Reddit: Julian Lin’s Top Conviction Idea

Summary:

• Reddit is viewed as a meme stock but is a top conviction idea for Julian Lin due to its potential for accelerated growth and re-rating.
• Why Meta and Reddit are not a valid comparison.
• Analyst coverage of Reddit has been uneven, with some underestimating its potential for monetization and growth.
• Reddit is close to generating profitability and upcoming earnings could show strong growth rates, indicating its undervalued status.

Listen here or on the go via Apple Podcasts and Spotify

Julian Lin goes in-depth on his top conviction idea, Reddit (0:30). IPO quiet period recently ended, analysts’ uneven coverage (4:15). Meta and Reddit – a valid comparison? (6:25). How to measure Reddit within the broader tech picture (10:30). Upcoming earnings (13:50). Sam Altman as major shareholder; curious insider IPO non-selling (16:25). Reddit very close to generating profitability (23:00). Recent large cap tech earnings (27:10).

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Transcript

Rena Sherbill: Julian Lin, great to have you back on Investing Experts. Always great to talk to you.

So, talk to us about a recent IPO that the market has reacted to a bit. What do you have to say about the company Reddit (NYSE:RDDT)?

Julian Lin: Yes. So, Reddit stock, it’s quite interesting. It just IPO-ed about one-month ago. A lot of investors might view it as a meme stock, especially because the origin of meme stocks has probably come from that WallStreetBets subreddit, a community on Reddit.

And then also Reddit stock is IPO-ing right now amidst some very rich tech valuations. So, there’s a lot of reasons to view it as a meme stock, but I view it as one of my top conviction ideas right now. So, I’m actually very bullish on the stock and the current valuation in spite of a lot of that negative sentiment.

RS: So, talk to us about why you wrote an article a little over a month ago on Reddit. You run an Investing Group called Best of Breed Growth Stocks. I imagine you’re talking about it there, as well as on the public site.

Talk to us about why you feel that way.

JL: One of the best ways to make money in stocks is to buy a high-quality stock at a low-quality valuation. And then you’ll be able to benefit once Wall Street views it as high quality. You benefit not just from the ongoing growth, but also from a dramatic re-rating.

So, here we have Reddit. It might be trading cheaply on the current fundamentals, but on a deeper analysis, I’m viewing it as being a high-quality platform potentially than something like Meta Platforms. And we’ll discuss that in a moment, but beyond that, it’s heavily under-monetized.

From my view, it looks like the management team has been focusing more on building the community. They still have their main co-founder leading the helm as the CEO, Steve Huffman. It’s not necessarily mismanagement, I guess.

Perhaps investors might view it that way just because the monetization has not been so smooth, but they’ve clearly been focusing more on just growing the users, building out their platform, but we end up with a situation where this is a very, very dominant social media platform, but it’s somehow generating 5x less revenues than even a Snapchat (SNAP) and over a 100x less revenues than Meta Platforms (NASDAQ:META). And that dynamic just does not quite make sense.

So, we had this opportunity to buy the stock at a cheap valuation based on the current fundamental picture, but because I view it to be under monetized, I believe we’ll start to see accelerated top-line growth, and then typically Wall Street is very forward looking with these under monetized plays, they tend to – Wall Street tends to value the stock based somewhere in between the current fundamentals and in the future more normalized picture. So, we have opportunities for both a strong returns from the growth, as well as a re-rating.

RS: Speaking of re-rating and getting more visible and more out there. As the IPO develops, last week, the quiet period ended, which brings out the ratings from analysts. Talk to us, if you go on the Seeking Alpha Reddit page (free plug), you can see where the analysts break down. I would say there aren’t a lot of Sells, but there are a number of Holds and there are definitely a number of Buys and four Strong Buys that we’re seeing.

On Seeking Alpha, analysts mostly have it as a Hold, although it’s not covered a lot since it’s fairly new. Talk to us about where you think the analyst community is on the stock and how you think they’re reacting and whether or not you see some of the talking points that are being bandied about to go Hold or negative or less than by, let’s say, how are you relating to that, and how are you thinking about that?

