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Coverage | Newsletter | Intel | Events
Coverage | Newsletter | Intel
July 1, 2021
The S-1 is packed with juicy tidbits. Here are a few things we learned reading the prospectus:
Robinhood released its long-awaited S-1 filing, required for an initial public offering, on Thursday, July 1. The filing came one day after Robinhood settled with FINRA, the brokerage industry's self-regulatory body, paying a record $70 million fine. The S-1 dropped months after Robinhood revealed it had confidentially submitted documentation to the SEC, with Bloomberg reporting that regulatory concerns had held up the filing.
On July 19, the company said it expects sell shares at $38 to $42 each, which translates to an expected valuation of up to $35 billion, according to an amended filing. Robinhood also disclosed that it expects revenue for its September quarter to decline sequentially due to "decreased levels of trading activity" compared to the previous quarter, particularly in cryptocurrencies.
The S-1 is packed with juicy tidbits. Here are a few things we learned reading the prospectus:
- Robinhood's famous referral program that promises users "up to $500 in free stocks''? It turns out around 98% of customers receive a reward in the much-less-enticing $2.50 to $10 range.
- The U.S. Attorney's Office for the Northern District of California executed a search warrant on Robinhood CEO Vlad Tenev's cell phone in connection to an investigation.
- Robinhood wants to sell traders its own IPO shares. The company said that it expects to reserve 20% to 35% of its Class A common stock for sale to Robinhood customers through the IPO Access feature announced in May 2021.
- What do Robinhood employees call each other? Robinhoodies.
By the numbers
- Revenue, 2020: $959 million (up 245% from 2019)
- Net income, 2020: $7 million (versus $107 million loss in 2019)
- Funded accounts as of March 31: 18 million
- Assets under custody as of March 31: $80.9 billion
- Employees as of March 31: 2,100
What Robinhood does
Robinhood blazed the trail for a new generation of self-directed stock investing, differentiating itself from the '90s wave of online brokerages like E-Trade with an easy-to-use mobile app and no commissions. Founded in 2013 by Stanford students Vlad Tenev and Baiju Bhatt, the trading app made it easy for anyone to buy and sell equities.
The company's success was based on two key innovations, said Silicon Valley investor Robert Siegel, a management lecturer at the Stanford Graduate School of Business. It developed a mobile app that made stock trading simple and seamless. And it launched at a time when social media had emerged as a powerful platform that could move markets.
"They had the right product in the right place at the right time," Siegel told Protocol.
The company upended the business of stock investing when it made the bold decision of eliminating trading fees and commissions.
The company makes money through the fees paid by Wall Street market makers to Robinhood for executing customer trades. That system, called payment for order flow, has become controversial for several reasons. It means the company makes more money the more customers make trades, which could conflict with their best financial interests. And payment for order flow, which several countries have banned, doesn't always deliver the best price, contrary to claims made by defenders of the practice, according to a noted expert on trade execution.
Robinhood took a lot of heat during the GameStop trading frenzy earlier this year, which highlighted fears that the company had turned stock trading into a dangerous game, especially for young and inexperienced investors. The S-1 shows that Robinhood was able to thrive despite the backlash: Monthly active users peaked at just above 20 million in February 2021, which was nearly four times as many as the same period in 2020.
Robinhood has also been expanding areas, including options and gold investing, digital banking and cryptocurrency trading.
Robinhood clearly was on a roll in 2020.
- The company's revenue more than tripled to $958.8 million last year, up sharply from $277.5 million in 2019. That momentum propelled Robinhood to swing to a profit in 2020 when it recorded a net income of $7.4 million, compared to net loss of $106.6 million in 2019.
- Robinhood saw strong growth in the first quarter of this year, as its revenue quadrupled to $522 million, up from $127.6 million in the year-ago period. But the company recorded a loss of $1.4 billion, compared to a $52.6 million in the same quarter last year. Robinhood saw operating expenses more than double in the quarter to $463.8 million from $180 million in the year-ago quarter.
