There will be no velvet rope at Robinhood Markets’ big debut on Thursday. The company is offering up to a third of its shares in its first public offering to the average Joes who use its app, rather than the Wall Street suits that usually get first prize. The wisdom of that crowd may confirm the $35 billion valuation the company predicted in a prospectus. But not his numbers.
Make no mistake, Robinhood is a truly transformational company. Founders Vlad Tenev and Baiju Bhatt took a simple premise – zero commissions – and turned the brokerage business on its head. Its success forced the other major brokers to eliminate commissions and opened the door for millions of new investors who had never traded before. The company estimates that nearly half of all new brokerage accounts in the US were opened with Robinhood between 2016 and 2021. That’s even more impressive given that 2020 was a record year for new accounts in the US, and 2021 will be even better.
Robinhood is on track to generate enough revenue this year to theoretically justify a $35 billion valuation. It reported revenue of $522 million in the first quarter, and the company estimated it brought in between $546 million and $574 million in the second quarter.
Thomas Mason, an analyst at S&P Global Market Intelligence, notes that when TD Ameritrade was a fast-growing broker in 1999, it was trading at more than 26 times its total net income. That would value Robinhood, with $1.35 billion in total net income for the four quarters ended March 31, at $35 billion.
Robinhood’s problem, however, is the quality and sustainability of its earnings. At least three-quarters of that comes from routing trades from clients to trading firms that execute the trades and take advantage of the spread between the bid and ask, a practice called order flow payment. During trading frenzies, the payment for the order flow rises. But when the trade collapses, so does the payment for the order flow. That is one of the reasons why most other brokers rely on other income streams for the majority of their income. Payment for order flow is also in the crosshairs of regulators, with Securities and Exchange Commission chairman Gary Gensler raising concerns about it in recent weeks.
|Funded Accounts||22.5 million|
|Gain||$546 million to $574 million|
|Net income||– $487 million to – $537 million|
|Assets in custody||$102 billion|
Note: The numbers in the application are tentative and subject to change.
Robinhood also relies heavily on cryptocurrency trading, another area that is now under close scrutiny by the SEC. Trading in Dogecoin, the joke cryptocurrency favored by Elon Musk, accounted for about 6% of the company’s revenue in the first quarter.
Thomas Peterffy, the president of Interactive Brokers, which focuses on more experienced traders, is impressed with Robinhood and his ability to introduce new people to the market. “I’m kind of talking about my own book because we get five to 10 customers from Robinhood every day,” he says. But he wouldn’t invest in the IPO. “I like understanding the profitability of a company,” he said. “But there’s no easy way to project Robinhood’s profits into the future, or even understand it’s going backwards.”
Robinhood could switch to other business models – the goal is to branch out into loans and payments. But the company’s forays into new territories have not gone well so far. In fact, they sometimes flopped in spectacular ways. In 2018, it had to withdraw its plan to offer checking and savings accounts after being sued for misleading marketing and a lack of insurance, and later backtracked on plans to offer trading in the UK and obtain a bank charter. Barron’s has followed Robinhood’s twists and turns, including a cover story last August.
The company says in its prospectus that its customers “already trust us with their hard-earned cash and assets,” so they’ll likely trust it to take care of their other needs while increasing their wealth. The company hasn’t revealed how much of that hard-earned money the typical customer has deposited into her account, but the Financial Industry Regulatory Authority said in an enforcement letter that the average Robinhood customer had $240 in her account as of February.
Many investors seem to view Robinhood as their “play money account,” said Hugh Tallents, senior partner at management consultancy CG42, which surveyed more than 1,000 account holders at various brokerages about their habits this year. To justify the valuation, “customers will have to change their financial behavior to integrate much of their financial lives with a company that has long been mired in scandal. I don’t think that’s likely,” says Tallents.
Nearly every financial technology company is now focused on cross-selling customers across multiple services.
(SOFI) and more all want a bigger slice of your financial life. And some can make a better first impression. SoFi is known for refinancing student loans, for example.
Going from a student loan to a mortgage is “a bit of a layup,” Tallents says. “It’s much harder to imagine a world where people take a pretty simple tool, which is Robinhood by design, and put a lot of their debt-based products or their savings accounts and integrate those things together.”
Write to Avi Salzman at firstname.lastname@example.org