Reddit review, take 2

Good morning. The S&P 500 hit an all-time high yesterday. More importantly, Trump's media and technology group rose another 14 percent, right after we wrote that it looked a bit overpriced. Unhedged's record as a contrarian indicator remains clean. We are off tomorrow for Easter. But you can still email us: robert.armstrong@ft.com and ethan.wu@ft.com.

Also, tickets are almost sold out for the FT Alphaville competition in New York in two weeks, where we will both be hosting a session. More information here.

Reddit is just another second-rate social media company

I said yesterday, roughly speaking, that trying to value internet platform companies like Reddit was a futile attempt to impose order on a chaotic and arbitrary world. My experience trying to extrapolate the future since the early days of Google and Facebook has taught me that trying to see the future of industries characterized by exponentially increasing returns at scale and winner-take-all dynamics is simply beyond the scope of financial analysis tools.

I can see now that I was being a bit dramatic. I realized this after speaking with Dan Salmon of New Street Research, who made the logical point to me that the Internet has changed a lot in 15 years. Nothing grows explosively anymore, and the land grabbing of the early days is over. In social media, in particular, a stable industrial ecosystem has developed that operates in fairly predictable ways. The main feature of the system is Meta's dominance of it: it was the first company to reach scale and master how to sell ads for user-generated content, so it shut down the market. Only TikTok is a serious competitor, and only in the short-video space. And the second-tier players — Twitter, Snap, Pinterest, Reddit — take the scraps.

To get a sense of Reddit's potential, I looked at the revenues of other social media companies, starting when each was roughly the size of Reddit now. Looking at it this way, you can see how Meta followed a very different path than other companies did:

However, taking Meta out of the picture, you can see how Snap, Pinterest, and Twitter have grown in very similar ways:

As with revenue, the number of active users has grown with those three companies growing steadily. As the companies matured, user growth stabilized in the low double digits (note that Twitter has some missing data and Pinterest reports monthly rather than daily active users, but the line slopes tell a clear story):

Another pattern across all businesses is that annual revenue per active user is never going higher. It seems to find a level and stabilize:

Given all this, it seems possible to make some reasonable assumptions about the trajectory of a company like Reddit, and derive a value estimate from that. Other companies have done what you are trying to do. Obviously, things could happen that might break Reddit out of the mold. A huge cache of user-generated text could become invaluable to AI companies for training their models; It is possible that further marketing will anger its core users and volunteer moderators, such that growth stops or declines. But the forecasting challenges facing investors in a social media group aren't much worse than those facing, say, a computer game company or a movie studio.

Salmon is the only analyst to publish his forecast. His model has Reddit having 131 million users and revenue of $2.3 billion in 2027, implying growth of 16 and 30 percent annually, respectively, over the next four years. This is in the range of what Snap and Pinterest did starting at a similar point in their development (Salmon holds Reddit in comment mode).

There is one area of ​​concern. I'm not sure if second-tier social media companies are profitable, even when their revenues soar into the billions. The profit measure I prefer to use for technology companies is what I call “true free cash flow,” which is operating cash flow minus capital expenditures and stock-based compensation (stock companies become a cash outlay when you become a successful growing technology company, because stock options vest and The company spends cash on stock buybacks to prevent shareholder dilution (this is happening to Uber now, for example). Maybe they'll figure it out, but so far, neither Twitter, Pinterest, or Snap have been able to generate real free cash flow on an ongoing basis. In other words, they are only profitable because they pay their employees in debt securities:

Salmon believes Reddit will generate $344 million in real free cash flow in 2027. I'm betting, without a lot of confidence, that it will be less than that.

Yen: It's all about the United States

The Bank of Japan has left negative interest rates behind, but the yen's weakness continues unabated. The yen touched its weakest point in 34 years on Wednesday, prompting Japanese officials to threaten to intervene in the exchange market and hold an emergency meeting.

Typically, big currency movements are followed by spreads – that is, the gap between nominal interest rates in two countries. Higher rates would attract capital and push the country's currency higher. But spreads haven't changed much in the past few months. The chart below shows the gap between two-year Japanese and US bond yields against the yen. The two tend to travel together, but the recent bout of yen weakness has coincided with interest rate differentials between the US and Japan moving mostly sideways. (Using 10-year bond yields instead of 2-year yields gives the same picture.)

Various explanations have been put forward. One common explanation is that traders expected the Bank of Japan to look more hawkish last week, so they were disappointed and started selling the yen. Jonas Goltermann of Capital Economics wrote last week:

We doubt it [the yen falling] It reflects market participants unwinding their short-term positions that had built up in anticipation of a more aggressive move from the Bank of Japan. However, press reports before the meeting (again) indicated the possibility of a tougher approach in the near future, causing the Japanese yen and Japanese government yields to rise in response, but policymakers issued another muted criticism.

The Bank of Japan's interpretation is not entirely different. As our colleagues Leo Lewis and Kana Inagaki reported yesterday:

Japanese financial officials privately told analysts they did not believe the yen's recent weakness was justified by the Bank of Japan's historic move, and said the declines represented speculative money testing the authorities' resolve.

This week, Masato Kanda, Japan's chief currency official, warned speculators against further attempts to sell the yen, and said “all options” were being considered by authorities.

You can find more outlandish views too, such as the idea that US trade policy is to blame.

We brought all of this up to Karl Schamotta, a currency strategist at Corpay, who had another explanation. He believes that the yen's movements largely reflect what is happening with the dollar. World-beating US growth, somewhat stubborn inflation, and central bankers' emphasis on patience mean that expectations of interest rate cuts have been tempered. The US two-year bond yield has risen by 37 basis points in the past two months, further talking about the possibility of the Fed not cutting this year. The result is that we are on the US-dominant side of the “dollar smile” – the pattern whereby the value of the dollar rises when US growth outpaces elsewhere.

One way to see this is that other currencies have weakened against the dollar in a similar way to the yen. The US dollar index has risen 3 percent this year. The recent weakness of the renminbi has been very similar to the weakness of the yen, and the weakness has also raised some speculation about official intervention. Shamuta says that the markets see that the strong American economy generates a strong dollar as a permanent feature, and are betting on that.

We find this convincing, and we would like to add that the size of the increase in interest rates approved by the Bank of Japan, which went from negative 0.1% to zero only, was more symbolic than substantive. This made it easy to overcome the strong momentum of the dollar. In this sense, saying that the yen is weak despite the interest rate hike by the Bank of Japan is not entirely true. Given the numerous restrictions imposed on its monetary policy, the Bank of Japan appears to have limited influence on the yen. It will have to do more to wrest control of its country's currency from the Federal Reserve. (Ethan Wu)

One good read

More about China's pivot to manufacturing.

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