JL: Sure, I think a lot of the initial investment coverage has been a little uneven. I’ve seen some coverage somehow called Reddit to be of lower engagement than Pinterest (PINS). I just laugh at this comparison. When anyone who uses either platform knows that it’s just the complete opposite, but I think where a lot of the current coverage perhaps might be in disagreement with my view is definitely on this view of under-monetization

A lot of their valuation assumptions are based on just the current growth rates, and they’re modeling it based on the current 20% growth rate thinking, okay, it’s going to decelerate from 20% pretty soon.

The current 8x sales multiple is nothing special, but I think a lot of them, a lot of the coverage is acknowledging the higher quality nature of this platform, but they just, they’re not quite grasping that the platform is just clearly under-monetized right now, and growth rates are going to persist and be much higher than they are expecting.

So, a lot of the consensus estimates, they have Reddit growing revenues at a 20% clip through the next decade, and a stock looks really cheap, really, really cheap on that estimate, but I think those estimates are just too conservative.

RS: Got it. And what would you say in terms of people getting in now? Anything that you would caution in terms of timing of entry?

JL: So, of course, when it just IPOs, it’s very clear just the way it’s trading, it’s trading in line with a lot of other meme stocks, even if I view it to be of higher quality. Investors buying now or even later just have to be mindful that volatility will be higher here.

And I definitely would say, of course, one should never really be investing just solely on memes, but always be mindful of your own analysis of the fundamental analysis. I definitely would mainly be buying here if one shared the view of mind that the platform is heavily under-monetized.

RS: And you mentioned earlier about Meta. Do you want to talk about that comparison?

JL: Yeah. So, just for those, just make sure we’re on the same page. Reddit is another one of the social media platforms. The unique thing about Reddit is one, it’s like a forum structure, but with the same threads that one is very familiar with. When you reply on something, it’s going to create a lot of threads on like an Instagram or Twitter, but the main difference with Reddit and other platforms is this idea of self-moderation and karma.

Okay, so I view Reddit as being like an anonymous Instagram. Most users, they’re not, they’re going to try to have this level of anonymity. And then they have these communities called subreddits where there’s a moderator, which is another user of Reddit. And so, you got these communities self-moderating themselves and they’re trading content.

It makes it very similar to that Facebook Instagram model. There’s a big distinction between Meta Platforms and Alphabet (GOOG) (GOOGL) in that Alphabet’s YouTube, they have to pay quite a bit of content creator costs. So, their gross margins tend to be lower at Alphabet.

Whereas Facebook has benefited from just higher, structurally higher levels of profitability. And Reddit benefits from that similar dynamic. But where Reddit differs from Instagram is this idea of karma. Basically, you could upvote certain votes and then as a Reddit user, you get a running tally of all of your upvotes ever. So, someone with a million karma, a million upvotes, is just someone who has posted a lot with very, very good – a lot of their posts are well received by the community.

So, just in a nutshell, that’s what Reddit is. It’s important to note the fact that Reddit is more text-based than Instagram, and it’s like an indexed version of your hobbies. Instagram, Twitter, Snapchat, they’re all quite similar in that they’re catering to your hobbies, but the main difference with them and Reddit is that Reddit has this idea of communities, this idea of subreddits, and it can get very specific. There might be a subreddit on cats or a subreddit specifically on miniature poodles or a subreddit for people living in the San Francisco Bay area, like I do.

So, because there’s this very, very close organization, it makes Reddit different from, again, different from Instagram, Facebook, Twitter. And this is important because, I mean, investors might have forgotten, but Instagram, Snapchat are facing TikTok threats, threats from TikTok (BDNCE).

And as today we’re recording on Wednesday, April 24th, yes, President Biden just signed the “TikTok Ban Bill”, but I think it’s pretty clear that that’s not really a TikTok ban, first of all, right? TikTok will be able to – ByteDance will be able to divest their interests. I don’t really see a scenario where this bill succeeds and ByteDance just exits America or United States more likely if it really comes down to it, they will have to sell it.