- With the explosion of interest in crypto, crypto has been a big area of growth for Robinhood. Cryptocurrencies represented 20.8% of Robinhood's total transaction revenue as of March 31, not far behind equities at 31.7%. (Crypto was just 4.4% of transaction revenue in the year-ago period.) Options made up 47.1%.
- Meanwhile, crypto was 14.3% of Robinhood's assets under custody as of March 31, 2021, up from 2.5% in the year-ago period.
What could go wrong?
To succeed in the long run, Robinhood will need to address significant risks relating to public perception, competition, regulation and (because, why not?) dogecoin.
These risk factors are often interrelated, as evidenced by the GameStop debacle: What started as a public perception issue soon became an opportunity for competitors, before ultimately transforming into a regulatory threat.
While Robinhood weathered the first iteration of the meme-stocks storm, the company still hasn't addressed larger questions surrounding its role in "protecting" users and monetizing trade data. These unaddressed questions have created a liabilities around Robinhood's public perception:
- NYU Professor Scott Galloway, Sen. Elizabeth Warren and a number of prominent media outlets have noted that Robinhood gamifies investing to entice more frequent trading. Critics portray this as a predatory practice, since Robinhood stands to gain from increased trading volume, while the traders themselves aren't always informed about associated risks.
- In June 2020, Alexander Kearns, a 20-year-old student at the University of Nebraska, committed suicide. Kearns reportedly misread his Robinhood account balance, leading him to believe he owed $730,000 due to an options trade. In a suicide note, Kearns asked: "How was a 20-year-old with no income able to get assigned almost a million dollars worth of leverage?" This incident generated significant media attention that drew scrutiny towards Robinhood.
- In its S-1, Robinhood references the continued risk of "negative media coverage regarding our products and services and the risk of our customers' misuse or misunderstanding of our products and services."
- Robinhood's revenue from market makers that pay the broker for order flow is highly concentrated. Citadel Securities made up 34% of Robinhood's revenue as of December 31, 2020, while Susquehanna International Group made up 18% and Wolverine Holdings made up 10%. Collectively, market makers made up 75% of Robinhood's revenue as of December 31, up from 62% in the year-ago period.
- On the other side of the issue, the likes of Barstool Sports founder Dave Portnoy, Mark Cuban and prominent r/WallStreetBets members have criticized Robinhood for blocking users from trading, a move the company said it was forced to do by clearing partners. This group tends to argue that Robinhood acted in the interest of institutional investors by limiting trades for stocks in which hedge funds had highly-leveraged short positions. Some critics point to Robinhood's mixed messaging on why it stopped trading as evidence that the company acted in bad faith; others argue that Robinhood betrayed its stated mission to "democratize finance for all" by placing the interests of institutional investors over traders when it mattered most.
- Robinhood also addresses this public perception issue in the S-1: "Any unanticipated system disruptions, outages, technical or security-related incidents or other performance problems relating to our platform, such as the March 2020 Outages and the April-May 2021 Outages, are likely to receive extensive media attention." The company also adds that "any negative experiences our customers have in connection with their use of our products and services, including as a result of any such performance problems, could diminish customer confidence in us and our products and services."
Robinhood pioneered the free consumer trading app market, but it now faces steep competition.
- Moving from one trading service to another can be a tedious and lengthy process (waiting for all the mandatory fund settlement delays). But the nominal costs associated with switching brokers are low, if they exist at all.
- Robinhood had a first-mover advantage, but there are now dozens of new competitors looking for a piece of the market. The company writes: "We operate in highly competitive markets, and many of our competitors have greater resources than we do and may have products and services that may be more appealing than ours to our current or potential customers."
- With the field of competitors growing, there's a risk that Robinhood loses market share since it is a more general trading service. Competitors can tailor their product to a niche audience to attract customers away from Robinhood: For instance, Coinbase might have more appeal to investors solely interested in crypto trading, while Tradier Brokerage might appeal to active investors looking for more customization.
Given the public controversy surrounding its business model, Robinhood is subject to regulatory risk.
