Robinhood: Rise Of The Retail Investor
Seeking Alpha Analyst Since 2020
Summary
- Explosive growth due to the pandemic.
- Major consolidation in the space leading to a highly turbulent climate- What matters more: Total number of accounts or account sizes?
- Category creator with fascinating narrative and new innovations.
- Expected to go public in 2021.
Business Overview
Robinhood’s platform offers commission-free trading in stocks, ETFs, options, and cryptocurrencies, as well as margins, enabling users to invest in the stock market right from their phone or computer. Robinhood has made investing frictionless, cheap, and accessible. Robinhood has three primary revenue streams: Premium subscriptions, Securities Lending, and Payment for Order Flow.
Current Metrics
- Total Users: 13 M
- Valuation: $11.71 B
- Average Account Size: $1,000-$2,000
- Total AUM: $20 B
- Total Money Raised To Date: $2.18 B
Source: Business of Apps
Strengths
Growth: Users & Trading Volume
The pandemic has acted as a huge catalyst for Robinhood. In terms of users, Robinhood now has 13 M accounts in comparison to the 10 M in 2019 and 6 M in 2018. This has led to a massive increase in transaction volume that the platform has had to handle. The primary accelerator has been work from home and unemployment. Robinhood’s narrative of democratizing Wall Street really resonated with individuals sitting at home.
This acceleration can be seen even in overall trading volumes in the first couple of quarters of 2020. This huge growth spurt helped Robinhood increased its valuation by over $4 B in the last 18 months.
Category Creator
Robinhood has completely disrupted the brokerage market by being the first company to target the youth. Baiju and Vladimir recognized this largely untapped market and built a seamless product around it. Their narrative around increasing accessibility, creating ease of use, and democratizing investing has resulted in Robinhood giving massive competition to existing players like E-Trade, Charles Schwab, and many others.
New Offerings
Going off its initial success, Robinhood has been wildly successful in adding additional functionalities for its current customers. For a fintech company in the brokerage space, this means adding more financial instruments like ETFs, Bonds, Cryptocurrencies, and margin buying. (Eg-Users can trade 7 different cryptocurrencies on the app now).
Risks
Consolidation
The stock brokerage business is highly competitive with multiple large players. But the last 2 years have shown a dramatic decline in overall margins as most services have become commission-free and the industry has seen massive consolidation.
Recent deals:
Charles Schwab acquisition of rival broker TD Ameritrade in a $26 billion deal.
Morgan Stanley acquiring E-Trade in a $13 billion, all-stock deal: This acquisition is aimed to help Morgan Stanley diversify its overall revenue stream by going deeper into its advisory business. E-Trade’s clients will help Morgan Stanely serve smaller retail clients at scale and hence increase overall stability in these turbulent times.
This is particularly fascinating as Charles Schwab, Morgan Stanley, and other players have very different strategic objectives behind the consolidation. This creates a complex landscape for a company like Robinhood to operate in.
In conclusion, I believe that this is market will have two/three winners and Robinhood could easily dominate the emerging investor segment considering the sticky product, strong user growth, and high levels of innovation.
Technical Glitches
Robinhood has benefitted from the pandemic but its recent technical glitches signal that the company was not completely ready for such transaction volume. In early 2020, Robinhood faced three outages in the same week(Anywhere between 15 minutes to even a day). This was a massive disappointment for regular traders as they faced massive losses by not being able to execute their trades.
Controversial revenue streams
Revenue streams:
Premium subscriptions: Provides basic features like- Research reports from Morningstar, Level 2 quotes, Increase your instant deposit limit, Extended hours trading (pre-market and after hours), $1,000 of additional margin.
Securities Lending: Let’s its traders use margins in order to trade
Payment for Order Flow: Sells the order flow to bigger operators like Citadel, Point72, and others.
Robinhood has definitely democratized investing but this quote from a Forbes article perfectly encapsulates the other side of the story: “In fact, an analysis reveals that the more risk Robinhood’s customers take in their hyperactive trading accounts, the more the Silicon Valley startup profits from the whales it sells their orders to. And while Robinhood’s successful recruitment of inexperienced young traders may have inadvertently minted a few new millionaires riding the debt-fueled bull market, it is also deluding an entire generation into believing that trading options successfully is as easy as leveling up on a video game.”
It seems like Robinhood has sold the story of helping the average investor but its business model does the exact opposite: sells the little guy to rich market operators with very sharp elbows. This has also landed Robinhood in some regulatory trouble around not being able to fulfill the promise of best execution of the trades while selling the order flow. This has not caused huge troubles till now but can be fairly controversial as the company grows further.
Revenue Diversification
Robinhood earns a majority of its revenue from PFOF which again consolidated in a couple of customers. As shown in the graph Citadel, Susquehanna and Wolverine account for more than 35% of overall revenue. I believe that Robinhood must try to capitalize on its huge user base to diversify its overall revenue profile through premium subscription and securities lending. I believe that this could be achieved if Robinhood starts spending more resources on overall customer education and service. This would kill two birds with one stone as it would decrease regulatory burdens and increase user’s engagement with other paid features hence provide increased stability.
Valuation
The company has raised three rounds in the last 18 months and is burning through cash like water. Overall growth is definitely strong but the valuation jump from $7.6 B to $11.7 in less than 18 months seems like a huge markup with no significant changes in revenue or margins(Considering that its biggest clients are hedge funds). Robinhood is expected to go public in November of 2021. As I mentioned in the DoorDash article, these high valuations root from four key assumptions:
Oversimplification of profitability with scale
Greater fool theory
Deployment issues
Winner takes all
I believe that the stock will do well considering the overall familiarity of investors with the company but the company still has to figure out a long-term strategy to create shareholder wealth.
Analyst's Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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