Reddit Stock: OpenAI Deal Is Big (NYSE:RDDT) (2024)

Reddit Stock: OpenAI Deal Is Big (NYSE:RDDT) (1)

Investment Thesis

I believe Reddit (NYSE:RDDT) and OpenAI's collaboration is expected to enhance user experience across both platforms by integrating Reddit's massive human conversation repository with OpenAI's advanced AI capabilities through ChatGPT, and will offer real-time, structured, and unique content. This is necessary for OpenAI's AI models to better comprehend and showcase topical and relevant content from Reddit's discussions, and make the ChatGPT experience deeper and more contextually relevant interactions.

Last week, in response to this, Reddit's shares jumped by 15% to 17% after the two tech giants' announcement​​​​, which also secured investor confidence in the partnership to offer new revenue streams for Reddit through enhanced AI-powered features and advertising opportunities.

The partnership will allow opportunities for Reddit to take advantage of OpenAI's technology by launching new AI-powered features for their users and moderators​​. This will likely lead to better user engagement and foster a more connected internet experience, aligning with Reddit's goal to facilitate community and belonging online. It should also be noted that the partnership does not affect existing terms around Reddit's data usage but also makes use of commercial exploration of this data for their mutual benefit. This is consistent with Reddit's strategy to monetize their data assets similar to their previous licensing agreements, including a deal with Google​.

I believe that this is part of a wider trend within the news & content industry nationally, where media giants take advantage of generative AI through alliances with AI companies. Initially, many media companies, including The New York Times and others under Alden Global Capital, pursued legal action against AI entities like OpenAI for content scraping and copyright infringement. However, rather than fighting against the trend, many already opted for lucrative licensing deals after recognizing the potential to monetize their vast archives of proprietary content through AI applications. Indeed, there's a growing emphasis on structured, mutually beneficial agreements for ensuring that media companies can maintain their relevance and financial viability in the AI era.

For instance, OpenAI has expanded their partnerships across Europe with Axel Springer, a German media conglomerate owning brands like Politico and Business Insider, allows OpenAI to use Axel Springer's content to train their AI engine while adding attribution and links to the original sources. This deal is reportedly valued at over $10 million dollars annually.

OpenAI also closed deals with Le Monde, a leading French newspaper, and Prisa Media, a major Spanish publishing conglomerate. The AI company will use their content for AI training, while ensuring that summaries and attributions are provided to ChatGPT users. The Financial Times also partnered with OpenAI to index their content for AI training, and Dotdash Meredith, a media company owning several popular magazines and websites, has collaborated with OpenAI to enhance their AI-powered ad-targeting engine, D/Cipher.

Beyond OpenAI, Google has agreed to pay News Corp between $5 million and $6 million dollars per year for developing new AI-related content and products.

It's clear enough that a quantitative model for compensating media companies (similar to the music royalties system), reveals a new trend in AI content monetization where it recognizes the value of content where AI and content creation coexist and mutually benefit. Moreover, with the generative AI market's forecasted growth to over $1.3 trillion by the decade's end, it underlines the immense potential of these partnerships. Leading tech giants like Meta, Alphabet, and Amazon have already set precedents by heavily investing in AI, anticipating substantial long-term returns​​. Reddit's early adoption of this model puts it at an advantage within this market and can take advantage of their 267.5 million weekly active users (as of 4Q 2023) and ChatGPT's 100 million users. Because of these factors, I believe the stock is a strong buy. Content monetization is huge. I think this is just the beginning.

Background

Reddit culminated their journey to an IPO with an impressive market debut on the NYSE this year. After a tumultuous history that saw the platform evolve from a startup in 2005 to an internet phenomenon, the company is now a publicly traded company valued at over $10 billion​​​​.

Initially, it confidentially filed for an IPO in December 2021, but the offering was postponed due to a stock market downturn influenced by the Federal Reserve's quantitative tightening. It was not also spared from controversies during the "meme-stock" saga of 2021 with GameStop​​.

Despite this, Reddit's shares surged up to 60% on their first trading day, which was supported by strong investor confidence and the platform's massive user base.

