Here's a Light Risk, Heavy Reward Trade for Reddit Amid Rally
On Tuesday evening, social media and creator content platform provider Reddit (RDDT) released the firm's third quarter financial results. To say that these results were merely "impressive" would be an understatement. For the three-month period ended September 30, Reddit posted a GAAP EPS of $0.16, crushing a consensus view that had been expecting a loss.
The firm also posted quarterly revenue generation of $348.351 million. Not only did that number also beat Wall Street, but on top of that, it was good enough for year-over-year growth of 67.9%. The firm reported that Daily Active Uniques (DAUq) increased 47% year over year to 97.2 million. Ad revenue increased 56% to $315.1 million, while "other" revenue increased several times over to $33.2 million. U.S.-driven revenue increased 70% to $288 million, as internationally-driven revenue increased 57% to $60.4 million.
Operations
As revenue grew 67.9% to $348.351 million, the cost of that revenue increased 31.2% to $34.633 million. That left a gross profit of $313.718 million on a gross margin of 90.1%. That was up 73.2% from a gross profit of $181.113 million on a gross margin of 87.3%. Total costs plus operating expenses came to $341.497 million (+50.4%), leaving an operating income/loss of $6.854 million (up from an operating income/loss of $-19.585 million).
After accounting for interest, taxes and other (non-operating) income/losses, net income printed at $29.853 milion (up from $-7.383 million). This works out to a GAAP earnings print of $0.16 per fully diluted share, up from the year-ago comparison of $-0.13.
Fundamentals
For the period reported, Reddit generated operating cash flow of $71.622 million. Out of that came capex spending of $1.353 million, leaving free cash flow of $70.269 million, which was up from $-11.639 million for the same period one year ago. Reddit does not return capital to shareholders.
Turning to the balance sheet, Reddit ended the quarter with a cash position of $1.745 billion including marketable securities. This puts current assets at $2.061 billion. Current liabilities add up to $172.3 million. This puts the firm's current ratio at a jaw-dropping 11.96. For those unaware, that's really, really strong. Total assets amount to $2.172 billion, including just $70.1 million in goodwill and other intangible assets. Total liabilities less equity comes to $194.1 million. There is absolutely no debt of any duration on this balance sheet. You will, in your travels, rarely find such a pristine looking balance sheet. It's a pleasure to analyze.
Guidance
For the current quarter, the firm projects revenue generation of $385 million to $400 million, which is well above the $358 million or so that Wall Street was looking for. The firm also projects an adjusted EBITDA in between $110 million and $125 million.
Wall Street
Since these earnings were released last night, I have found ten highly-rated (four-plus stars at TipRanks) sell-side analysts that have opined on RDDT. After allowing for changes, across the ten there are five "buy" or buy-equivalent ratings, four "hold" or hold-equivalent ratings and one outright "sell" rating. One of the "holds" did not set a target price, so we are working with nine of those.
The average target price across the remaining nine analysts is $106.56 with a high of $120 three times (Ronald Josey of Citigroup, Alan Gould of Loop Capital and John Colantuoni of Jefferies) and a low of $70 (Brian Nowak of Morgan Stanley). Once omitting one of those $120s and that $70, we are left with an average target price of $109.86 across the other seven.
Because you were going to ask, the average "buy" target is $118.80, while the average "hold/sell" target is $91.25.
My Thoughts
What's there to say? The quarter was excellent. The guidance is strong. Cash flows are better than healthy. The balance sheet is beyond outstanding. Should we own the shares? We should have already owned the shares. (Don't feel so bad. I'm not long either.) RDDT is up almost 40% on Wednesday morning, trading with a $114 handle. Safe to say, that I am not going to be buying any shares today.
The valuation will likely be nuts by the time this rally cools. Another thing... more than 10% of the float was held in short positions, so a lot of this price discovery overshoot the morning after, is those panicked souls having their faces ripped off by their risk managers.
Readers will see Wednesday morning's breakout from a Raff regression model that has left a large gap to fill in its wake. RDT needs to trade at $83 to fill that gap. Not likely any time soon. That said, I have my doubts that these levels will hold for very long. Relative strength now stands at 88, and the daily MACD looks like a hockey stick on its side.
RDDT is probably a good stock to invest in, but a bad stock to trade in from the long side for now. I have already told you that I don't like to short stocks where more than 8% of the float is already held in short positions. What to do?
A trader with a bearish interest in RDDT at these prices could purchase November 22 $110 puts for about $2.05 and sell (write) a like number of November 22 $90 puts for about $0.75. That's a debit of $1.30, which is the risk in attempting to make back up to $20 for a max profit of $18.70 per paired contract. This is called a "bear put spread" for the folks who are new to options and this trader would be getting long that spread. Light on the risk. Potentially heavy on the reward.
At the time of publication, Guilfoyle had no positions in any securities mentioned.