Reddit: Growth depends on the big brother's mood? High valuation is the "sword over the head"

After the market closed on February 12 Eastern Time, "$ Reddit.US" released its Q4 2024 performance. Overall, the speed of advertising monetization exceeded expectations, and the pace of operational efficiency improvement was impressive, with guidance also remaining strong. However, due to the core metric—user numbers in the United States missing expectations, Reddit's performance plummeted over 10% after the announcement.

Although during the post-earnings conference call, management explained that the sluggish growth in U.S. user numbers was due to adjustments in Google's search algorithm in Q4, Reddit has now adapted to the new algorithm and mitigated the impact. However, under high valuations, this uncertainty, which relies on external factors, has led the market to begin questioning the previously consistent optimism.

Specifically:

1. U.S. DAU "pauses" growth: In Q4, DAU user growth was 4.5 million, falling short of the market expectation of 6.6 million, which was the main reason for the poor performance feedback. The growth of users in the U.S. region lagged significantly, with a sequential loss of 200,000, while international user growth remained relatively stable, netting an increase of 4.7 million, which was slightly higher than expected.

Despite being an old community established over 20 years ago, user growth is the key driving force behind Reddit's revival. When discussing user growth, one cannot ignore the significant benefits brought to Reddit by Google's (intentionally or unintentionally) search algorithm adjustments (which lowered the weight of machine-generated content websites and increased the visibility of content produced by real users).

With the initiative in the hands of others, the situation is inherently less secure. However, based on the cooperative relationship between Google and Reddit, Dolphin Research believes that despite fluctuations in Google's search algorithm, the overall impact on Reddit should be more beneficial than detrimental.

Last year, Google made four major updates to its search algorithm in March, August, November, and December. The main tone of the algorithm updates remained unchanged, still focused on providing users with more authentic and useful content. The updates in November and December were relatively frequent, mainly targeting spam websites, third-party sites, and reducing non-original content.

Although the adjustment direction does not specifically target Reddit, the frequent updates over two consecutive months may have impacted some of Reddit's content, leading to a sequential decline in U.S. DAU users in Q3. However, as Reddit made synchronous adjustments internally, the impact on search rankings would also diminish; for example, management mentioned that since January of this year, traffic growth has been recovering.

Additionally, management further explained that the impact on short-term non-logged-in U.S. users was more significant. Dolphin Research believes that this implies Reddit may have been unable to adapt quickly enough to the adjustments in search rankings, resulting in a temporary slowdown in U.S. user growth However, at the same time, the unexpected growth of international user DAU, in addition to the rapid increase in machine translation capabilities brought by AI, which accelerates Reddit's international penetration, also indicates that the slowdown in user growth in the U.S. in the fourth quarter may be related to the growth ceiling of users in the U.S. itself. Currently, the DAU of U.S. users is 48 million. Due to the lack of connections between users and the incomplete realization of traffic mobilization, the traffic of online non-social attribute platforms will naturally be affected by some loss during the shopping holiday period in the fourth quarter.

2. Accelerated Advertising Monetization: User traffic performance is poor, but it has not hindered Reddit's pace of commercialization. Driven by the shopping season in the fourth quarter, Reddit achieved advertising revenue of $395 million, continuing to accelerate year-on-year growth, outperforming market expectations. As a result, the advertising value created per user has accelerated growth of nearly 15% year-on-year.

Reddit's advertising has not been affected by users, and Dolphin Research believes this is mainly due to the low base in the early stages of commercialization. Currently, the increased demand from advertisers mainly focuses on the conversion value of Reddit's basic traffic from "0 to 1." In the fourth quarter, Reddit tested the advertising function in the comment section, with the ad display volume in the comment section accounting for 3% of the overall display volume for the season. Management stated that this year they will continue to expand the precise recommendation of ads in the comment section, planning to raise the ad display volume to a mid-to-high single-digit percentage level in the short term.

In addition, based on the fact that Reddit is still in the early stages of building its foundation, Dolphin Research believes there is still room for AI to enhance ad conversion. On one hand, it can directly improve the precision of ad displays, such as search ads, recommendation page ads, and comment section ads, thereby improving ad conversion efficiency. On the other hand, AI can enhance the personalized recommendation of high-quality content, aiming to increase effective ad conversion from the perspective of improving user duration and stickiness.

3. Profitability Significantly Exceeds Expectations: In the fourth quarter, Reddit's operational efficiency was impressive, with adjusted EBITDA profit margin reaching 36%, a significant increase of 9 percentage points quarter-on-quarter, exceeding market expectations. The acceleration of commercialization led to a 2.5 percentage point optimization in gross margin, while the remaining 6.5 percentage points came from controlling the growth of expenses excluding stock-based compensation (SBC).

4. Overview of Key Financial Indicators

Dolphin Research's Viewpoint

Regarding the major issue that triggered the post-earnings plunge—"poor user growth in the U.S. region," if the dissatisfaction was solely due to user growth issues, then when management revealed during the conference call that the impact of Google's search algorithm has been eliminated and user growth has resumed, market sentiment should have quickly rebounded. However, the actual situation is that the potential rebound momentum has been suppressed.