Sam Altman, CEO of OpenAI, is one of Reddit's largest investors and has been key to the development of Reddit's IPO. Altman's stake in Reddit is worth approximately $615 million after the opening day of the trade. He owns 12.2 million shares of the stock, according to the company's IPO disclosures. Given Altman's track record with Y Combinator and his investments in numerous successful startups, his involvement, I believe, will be key to fast-tracking the advertising and data licensing for AI training, as shown by the company's recent $60 million deal with Google​​.

As it transitioned to a public entity, Reddit has aimed to balance growth with maintaining the highly engaged community that it is known for. The company's strategy is heavily focused on advertising, user transactions, and monetizing their data for AI training. This, I think, marks their shift towards more structured revenue models.

Despite this impressive debut, analysts believe that it still fails in comparison to the $1.2 trillion market value of Meta Platforms (META). But I believe there's a wave of change coming. Investors are observing how smaller social media platforms are competing with the advertising behemoths of Google and Meta, especially now that these companies are facing issues on their own, such as Meta's struggle with Apple's tracking restrictions impacting ad targeting and Google's reduced growth compared to the overall digital advertising market.

For smaller platforms like Reddit, the future looks promising, especially with their AI technologies from companies like OpenAI. They can offer content delivery and user engagement with prospects in advertising to challenge the traditional reliance on broad-scale data tracking and intrusive ad placements.

Moreover, as seen with the rise of TikTok and streaming services, there's a clear demand for diversified advertising options and formats that resonate with specific audience segments. Reddit's partnership with OpenAI signifies, in my opinion, a good opportunity for other companies to explore these new models and potentially disrupt the existing ad market by having an alternative approach to monetization that the duopoly of Google and Meta​​ have built on for years.

How This Changes The Business Model

Major tech companies such as Google (GOOGL) and Meta have long dominated the advertising market. Google and Meta together hold over 60% of the U.S. digital ad market. However, as I stated above, the broader digital advertising industry is already being fueled by innovations in AI.

This year, the ad market is anticipated to see accelerated growth, with projections pointing to an average growth rate of around 5.7%.

Google and Meta are focused on developing their proprietary AI models, which allows them to take advantage of their internal resources to support their AI-powered ad targeting without the need to license their data externally.

Reddit, on the other hand, represents a different approach since it has not invested in building their own large language models (LLMs) for AI. Instead, by licensing their data to OpenAI, the company can tap into the advanced capabilities of external AI technologies without the huge investment required to develop these models in-house. The company's approach allows it to leverage external AI advancements to potentially disrupt the traditional ad models, while Google and Meta can depend on their extensive user data and advanced AI to maintain and grow their market share.

I believe that this collaboration is multidimensional in its benefits and implications for Reddit. First, the partnership provides a financial incentive for Reddit. OpenAI needs data to train its models, particularly the advanced GPT-4o. This means that Reddit can monetize its nearly two decades worth of content. By converting its vast repository of user-generated content into a tangible asset, it can support its efforts at improving its revenue stream.

Second, the insights derived from OpenAI's use of this data can likewise benefit Reddit through insights into user behavior, preferences, and trends. Reddit can enhance their platform's user experience to make it more engaging for its community in the hopes of improved content discovery, more relevant community recommendations, and enhanced moderation capabilities.

Finally, Reddit's advertising model will be improved by AI thanks to OpenAI's advanced algorithms. The company can improve the targeting and effectiveness of their ads by better understanding user interests and behaviors through AI analysis. I expect more personalized and relevant ads to increase ad conversion rates in the coming months.

Valuation

Reddit has intangible assets totaling $29.9 million and goodwill of $26.3 million, summing up to $56.2 million. When this is set against Reddit's total assets of $2.02 billion, the intangibles constitute approximately 2.79% of their assets.

In contrast, a look at Meta's financials shows intangible assets and goodwill combining to $21.483 billion, which is about 9.64% of their total assets of $222.844 billion. Snap (SNAP) presents a higher ratio, with $1.81 billion in intangible assets, making up 25.38% of their total assets of $7.17 billion.

