Aggressive Waiters, and 3 Interesting Facts About the Reddit IPO
The waiter reached out his hand.
“I wanted to thank you for coming in tonight.”
Wow- this new restaurant is making a huge effort to serve people well.
And they needed to.
There are four other great restaurants within 200 yards of their front door. The competition will be fierce, and great service is a way to stand out.
I noticed little things.
A woman gets up to leave a table near me. The owner walks over, picks up her napkin, folds it carefully, and lays in next to her plate. Three different people- including the hostess- refilling water glasses.
Differentiating from the competition.
Reddit is in a similar position with their initial public offering of stock (IPO).
Investors are bombarded with investing data, and Reddit must make a strong case to convince people to buy the stock.
This article explains what Reddit does, and three important concepts related to the company’s IPO.
What Did Reddit Just Do
Reddit filed a prospectus with the Securities and Exchange Commission (SEC) to issues shares of common stock to the public for the first time, which defines an initial public offering. A prospectus provides a huge amount of disclosure to potential investors.
How Reddit makes money
According to CNBC, “Reddit said it had $804 million in annual sales for 2023, up 20% from the $666.7 million it brought in the previous year, according to the (SEC) filing. The social networking company’s core business is reliant on online advertising sales stemming from its website and mobile app.”
But they’re operating at a loss- not unusual for a tech startup, even after years of growth.
“It reported a net loss of $90.8 million for the year ended Dec. 31, 2023, compared with a net loss of $158.6 million the year prior.”
The good news- internet traffic
“Reddit is one of the most-visited websites in the U.S. Reddit has more than 100,000 communities, 73 million average daily active uniques, or DAUs, and 267 million average weekly active uniques, according to the filing.”
Reddit has a huge audience- it just needs to work on ways to drive more revenue and profits from that audience.
How will they use the money?
What will Reddit do with the sale proceeds from the stock sale?
“Reddit said it plans to use artificial intelligence to improve its ad business and that it expects to open new revenue channels by offering tools and incentives to drive continued creation, improvements, and commerce.”
Here are three concepts you’ll find in the Reddit’s IPO prospectus that are useful to know.
3 Interesting Points in the Reddit IPO Document
#1- What is convertible preferred stock?
Not all shares of stock are the same.
Reddit has over $1.8 billion dollars in convertible preferred stock on the balance sheet. I’ll separate the explanation into two parts: convertible and preferred.
The word “preferred” means “better”, and that’s true of preferred stock. Preferred stock is better than common stock for two reasons:
Dividends: If the company pays a dividend out of earnings, preferred shareholders receive their dividends before common shareholders. If there’s not enough money to pay the common stock dividend, only the preferred stock dividend is paid. Note: Reddit is not obligated to pay a dividend if it generates earnings- more on that later.
Claim on Assets: If the company liquidates, preferred shareholders have a claim on assets that’s ahead of common stockholders. Common shares are last in line to make a claim on assets.
Now practically speaking, when a company goes bankrupt, equity (stock) holders rarely get access to any assets (cash, fixed assets, etc.) when company assets are liquidated. Secured creditors, including bondholders, usually get any remaining assets.
OK, so what does convertible mean?
Convertible preferred shareholders have the right (at some point) to convert their preferred shares into common stock.
This impacts fully diluted earnings per share, which assumes that any security that can be converted into common stock is converted. Stock options, rights, and warrants can also be converted into common stock. More common shares outstanding means lower earnings per share- assuming the dollar amount of earnings stays the same.
I like to compare diluted earnings per share to putting a powder mix in a glass of water- the powder is diluted (spreads out in the water).
#2- Why not pay any dividends?
Here’s a statement in the Reddit prospectus:
“We have never declared or paid any cash dividends on shares of our capital stock. We currently intend to retain all available funds and any future earnings for use in the operation of our business and do not anticipate paying any dividends in the foreseeable future.”
This statement is not unusual. Many tech companies plow all earnings (once they’re profitable) into growing the business. That’s because shareholders expect to profit from share price increases- not from earning annual dividends.
Microsoft went public in 1986, but didn’t pay a dividend until 2003.
Seemed to work out for shareholders.
Here’s another way to look at it: New companies- particularly tech businesses- may struggle to make a profit for years. When they do, why not allow the company to keep the earnings for use in the business?
#3- Free cash flow: A critically important metric
Many CFOs believe that free cash flow is the best metric to assess business value.
Free cash flow is defined as “net cash provided by operating activities less purchases of property and equipment.”
If you manufacture furniture, for example, how much in cash inflows do you generate from making and selling furniture? That defines cash provided by operating activities.
Say it’s $3 million.
Now, subtract any property and equipment purchases, and you have free cash flow. Free cash flow is cash inflows from making and selling a product each month, less fixed asset purchases.
The total might be $2.5 million after fixed asset purchases. Picture free cash flow as cash you keep in your pocket after most costs are paid for.
Right now, Reddit’s free cash flow is negative, but once the business starts generating a profit, free cash flow is a great measure of business value.
Food for thought.