Reddit IPO Breakdown

Is Reddit a winner or loser? Deep-dive into Reddit’s S-1, metrics, comps, interesting learnings, and my thoughts

The last two years have been really hard for nerds like me because the “IPO Window” has essentially been completely shut since 2021 with the exception of a couple tech IPOs in 2023 (Klaviyo and Instacart). So with Reddit publicly filing its S-1 it is likely we will at least have one more IPO coming fairly soon. If the Reddit IPO goes well, then more tech IPOs will likely follow….

Outline:

1. Timeline & IPO Preparation (Free)

2. Valuation (Free)

3. Rule of 40 and Rule of X (Free)

4. IPO Float (Free)

5. Reddit Users Can Buy the IPO (Free)

6. Executive Compensation (Free)

7. Market Opportunity (Paid)

8. Revenue (Paid)

9. Revenue Growth Endurance (Paid)

10. Expenses (Paid)

11. Strong Balance Sheet (Paid)

12. Learnings from 409A Valuations (Paid)

13. My Thoughts on Reddit (Paid)

Timeline & IPO Preparation

Initial S-1: Typically after publicly filing an S-1 a company is aiming to go public in about 3 weeks, so Reddit is looking at a March IPO.

Roadshow: The roadshow takes ~2 weeks and is where the company executives fly around the world and pitch institutional investors on the IPO.

At the time an S-1 is publicly filed most of the hard work is done. The previous 8-12 months are where most of the heavy work actually takes place. In Reddit’s case they have been hoping to go public as early as the first half of 2022. Reddit hired bankers in late 2021 but paused plans after tech stocks started to crumble and the IPO window shut.

Companies can’t (or at least shouldn’t) be able to snap their fingers and go public. This was part of why SPACs were such a bad idea….

Below are some of the things that must be done from a finance perspective in preparation of an IPO:

• Build out public company team for finance, accounting, etc. You need people with the right experience leading up to the IPO.

• Auditors must review all quarterly and annual financial statements

• S-1 document must be written and reviewed. This isn’t as easy as it sounds. Reddit’s S-1 is about 300 pages. Most numbers in there have to be carefully reviewed by Reddit, the auditors, and legal. The team must carefully craft their message and choose the right key metrics.

• Act like a public company for 4+ quarters. Companies preparing to go public need to get some reps in before actually going public. Ensuring they can accurately forecast with a “beat & raise”, perform mock earnings calls so inexperienced execs are prepared, etc.

• Prepare the roadshow deck

• Build the forward financial model. It’s important to go public with confidence in forecasting and during period of expected strong revenue growth and endurance.

Valuation

Reddit most recent fundraising was $410M in 2021 at a valuation of ~$10B. In the initial public S-1 it is standard to leave out the deal specific terms such as price and number of shares being issued (which would provide valuation) so we don’t know yet what the valuation will be yet.

However, it is reported that the bankers are seeking at least $5B in the IPO (half of their last private valuation), which likely means they will try to push that a bit higher toward the end of their roadshow if there is decent interest.

Rule of 40 and Rule of X

The “Rule of 40” and “Rule of X” are shorthand metrics for helping investors determine valuation and health of a business. The Rule of 40 has become well-known in the software community while the Rule of X is a relatively new iteration of the Rule of 40.

Rule of 40 = Growth Rate + FCF Margin

Rule of X = (Growth Rate * Multiplier) + FCF Margin

The difference between these two metrics is that the Rule of X assigns a multiplier to revenue growth under the premise that revenue growth is more valuable than current profits — for a deeper dive on this check out my previous post on the Rule of X. The multiplier I am using in the analysis below is 2x, which is the current multiplier that has the highest correlation with revenue valuation multiples of public companies.

While the Rule of X was primarily developed for cloud companies, we can also apply it to Reddit and see how it compares.

Reddit’s Rule of X score on an LTM basis is a score of 31, which is bottom quartile compared to cloud companies.

31 = (21% rev growth * 2) + -11% FCF Margin

Reddit’s Rule of 40 score is pretty bad compared to other public companies as well. Its Rule of 40 score ranks #67 (out of 80) of the public cloud companies. The companies grouped near Reddit’s Rule of 40 have fairly low revenue multiples

While Reddit is on the higher end for revenue growth it loses more money than any of these companies with similar Rule of 40 scores.

IPO Float

The float represents the number of tradable shares. Most IPOs have a tiny float for the first 6 months because previous equity holders are locked up for 6 months of being public before they are tradable.

Below is a great chart that shows the tradable shares before the lockup expires. The average float is only 12%, but even this misrepresents the number of shares that are actually tradable because many IPO investors are invested for the long-term. These tiny floats are what can create a highly volatile IPO stock.

Reddit Users Can Buy the IPO

Reddit is reserving some amount of IPO shares for 75,000 of its users. These users will be given the chance to buy shares of Reddit at its IPO price before the stock begins trading. Typically the IPO price is reserved for large institutional investors and not the average retail investor. The normal individual investors typically can only buy on the open market, which is after the normal “IPO pop”.

So should Reddit users buy the IPO?

Are the r/WallStreetBets (guys who made Game Stop stock go parabolic) guys buying?

Of the ~80 cloud companies I am tracking only 7 of them declined on the first day of the IPO. In other words, ~90% of IPOs had a gain on the close of the first day of IPO trading. Not terrible odds if you can get in at the IPO pricing.

The IPOs with the largest 1st day IPO gains did *really* well. But remember, you only get these returns if you got to buy the stock at the IPO price, which the average investor typically doesn’t get.

However, if you look at what these IPO stocks do over the next 6 months, then things look A LOT different. If you were to buy an equal amount of all cloud stocks at the IPO price and sell 6 months later, then you would have a loss of 3%!!

Maybe you think this average 6 month loss is because of the market downturn in 2022 and a lot of cloud stocks went public in 2021?

If I exclude all IPOs where 6 months later is in 2022 then you would have a gain of 7%. Not a bad gain but if you dumped the stock on the first day of the IPO then your gain is 41%…. the average IPO declines a lot after the IPO first day so on average IPO investors would have been better off selling on the market close of the first day.

Executive Compensation

There have been a lot of social media memes about the CEO’s pay package that was disclosed in their S-1.

The CEO had disclosed compensation of $193M in 2023 but meanwhile in Reddit’s business risk section…

We rely on an approach to content moderation that depends on Redditors who volunteer to be moderators of their communities.

Below is the relevant table that shows the CEO, COO, and CFO’s compensation for the past two years.

There are an important couple of notes about this compensation:

1. $192M of this compensation was in equity so it has nothing to do with how much cash Reddit is burning.

2. The $192M of equity awards is the grant date fair value of all the awards given to the CEO within 2023. These awards still have to vest over several years.

3. Some of the equity awards only vest (i.e. have value) if certain price targets are met. As seen below, a lot of the stock options given to the CEO are “premium-priced” so the market value of the company has to increase significantly to have value.

Yes, it’s a lot of money, but it isn’t as simple as just looking at the total dollar amount.