To determine the potential undervaluation of Reddit, we assume it should align more closely with Meta's structure, where intangibles are 9.64% of total assets. Applying this percentage to Reddit's total assets, the estimated fair value of their intangible assets would be 9.64% × $2.01billion = $194.33 million.

Using Reddit's forward price-to-book ratio of 4.62, the market cap upside from adjusting their intangibles to this benchmark is calculated as follows: multiplying the difference between the projected and current intangible asset values by this ratio gives 4.62 × (194.33 - 56.2) = 4.62 × 138.13 = $638.35 million. This would represent approx. 6.3% upside alone here. Keep in mind that other social media companies (like Meta and Snap) trade at forward Price to Book ratios of 6.53 and 11.45 respectively. I think this estimate for Reddit's upside is conservative. We are assuming no increase in forward Price/Book ratio.

With this, I believe the analysis suggests that Reddit's stock might be undervalued when considering the potential value of their intangible assets compared to an industry peer such as Meta. This indicates a substantial upside for investors. The intangible assets that Reddit has are likely even worth more (in the billions) given the future potential of monetizing their data for AI LLMs. For now, I want to be more conservative at $638.35 million.

Risks To Thesis

Reddit's IPO did not come easy. It stirred controversy among its communities, with many turning against the company because of monetizing content. The company has earned the ire of volunteer moderators and users who provide content but will not benefit from the monetization. This has led to protests and dissatisfaction since the IPO was announced, apart from their disagreement over changes to the API access. This is justifiable, in my opinion. Reddit's unique culture and user base are not easily compatible with traditional commercial strategies, as one report mentioned.

Despite a recent surge in revenue, Reddit has also struggled to achieve profitability, since they are highly platform reliant on user-generated content. But the company's IPO was different. Investors were initially enthusiastic but also wary of Reddit's long-term financial health. We'll have to wait how they can balance their aggressive monetization with maintaining the integrity and appeal of the platform.

And then there's the scrutiny to manage its content effectively, which has been a lingering issue since the platform's launch. I think it could lead to increased spending on content moderation and trust and safety measures to maintain an open, user-driven community, but my prediction is that it will continue its AI bots policing content instead of investing in human moderators.

However, I am confident that Reddit's partnership with OpenAI will revamp its data monetization capabilities. Since AI can analyze vast amounts of data to identify patterns and preferences, Reddit can personalize and hit the market with better ad placements through user behavior prediction, optimized ad targeting, and improved overall efficiency of ad campaigns that resonate well with specific demographics. I think it's a win-win all around.

Bottom Line

I believe that the partnership between Reddit and OpenAI will trigger a huge shift in how platforms and content companies approach the monetization of their assets. By integrating Reddit's extensive repository of human conversations with OpenAI's advanced AI capabilities, this will bring changes in user experiences and ad targeting.

The company's approach to using AI could also offer it a competitive opportunity, since Google and Meta have already developed proprietary AI models for ad targeting within their own ecosystems. Reddit's use of external AI technology is more cost-effective since it will not rely on building AI models in-house.

Their AI-powered processes also mean that Reddit can deliver personalized ads that resonate with specific audience segments, enhancing user engagement and ad conversion rates. In light of these factors, I maintain a strong buy stance on Reddit. The strategic use of AI, combined with the untapped potential of its user-generated content and evolving ad models, offers a favorable future for the company. For these reasons, I am a strong buy on Reddit.

Noah's Arc Capital Management

This account is managed by Noah's Arc Capital Management. Our goal is provide Wall Street level insights to main street investors. Our research focus is mainly on 20th century stocks (old economy) undergoing a 21st century transformation, but occasionally we'll write on companies that help transform 20th century firms as well. We look for innovations in a business model that will cause a stock to change dramatically. Associated with SA contributors Thomas Potter and Elijah Buell.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of META, GOOGL, SNAP either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Noah Cox (account author) is the managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

Reddit Stock: OpenAI Deal Is Big (NYSE:RDDT) (2024)
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