TikTok still operates here. So that threat of TikTok is still going to be present for Facebook, Instagram, Snapchat, but I don’t view TikTok as being a direct competitor to Reddit. And this distinction is important because it will drive, I believe it will drive a higher re-rating of the stock, as investors appreciate that this business is just more insulated than the other social media platforms.

RS: So where do you think it fits in terms of looking at the tech picture? Or, sorry, let me ask this because I think it might paint the picture more clearly.

What markers would you need to see along the way for Reddit, or investors would need to see along the way to remain bullish with Reddit? In other words, what kind of growth should they be looking for? What type of profitability, or when, should that profitability arrive? Things like that.

JL: Yes. So, I’ve been covering these names, Meta Platforms, Snapchat, Pinterest, and even Twitter before it was acquired by Elon Musk. I’ve been covering them for many years. I realize Wall Street tends to really focus on revenues and profits as it should, but it should not be ignoring what you’re hinting at here, some of the more relevance, the relevance factor here.

So, for example, Pinterest has become a Wall Street darling, even though I would think people who don’t invest probably would be very confused why Pinterest stock would do so well, just because it tends to be far less relevant than a Facebook or Instagram.

And you can measure, the way I’d rather measure relevance is based on user growth. Something like Pinterest has definitely seen far slower user growth than I know TikTok is private, you got TikTok, Instagram, Facebook, or even Snapchat.

So, the way I’m using, viewing Reddit is definitely we want to see user growth continuing to remain healthy. And then we want to see Reddit continuing to make progress on increasing the average revenue per user.

RS: So, those are the main things that you’re looking at?

JL: Yes, just because that way you get a balanced view of the relevance. Are they able to improve their network? Because a lot of the moats, the barriers to entry here is not the technology necessarily. Even a Facebook or Instagram is not necessarily, just creating a network is not necessarily that difficult. Of course, nowadays, Facebook, Instagram have a very – artificial intelligence is backing their feed, but just the network itself, the platform itself is just a simple website.

It’s really the network. It’s really having that many people use your platform every day is the hard part. So, if Reddit can show that this network is alive, thriving, growing, then that will indicate that the long-term growth thesis is still intact.

RS: And in terms of Meta and comparing it to Reddit, that doesn’t take away from any bullishness that you have towards Meta, which you were on last time talking about, that’s why I asked?

JL: Yeah, so Meta was one of my top picks, especially coming out of the 2022 tech stock crash, largely because of valuation. It was similar to the current view, except of course, Meta is just much more profitable than now. I would say my bullishness on Meta has declined, but mainly just due to valuation.

The company is still firing on all cylinders. It’s very incredible to see how the company, in-spite of the ever-growing TikTok threats, has been able to still drive strong top-line growth, in large part due to their just innovation, just flat out being able to use artificial intelligence to boost their content feed, right?

I think they had a statistics where just several years ago, basically everything you see in your feed on Instagram or Facebook was from someone you followed, but nowadays, it’s like 75% of the content is not what you follow. So, somehow Facebook, Instagram, they’re able to guess what your interests are going to be.

They were able to innovate out of their issues. And that’s just incredible, but just after this big run up, the valuation, it’s still quite attractive, but I’m not viewing it with anywhere near the same conviction as I am with Reddit.

RS: Got it. Anything to say about upcoming earnings for Reddit?

JL: Yeah. So, Reddit is reporting earnings in two weeks. I believe this is May 7th on Tuesday after the close. I think, just based on what I’ve seen from Meta, Meta will report today after close.

What I’m seeing from the online advertising plays over the last couple of quarters has been that the macro picture is offering tailwinds right now because these companies had – saw growth really slowed down about a year ago, just due to higher interest rates, post-pandemic compression and so forth, but now they’re benefiting from the fact that those tough numbers are becoming easier comparables. That’s just how it works.

So, that’s making it very easy to generate very strong growth rates. And so, the funny thing with Reddit is that investors, they might be forgetting that this is still a very immature company, it’s still a very small company. Again, this company generated just over $800 million of revenue last year, whereas Meta generated $134 billion. So, that’s less than 1% of what Meta was – generated last year.

