Can Reddit Shrink to Grow?

Team Rule Breakers

Shares of Reddit (NYSE:RDDT) were getting crushed in the pre-market Oct. 30, down over 21% as of this writing on Friday. That's an opportunity, Fools.

Before I get into why Reddit should interest you more, let's first discuss why institutions seem to want it less. It all comes down to growth.

Reddit is forecasting Q4 revenue will be up about 40% year-over-year, which is a marked slowdown from Q3's expectations-busting 53%. Adjusted EBITDA -- a key metric for the company -- is expected to be up about 51%, down from a 70% jump in the third quarter.

Forget for a moment that deceleration comes for every business. Algos still hate to see it. So do most investors.

Unfortunately, slowing growth is only part of what's causing Reddit's drawdown. Comments from co-founder and CEO Steve Huffman seem to have lit the match that's led to this morning's inferno.

"A key piece of work to retain new audiences is shifting Reddit to a logged-in-only experience. It's a big one for us, and it's a big one for me," Huffman wrote in the Q3 letter to shareholders.

Why the switch to logged-in only? Search traffic isn't helping Reddit as much as it used to. Pivoting to a more private experience forces Reddit to focus on the logged-in audience that drives 80% of the business. It's a risk, but there's logic to it.

Ask New York Times Co. (NYSE:NYT) whether it regrets going to a paywall-based business. Reddit demanding users log in is similar in that it may shrink the audience in the short term, but the long-term benefits of increased monetization could prove worth it.

Which brings us to why you may want to be interested. Even before Friday's action, Reddit was squarely on the way to generating $1 billion in annualized free cash flow. The shares trade for a 3.7% FCF yield, or about 27 times its real cash flow, as of this writing.

That might feel like a modest premium ... if Reddit hadn't spent the last three years more than doubling its cash from operations annually. There's a very real chance Reddit is going to keep growing cash flow at greater than 27% annually. Perhaps materially so. I sense a potential mispricing here.

Reddit's getting downvoted today. So be it. This stock story is far from over.

Tim Beyers has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Reddit and The New York Times Co. The Motley Fool has a disclosure policy.