- Robinhood cited a concern that analysts have highlighted: its heavy dependence on revenue from payment for order flow. Such payments have been heavily criticized by regulators and lawmakers, especially in the wake of the GameStop trading frenzy. Robinhood disclosed that 75% of its total revenue in 2020 came from market-maker payments and other "transaction rebates." That number jumped to 81% in the first quarter of 2021.
- Robinhood said any major change in payment for order flow due to regulation "could have an outsize impact" on its operations and results. The company even noted a key criticism of payment for order flow, saying that if that belief becomes more widespread, Robinhood could lose business to competitors. One of its main rivals, Public, dropped payment for order flow in favor of tips in the wake of the GameStop controversy.
- The new SEC chairman, Gary Gensler, is not exactly a fan of payment for order flow. And Robinhood acknowledged in its filing that there is "no guarantee" that the SEC or other agencies would not put out new rules that "could substantially limit or ban" the practice.
And we would be remiss if we didn't at least mention the most absurd S-1 disclosure of the year: over-reliance on dogecoin.
- "If demand for transactions in dogecoin declines and is not replaced by new demand for other cryptocurrencies available for trading on our platform, our business, financial condition and results of operations could be adversely affected," Robinhood writes in the S-1.
- While it's tempting to not take anything dogecoin-related seriously, in this case Robinhood discloses details that suggest it is a very real risk. The company said that 34% of their entire cryptocurrency transaction-based revenue for the three months ended March 21, 2021 came from dogecoin. And during that period, 17% of total revenue came from cryptocurrency transactions. That's a lot of pressure to put on the shoulders of one shiba inu.
Who gets rich?
- The investors who hold more than 5% of Robinhood stock are venture capital firms DST Global, Index Ventures, New Enterprise Associates and Ribbit Capital.
- Besides its co-founders, Vlad Tenev and Baiju Bhatt, NEA managing general partner Scott Sandell and Index partner Jan Hammer sit on Robinhood's board. The company only recently expanded its board to include independent directors.
- Tenev, Bhatt and Chief Financial Officer Jason Warnick all had the same salary in 2020; $400,015. That's an unusually rich cash compensation package for a venture-backed company, where founders and top executives normally rely more on stock. (Tenev, Bhatt and Warnick have lots of shares, too.)
Another thing for investors to consider is the company's share-class structure.
- Robinhood has a three-class share structure for its stock. Its Class A stock will have one vote per share, its Class B stock will have 10 votes per share and its Class C stock will not have any votes.
- The founders of many startups that are growing quickly have demanded multiple-class share structures, which allow them to keep control of their companies even when they own less than 50% of a company's stock. Companies from Facebook to DiDi have implemented the structure. Some founders say it insulates them from short-term Wall Street interests, while others say dual class stocks underperform the stock market and limit investor input and control of a company.
What people are saying
- "The more their users trade, the more money Robinhood makes. And Robinhood users make a lot of trades — 9 times more trades than E-Trade users, 40 times more than Schwab users (88 times more options trades) relative to account size — a rate that makes no sense for the young, non-wealthy, and inexperienced traders flocking to the platform. But it makes great sense for Robinhood, which makes more money selling those orders than it could educating people re the wisdom of low-cost index funds, and occasional buy-and-hold company stocks." —NYU Professor Scott Galloway in his No Mercy / No Malice newsletter.
- "If and when IPO money comes, Robinhood will be on its way to becoming a finance version of Facebook: a free platform that keeps a sea of customers engaged with a hyper-stimulating user experience, while making money selling intelligence about those customers' behaviors to expert wealth extractors on the other end. … Instead of stealing from the rich and giving to the poor, the American version takes in the young and sells them to computer-powered hedge funds; this Robin Hood is the house that always wins." —Matt Taibbi on the TK News Substack.
- "Robinhood won't clean up its act with slap-on-the-wrist settlements. Our regulators need to show some backbone to hold Robinhood accountable." —Sen. Elizabeth Warren on Twitter.
- "When you try to grow that quickly … it's unsurprising that there would be these kinds of speed bumps along the way." —EquityZen founder Phil Haslett to Yahoo Finance.
This story was updated on Thursday, July 1, with additional details from the prospectus.