Dolphin Research believes that the impact of Google's algorithm adjustment on traffic is not a completely unexpected risk. Rather, it is a potential risk that management has repeatedly mentioned in previous communications following the prospectus and the release of the last three financial reports Reddit is a rare user growth platform on social media in the past five years, leading to overly consistent bullish market expectations. Reddit's valuation has suddenly reached $40 billion (exceeding the optimistic valuation of $35 billion mentioned in Dolphin Research's previous in-depth article, which can be seen as a bubble warning line), corresponding to EV/Adj. EBITDA valuations of 80x/52x for 2025/2026, far higher than its social media peers. Even considering Reddit's potential high growth, the EV/Adj. EBITDA/Growth also shows some premium compared to its peers.

Therefore, considering Reddit management's statements on algorithm impacts, the operational efficiency potential demonstrated in Q4, and the current favorable factors for Reddit in the "early monetization + AI assistance" phase, Dolphin Research does not have too many concerns about Reddit's fundamentals in the short to medium term. This user growth will not fundamentally change the growth expectations for Reddit. However, from a funding expectation perspective, this miss has indeed brought some emotional divergence that needs to be digested in the short term. Under high valuation pressure, it has also given some funds a reason to choose to take profits immediately rather than endure short-term volatility. Therefore, on the surface, it is a user growth bug, but essentially it is still the fault of high valuation. Conversely, if the valuation adjustment is in place, it will also attract new funds to bet positively.

The following are the details

1. U.S. DAU "pauses" growth

In Q4, DAU user growth was 4.5 million, falling short of the market expectation of 6.6 million, which is the main reason for the poor performance feedback. The user growth in the U.S. region lagged significantly, with a sequential loss of 200,000, while international user growth remained relatively stable, with a net increase of 4.7 million, slightly higher than expected.

The stagnation of growth in the U.S. is mainly related to adjustments in Google's search algorithm, which has a greater impact on the activity of non-logged-in users. Currently, the company has mitigated the impact through internal optimization, and traffic has resumed growth. In addition to algorithm adjustments, there may also be seasonal impacts in Q4 due to increased offline gatherings during the holiday season, with more online shopping behavior rather than browsing knowledge and interest communities. However, regardless of the reasons, this is not a trend that the market is willing to see at present. Although management has mentioned that the impact has diminished, it undoubtedly brings some short-term divergence to market expectations.

As of Q4, Reddit's global DAU is 102 million, with 48 million in the United States and 54 million internationally. Driven by AI and translation technology, Reddit's ceiling in the international market is still quite high.

In terms of user stickiness, among the total DAU, logged-in users (which we consider to be relatively high-stickiness loyal users) account for 45.3%, temporarily halting the downward trend. Meanwhile, the DAU/WAU metric also rebounded in Q4. Of course, the fluctuations in the calculated values may also be affected by the changes in Google search algorithms impacting unlogged users in the U.S., and whether actual user stickiness can be maintained or see a rebound still needs further observation.

II. Acceleration of Advertising Commercialization

User traffic performance is poor, but it has not hindered Reddit's pace of commercialization. In Q4, driven by the shopping season (with a significant increase in shopping-related ad impressions), Reddit achieved advertising revenue of $395 million, continuing to accelerate year-on-year growth and exceeding market expectations. As a result, the calculated advertising value created per user has accelerated growth of nearly 15% year-on-year.

Reddit's advertising has not been affected by user growth, and Dolphin Research believes this is mainly due to the low base in the early stages of commercialization. Currently, the increased demand from advertisers mainly focuses on the conversion value of Reddit's platform's basic traffic from "0 to 1." In Q4, Reddit tested the comment section advertising feature, with comment section ad impressions accounting for only 3% of the overall impressions for the season. Management stated that this year they will continue to expand the precise recommendation of comment section ads, planning to raise the ad impression percentage to a mid-to-high single-digit level in the short term 3. Data Authorization Customer Acquisition is Slow

Although in previous in-depth research, Dolphin Research has consistently downplayed the investment logic of the data authorization business, it achieved revenue of $33.2 million in the fourth quarter, which is flat compared to the third quarter. This also means that Reddit's customer base has basically not changed, still primarily consisting of Google and OpenAI.

However, management mentioned in the conference call that Reddit established a partnership with the Intercontinental Exchange (an online futures trading platform) in the fourth quarter, but the order scale may not be large, and the signing of authorization has just begun, so its contribution to performance has not yet been reflected.

Nevertheless, Dolphin Research still believes that due to insufficient scaling potential, the data authorization business should not be factored into the valuation for now.

4. Profitability Significantly Exceeds Expectations

Reddit's operational efficiency was impressive in the fourth quarter, with an adjusted EBITDA margin reaching 36%, a significant increase of 9 percentage points quarter-over-quarter, exceeding market expectations. The acceleration of commercialization led to a 2.5 percentage point improvement in gross margin, while the remaining 6.5 percentage points came from controlling the growth of expenses excluding stock-based compensation (SBC).

However, the "high" SBC expenses, due to the fact that it has been less than a year since the IPO and the market capitalization has continuously risen since then, have not yet seen significant optimization (still accounting for 22.7% of total revenue). Nevertheless, SBC expenses do not affect cash flow, and Reddit's free cash flow reached a new high in the fourth quarter, exceeding $89 million, accounting for 21% of revenue.