Happy Sunday and Happy 4th of July,
Wall St. folks have packed their cars for road trips, so the markets will be closed tomorrow and just two companies will go public next week.
Instead of analyzing the most promising upcoming IPOs in today’s issue, I’m gonna discuss perhaps the most controversial company in America. You guessed it, I’m talking about the investing app Robinhood ($HOOD) 🏹 that has filed for an IPO. Its filing has revealed some really interesting stuff about meme stocks, the company’s risks and its future potential, let’s see.
Finance for all!
Robinhood, the investing app that has become a household name, was launched back in 2015 and took the brokerage industry by storm. It introduced zero-commission trading at a time when legacy brokers like E*Trade or Scottrade charged $7 to $10 per trade. It also dropped the required account minimums of $500 to $5,000. In other words, it created the perfect investing app for the new generation of cash-strapped investors.
Less than a decade later, Robinhood has filed to go public at a valuation of $40 billion or more. The company has been so successful that as it says in the prospectus, close to 50% of all new retail funded accounts opened in the US from 2016 to 2021 were created on Robinhood.👀 Also, contrary to popular belief, Robinhood reveals that most customers are primarily buy-and-hold investors rather than traders.
Despite its huge success so far, Robinhood faces some really tough challenges.
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The biggest risks
Robinhood is not your typical high-growth startup. Its business model is highly controversial and after trading restrictions on meme stocks in January, many investors have lost faith. Its financials are also extremely volatile and unpredictable.
Here’s the biggest risks Robinhood faces:
- So many haters: Following the trading restrictions back in January, a lot of angry users 😡 took revenge with one-star reviews and countless lawsuits. More than 50 class-action lawsuits have been filed against the company regarding these trading restrictions, and there are other 6 pages of pending lawsuits in the filing. The company is also in a legal battle with Massachusetts alleging the company has broken three state securities laws. These are serious legal challenges for the company and regulators could take action against it.
- Controversial business model: Many of the class action lawsuits are filed by users who claim that Robinhood’s controversial “payment-for-order flow” model cheats them out of best execution on their trades (and it’s true). In 2020 Robinhood paid a $65 million penalty to the SEC because between 2015 and late 2018 it made misleading statements about its revenue source and didn’t give the best execution on orders. Payment-for-order flow is still Robinhood’s main revenue source, so it could attract scrutiny in the future if it repeats its past.
- Really volatile financials: Robinhood’s financials are extremely unpredictable and largely affected by trends such as meme trading and crypto trading. For example in 2020 the company reported a profit of $7.4 million — thanks to the surge in retail trading. But in the first quarter of 2021, it reported a huge loss of $1.4 billion due to extreme market conditions.
The company is also heavily dependent on Dogecoin 🐕🦺, which accounted for one-third of all crypto transactions in Q1. The company calls dogecoin one of its biggest risk factors in the prospectus. It’s true that if DOGE transactions slow or fall, crypto revenue will take a hit. Investors will definitely not love all this volatility in financials.
Robinhood faces great challenges but we can’t ignore some interesting positive things.
A growth monster
Despite its huge PR mistakes, Robinhood’s growth hasn’t been affected at all. In the first quarter of the year, accounts grew 151% to 18 million, and revenue surged 309% y/y to $522.2 million. While much of this growth was due to the crypto and meme craze, if you look at the chart above, you’ll see that the company doesn’t need extreme market conditions to grow fast; in Q1 2020, revenue jumped again, 131% y/y.🚀
Sure, growth will slow, but the momentum will continue as Robinhood has now become a household name. In the prospectus, it revealed that more than 80% of its users come from referrals or directly. This is a huge competitive advantage as the company doesn’t need to spend tons of money on customer acquisition, like smaller competitors that want to build brand awareness.
There’s no doubt that Robinhood will be a stock for aggressive investors. It won’t be a stock to buy for peace of mind. Even the company itself agrees on that, warning investors in its IPO filing that it could become a meme.😳
Yet for long-term investors who can stomach the huge expected volatility, Robinhood deserves a closer look.
The company hasn’t set its IPO price range yet, so we don’t know its expected valuation multiples. In the Sunday Newsletter before its debut, we’ll discuss all the latest details.
Have a great day,