What you need to know before buying into Robinhood

TL;DR

• Robinhood’s exceptional ability to bring stock trading to retail investors has seen its user base grow to 18 million this year from just 4 million in 2019.
• US retail trading activity could be lifted by another meme stock trading frenzy. However, gradual return-to-work could act as a dampener to retail participation.
• There are also rising regulatory and competitive risks as Robinhood’s public profile has grown.
• Robinhood trades at a valuation premium to other brokers, and its share price could also be more volatile.

What happened?

If you have been investing in the stock market over the past 12 months, you would probably have heard of Robinhood. In a nutshell, it is the zero-cost stock and cryptocurrency trading app in the US which aims to democratise access to investing. Robinhood has made headlines due to the role it has played in the meme stock trading frenzy involving Gamestop (GME) earlier this year. It has also caused much debate about how gamification, popular in other social media platforms, should be used in investing.

Putting aside the headlines, we are here today to analyse the recent IPO of Robinhood, which has seen wild swing in its share price since its listing on 29 July. Robinhood has seen a surge in the the number of users, with the monthly active users (MAU) growing from just 4.3mn in 2019 to 11.7mn in 2020, as the pandemic related lockdowns led to a surge in retail trading. The number of users grew further to 17.7mn in 1Q21, driven by the dual boom in meme stock and cryptocurrency trading.

What does this mean?

Having looked at Robinhood’s regulatory filings and analysed the industry prospects, we believe these are the things you need to know before you invest into Robinhood!

• Proxy to retail trading. Robinhood generates the bulk of its revenue from retail trading transactions, particularly in stock options, equities and cryptocurrency. Interestingly, of its US$521mn of revenue in 1Q21, option trading brought in US$198mn of revenue, while cryptocurrency contributed another US$88mn. As Robinhood charges zero trading commission, its revenue comes through from payment for order flow (PFOF), where it receives a payment from a market maker for directing orders for execution of the trade. This would mean that its revenue prospects would depend heavily on the level of retail participation in the US equity market. Robinhood’s MAU has fallen from a peak of close to 20mn at the peak of the meme stock frenzy in January and February to below 18mn in March. Whether such numbers can be sustained depends on how much a return to work would dampen retail trading, and whether we will see more of the meme stock trading boom in future.

• Rising regulatory risk. Robinhood’s success has led to significant regulatory scrutiny, particularly since it is in the business of getting consumers to invest. Apart from some fines and questions asked about its PFOF model, regulators in some states such as Massachusetts are also seeking a revocation of Robinhood’s broker-dealer license after charging that it encourages inexperienced investors to place risky trades without limits. While such regulatory scrutiny is of a different scale from China’s clampdown on tech sector, they nevertheless present a risk to Robinhood’s ability to scale up.
• Competitors are not standing still. And yes, Robinhood would need to find new areas of growth as it cannot idly await the next meme stock or crypto trading boom, while its competitors are catching up. Fintech companies such as Webull and Public have raised significant capital to be able to acquire customers, while others such as Square’s Cash app are also launching new functions in investing.

What would Beansprout do?

• Robinhood trades at a premium to peers. Based on its current market cap of US$47bn, Robinhood would be trading at close to 50x its 2020 revenue of US$959mn. This would put it on par with Coinbase’s valuation, and significantly above other broker platforms such as Futu, eToro and Interactive Brokers. The market likely thinks this is justified given its strong user growth and profitability metrics. Using its 1Q21 revenue of US$2088mn, Robinhood would trade at close to 23x its annualised revenue run-rate, above all of its peers.
• Volatility should be expected. Interestingly, Robinhood had set aside 35% of its shares at its IPO for retail investors, although only about 20% of it was eventually allocated to retail investors due to low interest. The larger allocation to retail investors and lower allocation to institutional investors which have traditionally been longer term holders would mean that the share price of Robinhood could be more volatile. This might explain the wild swings in its share price, reaching US$85 at one point last week and representing a gain of more than 100% from its IPO price!

Based on share price as of 9th August 2021

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