So that smaller size could mean that Reddit should grow faster in theory over the long term, but it also means that it will experience more volatility. For example, just during the pandemic, Reddit saw revenue growth of 80%. That’s what it disclosed in its S1 filing. So, some incredible, incredible growth rate, but then, once the post-pandemic hit, once interest rates rose, it saw revenue growth slow down all the way to 15% at some point.

And that’s not necessarily indicative of like, Oh, the growth disappears, it indicates just this is a smaller platform, advertisers have less experience with it, they’re going to pull back faster from this platform for now, whereas with something more established, like Instagram, Facebook, they just, they’re a little more resilient, just because they’re more mature.

So, I expect over this coming quarter, over the next coming quarter for Reddit to post strong acceleration in growth rates, especially from their online advertising, but I am also looking to see exactly how their data licensing deal with Alphabet shows in the financials. It’s reported to be $16 million of revenue annually over the next four years. So, if they just reported that as revenue, that would in itself already offer about 7% to 8% growth just from data licensing alone.

RS: What do you think about having Sam Altman on as a major shareholder? Are you a fan of that, or do you think it matters for investors?

JL: It’s quite interesting. I mean, yeah, let’s talk about investors. First, talk about Sam Altman. So, with Sam Altman, the CEO of OpenAI, or considered the modern-day Steve Jobs, right? It’s very interesting. You could read his comments on Reddit. I think he’s quoted as saying, he viewed it as being just a silly place to have fun, but now it’s becoming quite serious.

He incidentally, he invested in Reddit very early on, made a lot of money, but he also invested in Reddit around 2021 at much higher prices. The stock prices there were, I believe, were around like 40 – he has invested at $47, also $63 per share. So, he has purchased into Reddit at higher prices, but the significance of Sam Altman is definitely going to be just the fact that Reddit has already inked, I just mentioned that $16 million per year data licensing deal to train Alphabet’s, their large language models.

It seems just because Sam Altman’s, specifically his fund, owns around almost 8% to 10% of Reddit stock. It seems almost inevitable that OpenAI should at some point sign a similar deal with Reddit. But even looking beyond Sam Altman, it’s very interesting to analyze the IPO.

I think a lot of listeners are probably familiar with that unusual feature of the Reddit IPO in that Reddit allowed certain Reddit power users, basically Reddit users with a lot of karma, to buy in at that $35 per share IPO price. And then these users, if they bought in, they wouldn’t be subject to the IPO lockup. That was a very unusual, just a way for the company to encourage its user base to invest in the stock.

I’m not sure how many of those users held on, but what I don’t see talked a lot about in the IPO was the fact that the private equity, a lot of the private equity, the major private equity-backers in Reddit did not sell stock in the IPO. This is very curious, especially considering you got some names again, like Sam Altman owning 9% of the company.

Advance magazine publishers was the big majority owner. They owned 34%, roughly 34% of the stock in Reddit. They did not sell a single share in the IPO. It got $0.10 owning 10%. So, a lot of these private equities owning a large portion of Reddit and this allocation is probably worth a lot of their owned value. Very significant capital. They didn’t sell anything in the IPO.

It’s very interesting to note that a lot of that could just be some belief from the insiders that $35 per-share price is not really indicative of the share value. I view it more – the CEO and CTO, Steve Huffman and Jennifer Wong, they probably just money, that that’s probably the main use of the IPO.

RS: Do you think it was a good time to IPO?

JL: Yes, absolutely. I think, of course, Reddit is going to have to earn my anticipated re-rating. They probably would not have been able to get that re-rating multiple right out of the gate, which makes sense for them to choose such a low IPO price, but coming public now definitely makes a lot of sense, especially, as I mentioned earlier, they’re going to be benefiting from easier comparables on the online advertising growth front, right?

So, it’s going to, their results are going to look quite good, especially in the near term picture.

RS: In terms of what they have in development and in terms of what you can suss out that they might have down the horizon, something that Joe Albano of Tech Cache was talking about the cannibalization that’s happening in the tech sector.

Do you foresee, based on what you see currently, do you foresee cannibalization from Reddit of other companies or do you see Reddit benefiting from a certain cannibalization that’s happening in the tech space?

