Wall Street analyst cautious on Reddit following early rally ‘to the moon’

Shares of Reddit (RDDT) jumped again in Tuesday trading as they extended their run following the launch of options on the stock the day before. Of note, the social media platform’s stock ended Monday about 30% higher after having soared 48% on its first trading day on New York Stock Exchange late last week. Despite the enthusiasm, New Street initiated coverage of Reddit with a Neutral rating, as it expects volatility in the shares into the first earnings report, which it assumes will come in early May, and three days after when the lockup expires.

VOLATILITY AHEAD: New Street started coverage of Reddit with a Neutral rating and $54 price target after the stock closed at $59.80 on Monday, up 76% from its $34 IPO price. The firm expects volatility in the shares into the first earnings report, which it assumes will come in early May, and three days after when the lockup expires. New Street expects the near- and mid-term institutional narrative will be driven by an Open AI data licensing win, which it views as “baked into the stock,” as well as growth in users and the number of advertisers.

The emergence of data licensing revenue brings still more upside potential to Reddit, the firm argues. The challenge is sizing the opportunity, gauging progress, and gaining conviction in long-term viability, making this option value to many. Most investors expect Open AI, whose CEO Sam Altman owns 9% of Reddit, to be added soon, says New Street. Additionally, the firm expects double digit DAUq growth through 2027 supported by ML-driven retention improvement, and translation efforts. Near-term, DAUq growth peaks during Q2 2024 in its model, as the impact of moving from Google’s (GOOGL) AMP to Reddit’s proprietary mobile web browser platform begins to wane.

Reddit’s Top 10 advertisers represented 26% of revenue in 2023. New Street expects SMB penetration to improve diversification. Moreover, Retail — the largest category of online ad spending — is still just an “emerging” vertical for Reddit, the firm notes, and there is ample runway for growth from this dominant digital ad category.

FTC INQUIRY: The company said in an updated filing that, “(O)n March 14, 2024, we received a letter from the FTC advising us that the FTC’s staff is conducting a non-public inquiry focused on our sale, licensing, or sharing of user-generated content with third parties to train AI models. Given the novel nature of these technologies and commercial arrangements, we are not surprised that the FTC has expressed interest in this area. We do not believe that we have engaged in any unfair or deceptive trade practice. The letter indicated that the FTC staff was interested in meeting with us to learn more about our plans and that the FTC intended to request information and documents from us as its inquiry continues.”

New Street notes that Reddit voluntarily disclosed the “non-public inquiry,” and says it believes none of the company’s current deals are exclusive, and it should be expected to pursue many more of them, fostering greater competition among large language model trainers. With all that being said, an FTC inquiry could slow the pace of new deal signings and will certainly require attention and time dedicated to addressing the inquiry, the firm adds.

PRICE ACTION: In afternoon trading, shares of Reddit have gained over 15% to $68.80.