddit is spending more than $100 million per year on cost of revenue," he told MarketWatch, via email last month. "Other companies may be utilizing capital expenditures to bring this infrastructure in house," he added.

Related: Reddit's IPO could be a bellwether for other offerings this year

While Reddit is tightening capex, the AI boom has prompted the world's biggest tech companies - Alphabet, Meta, Amazon.com Inc. (AMZN) and Microsoft Corp. (MSFT) - to outpace major oil companies in terms of capital expenditure, according to the Wells Fargo Investment Institute.

When Meta reported its fourth-quarter results in February, the Facebook parent raised its 2024 capex forecast to $30 billion to $37 billion, a $2 billion increase of the high end of its prior range. Capex growth will be driven by investments in servers, including both AI and non-AI hardware, and data centers, the company said.

Google parent Alphabet's capital expenditure in 2023 was $32.3 billion, up from $31.5 billion in the prior year, and the company expects to increase its investment in technical infrastructure to support AI. "We do expect 2024 full-year CapEx to be notably larger than 2023," said Alphabet's CFO Ruth Porat, during the conference call to discuss the results.

Related: AI boom in data centers has top tech companies spending more than major oil companies on capex

Reddit shares, which have fallen 20.7% since the company's offering, are down 5.6% Monday, outpacing the S&P 500 index's SPX 1.1% decline. The company reports first-quarter results after markets close on May 7.

-James Rogers

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04-15-24 1456ET

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