JL: Yes, so I think just one separate basis, besides online advertising that Reddit benefits from is just, it’s aggregating forums, right? Whereas typically in the past, you would have forums, different specific websites for different specific interests, right? You would have to go to your biker forum or in my case, I like baseball card forums. For Reddit, everything is just there, right? It’s sort of like Amazon (AMZN) consolidating e-commerce and so forth.

Reddit is consolidating forums. So, in that respect, they’re cannibalizing forums, but as far as what are they doing nowadays, especially with regard to Generative AI, of course, it’s hard to know exactly all their top secret stuff, but they have discussed using Generative AI to increase their ability to have like instant translations because one issue facing – that has historically faced Reddit has been their inability to grow internationally, as well as in America because a lot of their posts tend to be English-based.

So, just because, like for example, let’s say I have an interest in baseball, of course, for me, in America, it’s very easy, you just go to the Reddit community, and you enjoy it, and you just read and contribute, but if you are like, you also a baseball fan, and you don’t speak English, maybe you live in Mexico or maybe you live in China or Taiwan, you may not feel so welcome in that baseball community, even though you do like baseball, but maybe you don’t understand everything that’s written, and you don’t know how to contribute.

The Generative AI potentially could help reduce that language barrier. I am hopeful that Generative AI could help Reddit solve this issue of international growth and offer another lever to accelerate growth.

RS: And what are your thoughts in terms of anybody shorting the company right now?

JL: Oh, I’m sure a lot of people are going to short the company, especially just given the fact, it’s not yet profitable. It’s quite curious that even after the last two years, we have seen tech stocks crashed, but then these companies, they responded to the crash and the higher interest rate environment by somehow dramatically boosting their profitability in spite of slower top line growth.

It’s incredible, but you’re still going to have investors who are in denial of this, the long-term profitability potential of the tech stock, they’re going to short it. I think, I mean, in my view, Reddit stock, it doesn’t have to do anything special to justify the current stock price, but I know a lot of investors will disagree just given that it’s still not yet profitable on a GAAP basis.

RS: What else should investors keep in mind or is there something that we’ve left out of the discussion about Reddit?

JL: I think it’s quite interesting that it’s very, it’s actually very close to generating profitability. I see a lot of notes about Reddit being unprofitable. They’re like, oh, it’s been in business for 20 years. So, why isn’t it profitable yet? But if you look at the last 4 quarters or 5 quarters of fundamental results, we could see that they, just like all the other tech companies, they started to show a lot of cost discipline. And this is evidenced by the fact that R&D expenses grew by less than 5% over the last 5 quarters, as well as sales and marketing did not grow at all.

You got this company that moving forward looks poised to start delivering operating leverage just because operating expenses, if they commit to the same plan that they have done over the last 4 quarters, you might get in a situation where operating expenses is growing at like 5% a year, while revenue is growing at 20%, 30%.

Just one-year of that should bring it to GAAP profitability. So, there’s a lot of headlines saying, oh, they lost $80 million or was it $90 million in GAAP net income in 2023, but that is missing the point that this company is actually very, very close to generating GAAP profitability.

RS: Any other metrics that you would point to investors to be keen to look at? I mean, I know you’ve mentioned a bunch. Any, anything else?

JL: Yeah. I guess we could discuss that under monetization and the valuation. So, the company’s average revenue per user for its United States users was just $5.50 in the last quarter. And that’s, that’s tiny.

Just for reference, Meta Platforms had $68 ARPU, Snapchat was at $9 and Pinterest was just over $8. So, to me, it doesn’t quite make sense for Reddit to be generating lower United States ARPU than Snapchat or Pinterest by almost like half. And it makes very little sense for it to be more than 10x lower than a Meta Platforms.

So this to me just indicates you’ve got this platform that should have comparable engagement, as these companies have been public for quite a long time. Reddit has competing engagement. It also is resonating at a better level with the younger generations than like a Facebook.

So, I see ARPU growth accelerating meaningfully, but of course, we need management to figure some of that out in terms of learning maybe, trying to learn from Meta how to monetize that user base.

