Robinhood is going public after having raised some $2.1 billion on NASDAQ at a $32 billion valuation. So we thought maybe we could look at the company and see what’s happening under the “HOOD.”
The Story
Robinhood was built around a zero-commission model. That is to say, you could buy and sell stocks without paying a commission to the broker. And while it was a stark departure from the traditional broking model — where one had to pay sizeable sums in fee, it wasn’t exactly what set them apart. In fact, in the early days, a lot of millennials flocked to Robinhood because it was fun to trade on Robinhood. The design was intuitive, The confetti animation added to the excitement, and buying and selling stocks was as easy as ordering something off of Amazon.
Add to it the fact that you had to pay no commissions, Robinhood was the go-to place for first-time investors.
But you could now turn around and ask — “If Robinhood passed up on commissions, how did it make money?”
Well, as they say, if you’re not paying for something, you’re probably the product. Except in the case of Finshots. At Finshots, we have a different plan, but more on that sometime next month. Anyway, since they weren’t making money off of commissions, they had to figure out something else. And that something else happened to be ‘payment for order flow.’
It’s sort of like this — Every time you want to buy or sell a stock, Robinhood forwards this information to a market maker in exchange for a small fee. These people pay Robinhood for your “details” because they can make money off of it while matching orders. For instance, the market maker may purchase 10 shares of Apple for $100 each from somebody else and then offer to sell them to you at $100.05. And if you think this price is acceptable, your order goes through. It’s an oversimplified explanation but hopefully, you get the point. Robinhood makes money off of your orders. And while advocates of this model argue that this is a win-win for everyone involved, the practice has drawn criticism from people who believe the arrangement is inherently flawed.
After all, there is a clear conflict of interest here. Robinhood in this case is incentivized to route your trades to matchmakers who pay them the most. Not necessarily to those who offer you the best price or the fastest execution. So even though you don’t pay a commission, there is a hidden cost here. In fact, it probably explains why ‘payment for order flow’ is banned in India. However, regulators in the US don’t seem to be too intent on changing this aspect, and for now, Robinhood has a clear monetization plan.
In the first three months of 2020, Robinhood made revenues of $420 million (far greater than the $96 million they made during the same time last year). And while losses ballooned to $1.4 billion during the period, not a lot of people think this would have a huge impact on the IPO.
Why?
Because Robinhood is playing a rather dangerous game.
During a typical IPO, investment banks embark on a “roadshow” where they pitch the likes of Robinhood to big investors and showcase the promise these stocks hold. In the end, these big investors — think banks, pension funds, and hedge funds end up buying a sizeable chunk of the company as the IPO unfolds. And truth be told, it kind of works alright because institutional investors of this kind don’t dump their holding overnight. They stick around for a while and this gives a semblance of stability as the stock begins trading on Wall Street. But regular investors like you and me — We often don’t care much about long-term prospects. If we like a stock we will push it to stratospheric levels. If we don’t, we will hammer it. We are not to be messed with. However, Robinhood has decided to shun this age-old wisdom and reserve as much as 35% of the 55 million shares up for listing, to the scores of retail investors that have made the app a roaring success. They are perhaps convinced retail investors will see Robinhood for what it could become and not necessarily for what it is.
So yeah, Robinhood’s fate now rests in the hands of thousands of retail investors who’ve already subscribed to the IPO. And as the stock finally begins changing hands, we will perhaps better understand what the future may hold for the popular internet company.
Until then..