Reddit's Strong Earnings Masked by Stalled U.S. User Growth

Reddit's second quarter looked like the kind of earnings report that makes investors cheer. Revenue climbed 61 percent year over year to $805 million. Net income nearly tripled, reaching $253 million. The company guided for continued strength in the third quarter. And then the stock fell 21 percent anyway, closing Friday around $141.

The culprit was a single line item that most investors probably glanced over: U.S. daily active users. The number ticked down to 53.2 million in the second quarter from 53.5 million in the first. It was small. It was the first sequential decline in five quarters of reporting. But it was enough to unwind the entire celebration.

The reason is geography and money. Reddit generates 79 percent of its revenue from the United States, where it has 53.2 million daily users. Those American users are worth $11.85 each in quarterly revenue—more than five times what the company earns from international users at $2.26 apiece. An American user is simply a different animal to Reddit's advertising business. And for the first time, that American user base stopped growing.

The quarter's strength came from everywhere else. Global daily active users rose 18 percent year over year to 130.3 million. Weekly uniques crossed half a billion for the first time. Advertising revenue, the engine of the business, grew 64 percent to $762 million. Free cash flow more than doubled to $261 million. The company even spent $235 million buying back 1.5 million shares at an average price of $157.57—well above where the stock trades now.

But the composition of that growth reveals the vulnerability. U.S. revenue climbed 56 percent year over year, while international revenue surged 84 percent. The international audience expanded 28 percent. Yet that international growth, while impressive in percentage terms, still amounts to only $167 million of the company's $805 million total. The American market is where the money lives. And the American market just flatlined.

More troubling is how the U.S. growth that did occur happened. Average revenue per U.S. user jumped 51 percent year over year, while the actual U.S. audience grew just 6 percent. The company is charging advertisers more per user rather than expanding the user base itself. That works for a while. But if the audience stalls, the math becomes precarious. Price increases can only stretch so far before advertisers balk.

CEO Steve Huffman acknowledged the vulnerability in his shareholder letter. Search referrals were volatile during the quarter, he wrote, and the company's visibility into referral traffic remains low. Reddit depends on search engines to deliver a large share of its visitors—a dependence that shows in the user breakdown. Logged-out U.S. daily uniques, the casual visitors who typically arrive from search results, grew 10 percent year over year. But logged-in U.S. users, the committed core that signs in regularly, grew just 1 percent to 23.1 million. The company is trying to convert search traffic into habit-forming users, but that work sits outside its control.

At 33 times earnings after the drop, the stock looks cheap for a company growing revenue at 61 percent with a 31 percent net margin. If U.S. users resume growing next quarter, the sell-off will look like panic in hindsight. But the market is signaling it wants to see that rebound before believing the story again. One more sequential decline in American users would likely start to look like a trend rather than a wobble. For now, the business remains impressive. The question is whether the American audience—the one that actually pays—has stopped expanding or merely paused.