RS: Speaking about competition, it reminded me of something that we were talking about last time you were on the show, which is just briefly, I mean, we don’t have to get deeply into it, but just curious how you see the development in terms of Apple (AAPL) developing its search with Google. Just curious where your thoughts are there?

JL: I think that based on the fact that Apple had recently announced that they’re going to be using Alphabet’s LLMs in their smartphones that are – at least they were really aggressively looking into this partnership. I think that in the near term, it seems very unlikely for Apple to unveil their search offering, especially when it’s revealed that Google’s paying Apple just that much money.

It doesn’t seem at the current moment, just given how much Alphabet is paying Apple, it doesn’t seem economically, it doesn’t just make sense for Apple to release their own search offering yet. Because they basically are making money from search when they’re getting paid from Alphabet.

I think for now, the real threat to Alphabet is definitely going to come from OpenAI and even maybe Bing, just because Alphabet seems to be lagging in the Generative AI versus ChatGPT and Bing.

RS: And anything to say, a big earnings week this week in terms of tech stocks reporting? You mentioned that Meta is reporting today. Anything to say in terms of broadly speaking tech sector for investors to be aware of?

JL: So, I think the market is definitely being a bit shaky in the last couple of weeks, especially given that investors are getting to realize that we may not get so many interest rate cuts this year or any this year, given that inflation is proving more resilient than the Federal Reserve has anticipated, but I think with large cap tech reporting this week, I expect strong results all around.

Just again, they’re going to be benefiting from easier comparables and these tech companies, they are still reaping the benefits from Generative AI and just in the other words, just executing very strongly. I am, of course, I know Reddit is not reporting this week. They report in two weeks.

I will be looking at results from Meta Platforms, Alphabet, Snapchat to see, to just confirm that online advertising growth is continuing to recover and accelerate.

And just coming back to Reddit, it would be interesting because if Reddit could start to show, continuing to show 25%, 30% revenue growth, then the current valuation just may not make so much sense. Just for reference, we have Meta Platforms trading at just around 8x forward sales. Microsoft (MSFT) is trading at 13x forward sales.

But here we have Reddit trading at 8x sales, but 6.5x sales net of cash. They have just over $1.5 billion of cash on their balance sheet after accounting for $500 million raised in IPO. And I don’t view this valuation discrepancy as being justifiable just because Reddit, it should be generating far superior top line growth rates than Meta Platforms.

I don’t even view Meta Platforms as being a great comparable piece because I think Meta Platforms should see top line growth decelerate to a 10% range starting as early as next year. And it shouldn’t accelerate from there. It’s just too large of a company. The valuation still could work out even with that slower growth rate, but Reddit is going to be offering more like 20%, 25%, 30% growth for a long time. So, it makes Meta a silly comparable.

And just to see where other software names are trading at, right, you get a CrowdStrike (CRWD) that’s also growing at like that 25%, 30% range that’s trading at 20x sales. Cloudflare (NET) very similar, also trading at 23x sales. So, I see this Reddit, and of course, those names are richly valued, but the idea is these names, they’re not really typically associated with “meme stocks.” They’re just viewed as richly valued tech stocks, right?

So, of course, if Reddit could get a richly valued tech stock valuation, it ends up at 18x, 20x sales, which could make sense given that it could sustain 20%, 25%, 30% top line growth for a very long time, you’re already looking at a stock price – at 20x sales you’re already looking at a stock price in the 100s.

Then we factor in the fact that over the next 5 months, the IPO lockup remains in play, right? So, you’re still only going to have about 30 million shares floating, which is about 15% of shares outstanding. So, we’re getting to buy Reddit at this very, in my opinion, cheap valuation, but there’s this potential that it reaches this meme rally.

Obviously, we should never buy a stock solely on the potential for it to have like a meme rally, but in this case, it seems like a very low-risk way to invest with meme optionality.

RS: Good stuff, Julian. I appreciate it very much. Anybody looking to get more educated on Reddit or other companies that Julian covers, you can check out Julian Lin on Seeking Alpha. He also has the investing group, Best of Breed Growth Stocks, where he covers more stocks, more in-depth. Appreciate your time as always Julian and appreciate the insight.

JL: Thanks for having me, Rena.

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